We have obtained Third Point Avenue’s fourth quarter letter which was recently released. Third Point is a hedge fund run by activist value investor, Dan Loeb. The fund has approximately $8.5 billion under management as of the date of the letter. The letter focuses a great detail on one of Loeb’s largest holdings, Yahoo! (NASDAQ:YHOO).
Loeb discusses in detail the valuation of Yahoo! , which Loeb believes to be severly undervalued. Loeb like fellow value investor David Einhorn, thinks the crown jewel of Yahoo are the assian assets, namely Yahoo! Japan and Alibaba. Loeb currently owns over 5% of outstanding shares of the company and has been waging an activist war to shake up management.
Below is a segment from the letter titled “The Case for Alibaba.”
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As investors are aware, we established a sizeable position in Yahoo following a difficult operational and strategic stretch during the waning days of CEO Carol Bartz’s tenure that culminated in a significant sell-off in the shares in August. Initially, we were attracted to the company simply by its significant discount to intrinsic value. In September, we announced publicly that we had accumulated 5.2% of the shares of the company and laid out our case for why valuation was depressed. While the travails of “core Yahoo” grab all the headlines, core Yahoo forms only a modest portion of the Company’s actual value (a mere $2.00 per share, trading at ~14.49 as of 03/12/12). The after-tax value of Yahoo’s Asian assets — Alibaba and Yahoo! Japan — currently constitutes $11 per share of its value (73%), with an additional $2 per share of net cash.
Central to our investment thesis is the hidden jewel in the Asian asset portfolio, and indeed in Yahoo itself: Yahoo’s 40% stake in Alibaba Group, the dominant e-commerce platform in China. According to iResearch, Alibaba currently has 49% of the B2B e-commerce market (four times greater than its nearest competitor), 90% of the C2C e-commerce market (analogous to Ebay), and 53% of the B2C e-commerce market (analogous to Amazon) in 2011. It has complemented these core commerce positions with the leading online payment platform, Alipay, with 49% market share, and also holds the #2 share of the Chinese online ad market (17%, behind Baidu at 28%). Particularly exciting is Alibaba’s share of China’s rapidly growing B2C market represented by Taobao Mall, or Tmall (recently renamed Tian Mao).
According to iResearch, China had 187 million online shoppers in 2011, compared to 170 million in the U.S. As Boston Consulting Group noted in its November 2011 report, “The World’s Next E-Commerce Superpower,” e-commerce transaction value in China is likely to overtake the U.S. by 2015, helped by conditions that mirror the U.S. and in some ways favor e-commerce in China. A combination of broad product assortments and lower prices mirror the U.S., while e-commerce in China benefits from the fixed price certainty missing in China’s traditional retail culture (where haggling is common), from relatively lower shipping costs than in the U.S., and from the limited geographic reach of brick-and-mortar chains.
The Boston Consulting Group report highlights “The Taobao Phenomenon” and notes more products were purchased on Taobao in 2010 than at China’s top-five brick and mortar retailers combined.
The scale and velocity of China’s e-commerce opportunity, when combined with Alibaba’s dominant position, make for a very compelling story. As it moves toward an IPO, Alibaba should quickly take its place amongst China’s online leaders — Tencent ($47 billion market cap), and Baidu ($48 billion market cap). A November 2011 report on Softbank by UBS’s Makio Inui, the product of extensive research into Alibaba Group and a detailed valuation, placed a $63 billion value on Alibaba Group, which would imply just over $13 per Yahoo share after tax. It appears that while 2012 will be the year of Facebook, 2013 could very well be the year of Alibaba as it moves toward a listing.
At the reported $35 billion valuation ascribed to the October 2011 purchase of employee shares by Silver Lake, Temasek and Yunfeng (an affiliate of CEO Jack Ma), Yahoo’s stake was worth ~$7.60 per share after tax. That implies Yahoo’s stake has grown at a compounded rate of 55% per annum since its investment in October 2005, and it is significant that the majority of Yahoo’s value is now driven by its Alibaba stake.
Clearly, as evidenced above, we see tremendous upside in just the Alibaba piece of the Yahoo puzzle.
While the media has covered the drama surrounding the negotiations with Mr. Ma in some detail, Wall Street has continued to neglect the underlying Alibaba valuation story and the press makes too little of it. Certainly there is some compelling reason why Mr. Ma is so interested in repurchasing Yahoo’s stake! We share his excitement and enthusiasm for the Alibaba opportunity, and we respect and appreciate the dominant and dynamic franchise he has built amongst the world’s largest base of Internet users.
Over the last six months we have witnessed the Board of Directors’ “strategic review” that has to date resulted in the hiring of a new CEO, Scott Thompson, the resignation of Jerry Yang, and the pending exit of Board Chairman Roy Bostock and three other Directors. In mid-February we announced that we intend to run our own slate of Directors for the Yahoo board during this proxy season. We stated our intention to nominate well-known leaders in the media space Jeff Zucker and Michael Wolf, restructuring guru Harry Wilson, and Dan himself to the Board. We are glad Yahoo has played a critical role in Alibaba’s early development and hope new leadership at Yahoo can chart a new course for the company’s relationship with Mr. Ma and Alibaba.