What Would You Pay for Yahoo (YHOO)?
November 20th, 2007 by 
Tom Lyons
How much would you pay for a share of Yahoo (YHOO)? It seems like a simple question and it has a simple answer - mine is $18.50 per share. But how did I come up with this number? Now that is a more difficult question with a longer answer.
Yahoo is a leading global internet brand that operates one of the most popular internet networks on the web. Yahoo offers a broad range of internet products and services. Many of these services are offered free to the users, but Yahoo is able to make a profit from these free services by providing marketing services to advertisers. Along with its marketing services, Yahoo creates additional revenue by charging a fee to be able to use premium services.
The marketing services portion of Yahoo’s revenues is broken down into two major divisions. The first part of this division is the revenue generated by sites that are owned and operated by Yahoo. This network made up 47% or $741.9 million of total revenues during last quarter, with the affiliate sites network pulling in 40% or $628.4 million of Yahoo’s total revenue during that time. The remaining 13% or $209.9 million in revenue was generated by the premium fee services. These percentages are extremely interesting when comparing them to Yahoo’s main rival Google. Google-owned sites generated $2.73 billion or 65% of total revenues in the last three month earning period. Google’s partner sites generated $1.45 billion or 34% of total revenues in the last three month earning period. Given the difference in percentages I feel that it is important to note the dependence Yahoo has on its affiliate publishers. Given this dependence I feel that future revenues may be hard to predict.
Now consider the market in which Yahoo operates (for more, see “The Economics of Internet Search“. We could come up with a few definitions here, but the “internet marketing industry” is probably as good as anything else. This is a very lucrative and competitive industry that is expanding at a fast pace. Given the rate online advertising is supposed to grow over the coming years and the efforts that Yahoo is putting into further enhancing its marketing services through the introduction of Project Panama, I believe Yahoo will be able to grow revenues in the near future close to the rate that is has over the past year - about 22%. Given this, I think that the analysts have a fairly accurate estimate of 25% growth annually over the next five years.
So how did I arrive at $19/share for YHOO? I discounted past cash flows based off of future growth rates. The main things that are needed in order to arrive at a target price are; operating free cash flow, capital expenditures, a discount rate, future growth projections, and terminal/exit multiple.
For operating free cash flow we take the combined operating free cash flow from the previous four quarters and the subtract that number by capital expenditures from the previous four quarters. The number that we arrive at is the initial free cash flow, which is $923 million.
The next question in determining present value is finding out the rate at which Yahoo will grow free cash flow over the next five years. Given our assumption that the online advertising markets will continue to grow at the rate of the past year and that Yahoo will be able to continue its innovative ways we will use consensus analysts’ growth rate of 25% annually for the next five years.
In order to find the discount rate the use of Capital Asset Pricing Model is used. This model is R=Rf + B(Rm-Rf) where R=discount rate, Rf=risk free return, B=Beta of security, and Rm=expected market return
In this situation we will have
Rf=3.35%, the rate of the 3-month T-Bill
B=1.22
Rm=6.6%, rate of return from S&P 500 plus dividends
Using this model we get an implied discount rate of 7.315%. In order to determine an exit multiple, we take 1 and divide it by the discount rate. This gives us an exit multiple of 13.7x. The model below shows the price targets of Yahoo by using the method described above. By using the CAPM discount rate of 7.315% we get a price target of $26.40 after adding in Yahoo’s net tangible assets, or approximately 1% below today’s close. The diagram below gives target prices with sensitivity toward changes in growth and discount rates.
Given these numbers, my rationale for having an entry point under $18.50 dollars a share is that I like to have a margin of safety when I enter into my trades. As it becomes evident the DCF valuation only gives us a implied valuation and I therefore like to buy stocks at a 30 percent or more discount to implied valuation, so 70% of the $26.40 fair value gives you my desired buying price.
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November 21st, 2007 at 2:37 am
Tom, thanks for a detailed analysis. Great stuff!
Couple of comments - Morningstar has fair value set for Yahoo at $34 and its touching their “consider buying” at current price.
M* assumes $6 per share for Yahoo’s stake in Yahoo Japan. I am not sure what do they assume for Yahoo’s stake in Alibaba. The cash holding is at $3.4B.
I wonder if you add all these, your estimate probably matches M*.
five_whys
November 21st, 2007 at 2:04 pm
Five_whys
The holding in Yahoo Japan and Yahoo’s stake in Alibaba are somewhat hard to value in the price of Yahoo and it does leave some room to change share price. Given that Yahoo accounts for their stake in Yahoo Japan on a market value price the value of the asset is always changing. In my analysis these investments added around $2-3 a share. If you switch in the $6 a share that Morningstar uses the target price jumps to around $30 a share. Depending on what discount rate they used along with the exit multiple I can understand where a price target of $34 would come from. I like to be more conservative in my analysis.
November 21st, 2007 at 4:19 pm
The break up value alone ispriced between 39 to 42.00 usd that is without the 40% ownership in Allibba or even the 100 million dollar investment in the new IPO of 17% of Allibba. Allibba just posted numbers of roughy a 4x increase of last years renvenue as stated in the business daily and another Hong Kong news letter. Companies are also put in a value of forward looning numbers that would compare to the industry sector they are in. As companies resale value is in a range of about 30% above calculated break up value and because of the market out look in this sector to say 2010 which where the search and Add revenue should triple and between 4 to 5 more IPO’s of Allibba business alone coming outr in the next year plus trading for all USA investors through Hong Kong being able to buy Allibba stock on this day and Allibbba to be listed on the shanghei market with a usa ADR to follow with respect to you your figure of 18 and change is very much off base. Looking at most other internet buyouts also in the last years or even part partnership companies are paying high priemiums. No search and Add internet companies are being bought anywhere near their book value which again you are way off base cause Yahoo’s break up value stated by many brokerage houses is priced before the Allibba IPO at anywhere between 38 to 42 dollars and higher. Yahoo will be bought out whether friendly or hostile it will be brought out and it will happen quicker then most will think. It is a must. One big reason that has pushed the buy out as critical is the interest Google has in building its own wireless network. It has already set aside close to 5 billion dollars for the new licences with even longer ranges coming avaibile for release in Jan 2008 by the FCC The only way any company will come near to gaining the market share on Google that Mr. Balmer stated at the UBS conference in two to three years time frame cannot be done by piece buying small internet start ups or small internet search engine companies. It is impossible. He is laying it out to you. Microsoft is going after Yahoo. It would be the best bet out there and the fastest way to gain market share and it will not have an anti trust problem at all, In fact it will be met with open arms here and the European States. Whether it be Microsoft, Ebay, Apple or Verizone Or AT&T which by the way the Comcast deal seems to be dead all of a sudden and the stratgey has switched and the big fish and big prize here is Yahoo and the price range will be between 60 to 65 dollars a share no less. Yahoo is not desperate and can hold ourt because of Allibba but the rest have a duty to their shareholders to build maxium share holder value and build up market share and the only ticket in town to acheive that goal is buying Yahoo. Again 60 to 65 dollars will get the deal done now. After Jan 1st when Allibba releases new numbers and more IPO’S and Yahoo releases its Qtr tack on another 5 billion easy. So Mr. Balmer will meet the 60 to 65 dollar price very soon before years out.
November 21st, 2007 at 4:23 pm
Allibba opens for trading for USA and other retail investors is on DEC 17 2007. I am sorry i forgot to add that in.
November 21st, 2007 at 6:27 pm
Jay,
I have to disagree with your justification of $60-65 a share for Yahoo. If you read this article from today http://biz.yahoo.com/ap/071121/comscore_october_search.html?.v=1 Yahoo is losing even more ground in search. While Yahoo’s ownership stakes in other companies are infact appreciating they can go down just a quickly. Stock prices can be a fickle thing and I would be extremely reluctant to try to value Yahoo’s ownership positions in Yahoo Japan and Alliba on a mark to model basis. To many variables are involved with that.
Also, your comment that growth of Yahoo should be equaled to the growth of that industry. I strongly disagree with this as we are constantly being shown that Google is taking more and more of the search market from Yahoo. As it stands Yahoo’s affiliate programs are becoming more and more of revenues. I am not really suprised by this as most of the Premuim parking companies have their feed sydication through Yahoo. Like I said in the article I think it will be extremely risky for Yahoo to rely on its revenue growth through affiliates.
Overall, I agree that Yahoo’s holdings may appreciate greatly over the coming months I am very reluctant to up my target share price of Yahoo because of possible gains in stock holdings. That is the great thing about quarterly reports. It gives us updates and new information to relook and produce new price targets.
November 21st, 2007 at 10:49 pm
Tom,
Understand and appreciate your comment. Valuations based on Alibaba may be better understood in a quarter or two from now!
November 21st, 2007 at 11:56 pm
Have you just seen or heard of the new search engine that Allibba just released and how many small and medium business’s since August and is cutting its commission by just about half of Baidu? Allibba is the saver of Yahoo and is the star and the smartest investment Yahoo ever made. Jack Ma is no fly by nighter. George Soros is now fly by nighter aand just tripled his position and i am going with straight figures here and Yahoo combined with all is cheap between 60 to 65 take over price. Look at all the contracts being released and again look what Facebook take over value is. Search only is not the key…the future is in add revenue…..Allibba seems to have that rapped up. The fundmentals for Yahoo’s future and all search and add revenue is unbeleivable. You have seemed to have done your homework so have i but the listing of articles reports and data coming out on Yahoo in the last two months is too much to type here. Anyone that wants to compete or gain fast market share away from Google without anti trust problems will be Microsoft maybe AT&T. Yahoo is cheap at between 61 to 65 dollars a share and i beleive you will see a deal on the table if not by the early part of next week but by that Friday. The market and technology warrants it, The sector is just heating up too fast and this deal will be done at 61-65 dollars a share. You have no idea how big the Allibba factor really is and the backers. You Think George Soros is not a smart investor? You most likely again see a deal on the table in the next ten days. This will slow down Googles madness. By the way on true calculation going over the finanicals do you really think with all factors in that Yahoo is really running at 56 to 58 PE? Check them again their much lower. People are under estimating the Allibba Factor. Even Cisco invested over 20 million in just the 17% IPO Mutual Funds have also increased their holdings in Yahoo sinceAugust by at least 25% I respect your thoughts and infromation and i thank you but i have been in this business a long time and i am going with my homework and thoughts buy out on the table very soon 61 -65 dollars a share seals it!