|Altaba (formerly Yahoo) owns a 15% stake in BABA. It is looking to unwind that position in 2018.|
h/t Sr K
Altaba’s Endgame Could Reward Investors Nicely
The former Yahoo! trades at a 30% discount to the value of its assets, including a 15% stake in Alibaba. Management is aiming to close the gap.
By Andrew Bary Biography
Sept. 8, 2017 11:29 p.m. ET
Under CEO Jack Ma, Alibaba could buy Altaba in a tax-free exchange. Qilai Shen/Bloomberg
Alibaba Group Holding is having a stellar year. Shares of the Chinese e-commerce leader have risen 95% in 2017 to a recent $170, giving the company a market value of $437 billion. The stock added to its gains after management, headed by CEO Jack Ma, announced better-than-expected results in mid-August for the June quarter, including a 56% increase in revenue and a 65% jump in adjusted earnings per share.
A cheap way to play Alibaba (ticker: BABA) is through Altaba (AABA), the former Yahoo!, whose 15% stake in Alibaba is valued at $65 billion. That’s more than Altaba’s entire market value of $57 billion.
Altaba shares are up 65% this year, to about $64, on Alibaba’s big gains, but trade at a 30% discount to the value of the company’s assets (see table). These include the Alibaba stake; a 36% interest in Yahoo Japan, worth around $9 billion; net cash of $8 billion; and a patent portfolio worth about $700 million. There are some potential liabilities stemming from data breaches at Yahoo! a few years ago, but they aren’t expected to be significant. Barron’s has written positively about Altaba this year, including in a Follow-Up on July 1, when the shares traded around $54.
After Yahoo! sold its core business in June to Verizon Communications VZ -0.19480519480519481% Verizon Communications Inc. (VZ) for $4.5 billion, the company morphed into a New York–based investment concern and changed its name to Altaba. Its goal probably is to wind down its assets and realize as much value as possible for shareholders. The challenge is doing so in a way that preserves most of the value for holders.
The current discount to net asset value reflects several issues, chiefly investor concerns about potential taxes imposed and concessions that could be required in order to unwind the equity interests, mainly in Alibaba, which accounts for more than 75% of Altaba’s asset value. It is uncertain how long the process will take; many investors in Yahoo!/Altaba want to see the situation resolved by the end of 2018.
Altaba will probably not realize its full net asset value due to the cost of unwinding the equity stakes. But, bulls argue, the discount is too steep.
“Management at Altaba is singularly focused on creating shareholder value,” says Jeff Lignelli, a portfolio manager at Incline Global Management, a New York investment firm that holds Altaba shares. “We expect a large share buyback to help close the discount, and a tax-efficient sale of the Yahoo Japan stake, followed by the ultimate transaction: a share swap with Alibaba.”
He values Altaba at about $77, assuming a 20% discount on the Alibaba stake and a 10% discount on Yahoo Japan. Lignelli is bullish on Alibaba, calling it one of the fastest-growing megacap companies in the world. He thinks Alibaba shares could top $200.
Robert Willens, a New York tax expert, also thinks the discount to net asset value is too wide. “I’m convinced that Altaba will be able to dispose of or monetize its holdings on a tax-efficient basis,” he says. “The market is seriously undervaluing Altaba’s stock.”
Brett Harriss, an analyst at Gabelli, values Altaba at about $76, assuming a full tax bite on the sale of the Yahoo Japan interest and a 15% discount on Alibaba. He says SoftBank Group [9984.Japan] is a potential buyer of Altaba. Both SoftBank and Altaba own stakes in Yahoo Japan and Alibaba.
After the Verizon sale closed, Marissa Mayer departed as Yahoo’s chief executive officer. Altaba’s small executive team now is headed by CEO Thomas McInerney, a former chief financial officer at Barry Diller’s IAC/InteractiveCorp (IAC). There are just 15 employees.
In a June 19 letter to shareholders, McInerney pledged to reduce the discount to net asset value, which has remained around 30% since then. Management compensation is based in part on reducing that discount. The company maintains a live NAV calculation on its website. Last week, it was nearly 31%.
IN ITS FIRST ACT as an investment company, Altaba bought back $3.4 billion of stock at about $53 a share. It has since authorized a new, $5 billion share buyback. But it probably needs the cooperation of Alibaba to unload its 15% stake in the Chinese company, equal to nearly 384 million shares, without incurring a huge tax bill.
The scenario favored by investors, as outlined by Lignelli, would involve a return of Altaba’s current cash to holders via buybacks, followed by a tax-efficient sale of the Yahoo Japan stake to Yahoo Japan, possibly through a technique called a dividend strip, involving the payment by Yahoo Japan of cash and equity warrants. Willens favors this approach. If it happens, Altaba would be left with one dominant asset: its Alibaba shares.
It could sell its Alibaba stake in the open market, but unloading such an enormous block of stock could depress the price and generate a huge tax bill, because Yahoo! originally paid little for the shares more than 10 years ago. “We would be highly unlikely to ever sell Alibaba shares at a 36.5% combined federal and state tax rate because there’d be no incentive to do that,” McInerney said at an Oppenheimer investor conference last month.
The preferred scenario would involve Alibaba buying Altaba for stock in a tax-free exchange, essentially swapping its shares for the Alibaba stake held by Altaba. Since Alibaba is the only company that can make this happen, it has leverage. Alibaba might demand a concession as an incentive for the swap, such as getting a 15% or 20% discount on the shares. That means it could offer, say, to issue 310 million shares to Altaba holders in order buy Altaba and its 384 Alibaba million shares, effectively netting $12.5 billion (74 million shares times the recent Alibaba price of $170).
This financial incentive and the desire to keep Altaba’s large block in friendly hands might motivate Alibaba to act, although it probably couldn’t retire the stock without incurring a tax penalty. Willens says this issue is overblown and could be “just a negotiating ploy” by Alibaba to get a better price. However, it is unclear whether Alibaba wants to do a deal and whether it might seek a steeper discount, to accommodate Altaba. Alibaba declined to comment.
ALTABA’S MCINERNEY has said the company is watching to see if the tax-reform push in Washington will lower taxes. A cut to a 20% or 25% corporate rate from the current 35% would help reduce Altaba’s potential tax bite on an open-market sale of Alibaba stock.
A big risk with Altaba is a drop in Alibaba shares. To hedge the risk, some investors have sold Alibaba shares short to create a cheap “stub” of the remainder of Altaba. If the discount narrows, Altaba investors could score, even if Alibaba shares decline.
Another risk is that Alibaba won’t execute a transaction with Altaba. If that happens, Altaba’s options may be limited, possibly leading to a sale of the Alibaba stake in the open market—and a tax hit. In 2015, Yahoo! sought to spin off the Alibaba stake tax-free, but dropped the idea when it couldn’t get a blessing from the Internal Revenue Service.
Willens notes that Altaba could convert to a regulated investment company and pay out the Alibaba stock to shareholders in a tax-friendly way through a technique called distributions in redemption. But that approach is complicated and could face challenges from the Treasury or IRS.
It is tough to handicap the Altaba situation, given the uncertainty about Alibaba’s intentions. But the Chinese e-commerce company just might want to negotiate a share swap that benefits itself and Altaba, finally concluding the Yahoo!/Altaba saga.