What Does Alibaba’s (BABA) IPO Mean for Yahoo (YHOO)?

by Ryan Fitzwater, Director of Research, The Oxford Club
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Last Friday, Chinese Internet and e-commerce giant Alibaba (NYSE: BABA) launched its initial public offering (IPO). This was big news across Wall Street. But it was also big news for Yahoo (Nasdaq: YHOO), which had an initial stake of 23% in Alibaba before shares went public.

During the IPO, Yahoo unloaded around 122 million shares of Alibaba. Today, it still owns about 15% of Alibaba’s outstanding shares. And yesterday, the company announced it had entered a one-year lock-up agreement, restricting the sale of its remaining shares.

But the IPO party is over, and now attention has turned back to Yahoo’s core business, which has struggled over the past decade.

Struggling Growth

The days are long gone when Yahoo was the go-to choice for Internet search. It has Google (Nasdaq: GOOG) to thank for that.

Since its fall from the top, Yahoo has done its best to either acquire companies or launch new products to grow its business. This year, Yahoo launched four digital magazines dealing with travel, movies, beauty and health. And it acquired social networking site Tumblr last year for $1.1 billion.

New products and acquisitions aside, Yahoo is still struggling to grow its core business in the digital advertising space. As you can see in the chart below, Yahoo is expected to grow its digital display advertising business only 2% this year. All of its competitors are expecting substantially larger growth.

AOL (NYSE: AOL) has been rumored to be a potential takeover target for Yahoo for a while now, and this year it is projected to grow at a rate eight times better than Yahoo. With a measly 2% projected growth rate, you can bet Yahoo is still eyeing up AOL.

More Rumors

Over the last few days, rumors have surfaced that Yahoo might now be the takeover target. And by whom? None other than Alibaba, the company it still has a large stake in.

Since Alibaba is flush with cash after its IPO, the rumor is that it could now turn around and buy out Yahoo.

And there has also been speculation that hedge funds have been driving down Yahoo’s share price to possibly capitalize on this situation. Since Alibaba’s IPO, shares are down 7.6% from a high of $43.19 a share on Friday. This is a common tactic by hedge funds. Drive down the price of a stock by unloading shares today, buy them at a more attractive price tomorrow and then profit from a potentially bigger jump in price later.

If Alibaba does indeed buy out Yahoo, hedge funds who picked up shares at today’s discounted price will be laughing all the way to the bank.

Both the hedge fund price manipulation and Alibaba takeover stories are still just speculation at this point. Don’t go rushing to pick up shares just yet.

Rumors aside, many analysts still think there isn’t much value in Yahoo’s core business, especially when you remove its stake in Alibaba and its partial ownership of Yahoo Japan from the equation. Others have noted that its standalone business is actually worth around $4 billion alone, meaning it could be undervalued at the moment. So are shares attractive at today’s price?

Let’s take a deeper look at Yahoo’s fundamentals with our Investment U Fundamental Factor Test and see what type of grade shakes out:

Earnings-per-Share (EPS) Growth: We already know that Yahoo has been struggling, and its earnings show it. It saw EPS drop 12.90% in the last quarter.

Price-to-Earnings (P/E) Ratio: From an earnings perspective, Yahoo is attractive. Its P/E ratio of 34.44 is well below the industry average of 50.47. Should we thank hedge funds, flatlining growth or investor and media skepticism for Yahoo’s lower share price? Maybe all of them.

Debt-to-Equity The balance sheet is looking nice. Yahoo has a debt-to-equity ratio of 8.96%, almost half the industry average, which clocks in at 16.72%. This is what we like to see.

Free Cash Flow per Share Growth : Another positive mark here. Yahoo saw cash flow per share jump 8.53% in the most recent quarter. And remember, more cash will be coming in since it just unloaded a large portion of its stake in Alibaba.

Profit Margins While Yahoo has been struggling to grow its bottom line, it has been efficient at controlling cost. Its profit margins of 24.88% are well above the industry average of 15.09%.

 Return on Equity And the streak ends. Yahoo’s ROE of 9.25% comes in below its peer average of 12.44%.

*Why did we look at these specific metrics? Find out more here.

Fundamental Factor Test Score

B: Buy with Caution (Matches four key metrics, no less)

Please note that our fundamental factor checklist is just the first step in performing your own due diligence. There are many other factors you should consider before investing. That's why The Oxford Club offers over a dozen newsletters and trading advisories all aimed at helping investors grow and maintain their wealth. For more details, click here.

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