Yahoo For Sale

Company For Sale
The Fiasco At Yahoo
To say that the Yahoo's core business is being mismanaged is an understatement. To say Yahoo has been taking piles of cash and lighting in on fire would be a better description. Here are some examples of how Yahoo has incinerated shareholder money:
  • Yahoo paid $20 million for rights to stream an NFL game. In addition, there were production and streaming costs. The result was $3 million of ad revenue
  • Yahoo pays Katie Couric over $10 million a year for a streaming show with low viewership
  • Yahoo also created two original series that resulted in low viewership
  • Yahoo has spent hundreds of millions of dollars buying zombie companies in order to hire programmers
  • Yahoo top management pays itself handsomely for the amazing feat of lighting cash on fire
Yahoo Core Value In A Sale
I could make a page long list of how Yahoo wastes money but I believe I have made my point. Any half competent, non arsonist should be able to at least double Yahoo's EBITDA and cash flow. I am assuming that in a sale Yahoo would be able to fetch at least 8 times its very depressed EBITDA, which would be $6.4 billion or $6.81 per share. 
Some large Yahoo shareholders believe that Yahoo can fetch a price 50% higher but I want to be conservative in my assumptions. Despite complete mismanagement Yahoo is still one of the top visited sites on the internet with nearly $5 billion in revenue expected for 2016. Yahoo owns real estate that Starboard had appraised for a value of $1.5 billion (the crown jewel is a nearly 1 million square foot campus in Silicon Valley). Yahoo also owns $700 million worth of intellectual property and patents. I assigned no value to either the real estate or the IP in my estimate of the value of Yahoo. It is very possible that my assessment of Yahoo core's value is too low.
Cash, Yahoo Japan and Alibaba Holdings Value (all values as of the close of December 16, 2015)
The value of the remainder of Yahoo's assets are as follows: Yahoo has $5.8 billion in cash or $6.16 a share in cash. Yahoo owns $32.5 billion worth of Alibaba shares at yesterday's closing price of $84.63. I am assuming that once the core business is sold and the company is simplified into essentially a holding company that the discount on Alibaba shares will narrow to 20%, which I believe is conservative. At a 20% discount Alibaba is worth $27.66 per share. Yahoo's stake in yahoo Japan is worth $8.4 billion. I am assuming that Yahoo Japan will trade at a 40% discount as it currently is not clear to me how Yahoo will dispose of Yahoo Japan without paying taxes. If they find a way to do this than there is additional upside in the shares. At a 40% discount Yahoo's stake in Yahoo Japan is worth $5.35 per share.
Yahoo Total Value (all values as of the close of December 16, 2015)
Yahoo core                $6.81 per share (at 8 X depressed EBITDA)
Cash                          $6.16 per share
Alibaba Holdings     $27.66 per share (at 20% discount)
Yahoo Japan             $5.35 per share (at 40% discount)
Total value                $45.98 per share
Recent Price             $33.78
Total upside              36.1%

Yahoo Current Valuation
I believe the market is currently pricing in a worst case scenario for the value of Yahoo (assuming that one hedges the value of Alibaba and Yahoo Japan). At the current valuation both Yahoo Japan and Alibaba Holdings are being valued at a 40% discount to their market value, which is lower than their fully taxed value. The core business is being valued at four times depressed EBITDA and receiving no credit for real estate and IP. In a worst case scenario where Yahoo core could not be sold a decent operator should be able to increase EBITDA by getting rid of the obvious waste and by monetizing some of the assets. Yahoo has roughly 11,000 employees and one can make the argument they can operate with a significantly smaller amount.
Yahoo Shareholder Revolt
Yahoo has an array of activist shareholders that are all fed up with the performance of management and the board. I would encourage you to read the letters from Canyon Capital and Starboard to the board of directors among others. The writing is on the wall that  a nasty proxy fight is in store if Yahoo does not sell the core business. The only way for management and the board of directors to gracefully exit the situation is to sell the core business. The alternative is being humiliated as it is clear that Marissa Mayer is not the right leader for this company. I believe the board will take the logical route and sell the core business or it will be done for them once the board is ousted in a few months.
The Reason For This Opportunity
There are a number of reasons I believe such an attractive opportunity exists. I believe there are currently non economic sellers in the stock. Yahoo is likely most appropriate for event driven investors because of the many moving parts. A year ago event driven was the hottest category of hedge funds and was seeing inflows. After a year of poor performance the strategy is now seeing outflows, creating the equivalent of forced sellers.  In addition, there are likely a number selling for tax loss purposes and because they are fed up in general.
Yahoo is a difficult stock for a plain vanilla fund to hold because one must have an opinion on all the parts. Alibaba Holdings and Yahoo Japan cannot be hedged out because of short selling restrictions for these funds.  Once the core is sold and Yahoo Japan is sold or separated the remaining stock will be much simpler, essentially an Alibaba tracking stock.
After years of stumbling around the Yahoo board is finally doing the right thing by putting up the core business for sale. While investors are fatigued there is finally a light at the end of the tunnel.

Qualcomm's CEO Sad Admission

"I try to buy stock in businesses that are so wonderful that an idiot can run them. Because sooner or later, one will." -Warren Buffett

In evaluating Qualcomm I came to the conclusion that expenses were out of control. Despite knowing this I was shocked by the admission of the CEO of how little thought has gone into Qualcomm's spending. The following is a quote from Qualcomm's CEO, Steve Mollenkopf, at the Merrill Lynch Global Technology Conference a few weeks ago:

"But now we are in a position where you know looking at things like how much we are spending in R&D, are we getting the right return for R&D, are people in the right place, are we getting leverage in our supply chain" -transcript from Seeking Alpha

Steve Mollenkopf and his management team are one of the highest paid in the world and they were not looking at how much they were spending? They were not analyzing their return on R&D spending? They were not maximizing their supply chain? They don't even know if people are in the right place (whatever that means)?. What were they doing? This same management team wants to do acquisitions before they get their house in order?

Luckily, Qualcomm's business is so "wonderful" that even with a free spending management team that pays itself very handsomely the business generates loads of cash. Qualcomm's licensing business alone is expected to generate about $7 billion in EBIT next year. Qualcomm's entire enterprise value is roughly $70 billion.

Qualcomm owns many of the patents related to 3G, 4G & 4G LTE technology among others. Money manager Andy Macken of Montgomery Funds makes the following analogy to Qualcomm's licensing business  "It's a bit like owning the English language and then charging anyone that learns to speak English."  To which I would add, I believe more people use 3G or 4G technology than speak English.

The Qualcomm licensing business is a business that an idiot can run, to paraphrase Warren Buffett. This business is expected to generate the vast majority of profits at Qualcomm. The semiconductor business, which requires some management skill, has performed miserably. Even though Qualcomm is the market leader in its space with limited competition, Qualcomm has one of the worst profit margins in its industry. Qualcomm's profit margins are less than half of what they should be. With Qualcomm's scale there is simply no excuse for this.

Despite mismanagement Qualcomm is one the cheapest large cap tech stocks with an expected free cash flow yield of greater than 11% (to enterprise value). With the admission of the CEO that they weren't really paying attention to their spending it likely means that there are easy changes that could further boost profits. If they can get their margins to the industry norm for a market leader the boost would be tremendous.

Activist, Jana Partners, has taken note of Qualcomm's missteps and has been trying to prod management in the right direction. Some positive steps are being taken including returning over 20% of the market cap to shareholders over 2 years and a cost review by outside consultants. Qualcomm management is going along with these suggestions but it seems to be doing so in a  half hearted manner. Qualcomm waited months before beginning its accelerated repurchase program and then only announced a $5 billion program. Expense reductions have not yet begun in earnest even though management admits they are necessary. Further activist pressure on management will likely be necessary.

Even in its current state Qualcomm is undervalued. With a management team that finds religion (or is forcefully converted) the return potential is tremendous.  

Qualcomm : The Biggest Bargain In Large Cap Tech

Qualcomm Business
Qualcomm (QCOM) owns patents related to 3G, 4G & 4G LTE technologies (among others) that power smartphones. As a result Qualcomm receives a roughly 3% royalty on most smartphones sold in the world. Getting 3% of every smartphone sold seems like a pretty good business to be in but the market does not value Qualcomm that way.
Qualcomm trades at a roughly 10% free cash flow yield or 10 times earnings once one adjusts for the roughly $30 billion in cash they are hoarding. The reason for this valuation is that Qualcomm owns a second, less attractive business. Qualcomm makes chips for smartphones and this business has recently encountered more difficult competition. While semiconductors account for a smaller part of Qualcomm's profits they attract almost all the attention of analysts and investors.
If one were to put a market multiple on Qualcomm's attractive, licensing business and add back cash Qualcomm would trade at $85 versus the roughly $69 Qualcomm trades at today. However, this valuation assigns no value to Qualcomm's "terrible" semiconductor business that produces roughly $2 billion a year in profit. Even putting a ten multiple on that business would raise Qualcomm's valuation to $95.
Reasons For Undervaluation
I believe there are a number of reasons for Qualcomm's undervaluation. Qualcomm's licensing business is simple and predictable. As a result this business generates few headlines, little news and as a result receives little attention. The semiconductor business generates constant news of design wins & losses, more recently losses. As a result it seems Qualcomm's business is constantly under siege, even though its main profit engine has been chugging along. Additionally, Qualcomm is mainly followed by semiconductor analysts and investors who tend to focus solely on design wins & losses instead of keeping their eye on the main profit engine.
Qualcomm has grown its revenue nearly nine fold since 2002, attracting a number of growth investors. More recently growth has slowed due to the slowdown in the semiconductor business (even as earnings for the licensing business are growing at a double digit pace). As a result Qualcomm's investor base is transitioning from growth investors to value investors.
Catalyst For Change
An activist has recently accumulated shares of Qualcomm and nudged management to make positive changes. Instead of hoarding cash management will repurchase over 10% of the outstanding shares of Qualcomm this year in addition to paying a nearly 3% dividend. Moreover, Qualcomm has hired outside consultants to review their cost structure.
Almost every large cap technology company has had a period of transition after their explosive growth phase passed. Microsoft, Intel, Cisco, Oracle and even Apple's stock sputtered when growth slowed. In all these cases it was not until the stock became cheap and management began to return cash to shareholders in earnest that the stocks rebounded nicely. Qualcomm's stock has spent the past three years going nowhere while the market has exploded to the upside. As a result Qualcomm is now the cheapest large cap tech stock. Additionally, Qualcomm will likely return over $25 billion to investors over the next two years or greater than 22% of its market cap. If Qualcomm follows the script of any of these large cap tech stocks the stock price should rise by over 50%.
Qualcomm has always been a fast growing business that did not focus on expenses in the same manner that a mature company would. As a result there is a good chance that there are significant savings to be had by cutting expenses, resulting in improved margins. Qualcomm's margins are well below their peers even though Qualcomm has the scale necessary to have industry leading margins. Qualcomm has never undergone a major restructuring and has now hired outside advisors to review their cost structure. If Qualcomm can improve margins they can greatly improve the profitability of their semiconductor unit even if revenue declines.
Qualcomm Ventures
Qualcomm Ventures is likely the canary in the coalmine for the amount of waste and pet projects there are at Qualcomm. Qualcomm has a venture capital subsidiary that has somehow managed to lose money during the largest venture capital bubble ever. Qualcomm has no business being in the venture capital business and should instead return this cash to shareholders. If I was able to find this huge waste of money by reading through the 10-K, I can only imagine what the consultants will find once they thoroughly investigate the business.
Qualcomm is currently undergoing a process that almost every large cap tech stock has been through. Qualcomm is now a cheap stock, with a steady business, that is returning cash to shareholders by the boatload. The Qualcomm saga feels like a movie I have seen a hundred times before and the ending is a much higher stock price.