One of the key aspects we at Farnam look for in an investment opportunity is asymmetry. What we mean by this is that the potential upside, or return on investment, far outweighs the potential downside, or loss from investment. These instances are said to have an asymmetrical return profile. We believe Yahoo! represents such an opportunity.
Yahoo! is a relic of the dot-com era and has been struggling for a number of years. After years of investment and increasing costs in the hopes of turning their core business around, the Yahoo! board is slowly conceding defeat and is now looking to separate the business’s assets to realise its intrinsic value.
Frequent readers of material produced by Farnam might be asking why we are interested in a business with deteriorating economics, when we tend to focus on high quality assets. At heart we are value investors and from time-to-time, the market presents us with opportunities that have very little downside and potentially material upside. Monhish Pabrai frequently refers to these type of investments as “heads I win, tails I don’t lose much.”
Our analysis concludes that the market is either ascribing a severe tax liability upon the separation of their stake in Alibaba, or a negative equity value for the core Yahoo! business.
|Business Unit||Current Market Value (US$m)||Adjustments||Adjusted market value (US$m)||Per share value|
|Group (ex Yahoo!)||$37,364||$39.50|
|Implied value of Yahoo!||-$2,824||$3.00|
The Yahoo! board has set in motion a plan to either “spin-off” their core Yahoo! business into a separately traded vehicle, or sell the business to a suitor. We believe that there is still a valuable business in Yahoo! and that the board’s current strategic plan should realise it. Large telecommunications companies or private equity firms may be interested because:
- Over the last 3 years, operating expenses at Yahoo! have increased by USD$500m despite declining revenues.
- The management team has deployed an additional USD$2.3bn into new investments, with little to no incremental return.
- They still have over 1 billion monthly active users (MAU’s).
- They still command 8% of the US desktop search market.
- Their websites still receive over 140 million monthly unique visitors.
Therefore, there is some easy fat to trim for a private equity firm and there is also a valuable database of active users for a global telco to exploit. Companies such as Verizon, which acquired AOL a few years ago, have already stated their interests, while Google and Microsoft have signalled they may aid in financing the deal with a private equity partner.
When we initially began purchasing shares in Yahoo!, we estimated that it had potential downside of ~$1 per share based on a worst case taxation scenario, and Alibaba’s share price trading at 12 month lows. The upside however, was materially more than this at approximately $13, which, on a risk/reward basis, created a highly asymmetric return profile, with the potential return being 13x greater than the likely downside. We are continually seeking investments with these types of parameters, ever cognisant of Warren Buffett’s first two rules of investment:
- Don’t lose money
- Don’t forget rule number 1.