By Alex Gavrish, Etalon Investment Research; author of “Wall Street Back To Basics”
It is still not too late to initiate a position in Yahoo! Inc. (NASDAQ:YHOO) and profit from the upcoming IPO of Alibaba. Conservative investors can implement a put-write strategy and sell put options on Yahoo’s stock in order to generate an attractive premium.
Alibaba Group’s IPO could be the largest tech IPO of the year. According to different sources and media reports, Alibaba Group’s valuation can even reach $200 billion dollars. Estimated average valuation, according to a Bloomberg report, rose to $153 billion in February 2014. Yahoo, with its significant stake of 24% in Alibaba, attracts a lot of investor attention, and can serve as an alternative way to participate in the upcoming IPO and enjoy the potential benefits of the growth and success story of Alibaba Group.
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Sum-of-parts valuation of Yahoo
Let’s do a quick sum-of-parts valuation of Yahoo! Inc. (NASDAQ:YHOO). First, Yahoo’s 24% stake in Alibaba Group, using an estimated $153 billion valuation, is worth $22 billion after-tax (assuming a 40% tax rate). Second, Yahoo’s 35% stake in Yahoo Japan is worth $5.6 billion after-tax (assuming a 40% tax rate). Yahoo Japan’s share price declined by approximately 27% since January 2014 highs, so it can be said that this valuation is reasonable. Third, as of the end of the first quarter of 2014, Yahoo had $4.6 billion in cash and marketable securities, and after deduction of an existing long-term debt a net cash holding of $3.5 billion. These three parts add up to a total value of about $31 billion.
Yahoo’s own operations generated an EBITDA of $1.6 billion in 2013. Applying an x8 EV/EBITDA valuation multiple, Yahoo’s own operations can be valued at about $12.5 billion. The total value of Yahoo can therefore be estimated to be around $43.6 billion dollars.
Example of a put-write position for a more conservative investor
Based on April 17th 2014 closing prices, one could sell an out-of-the-money put option on Yahoo! Inc. (NASDAQ:YHOO) shares with a maturity of about nine months (January 17, 2015) and exercise price of $30 for a premium of $1.68 per share. By doing this, the investor agrees to purchase Yahoo shares for $30 per share in case the stock price declines below this price. Actual cost and breakeven price of shares for investor would be $28.32 as the investor receives $1.68 per share in option premium upfront.
At such a purchase price, one would acquire Yahoo shares at a 28% discount to sum-of-parts valuation above. In addition to this, there is still additional upside optionality in Yahoo shares due to a potential growth of Alibaba Group’s value, and improvements in Yahoo’s own operations. In percentage terms, a decline of 22% from the current market price of $36.38 is required to get to this price – a nice downside protection during uncertain times. If, on the other hand, Yahoo shares trade sideways or rise, investor will earn an annualized premium income of about 8% for taking the risk.