It’s funny how market opportunities seem to repeat themselves. I remember talking to a coworker in late 2011 about how investors were not giving Yahoo (NASDAQ: YHOO) the credit it deserved for its assets. Shares were trading just under $16 then and the stock was one of my top picks.
Eight months later, Marissa Mayer took over as CEO and shares began to climb on hopes she could unlock value at the internet behemoth. I cashed out at $25 a share in June 2013, well before the late 2014 peak but still at a hefty profit.
Now, the market has once again lost respect for Yahoo even though it is transforming itself into a new company.
Shares are trading for less than the value of the sum of its parts, even based on the strictest of estimates. And I plan to use this as an opportunity to turn the company into a cash machine before and after its core asset sale.
Yahoo Worth More Dead Than Alive
Despite the initial euphoria over Mayer taking the helm, investors have been disappointed with the lack of progress since late 2014. Even after recent gains, shares are still about 30% below their November 2014 high.
Late last year, Yahoo canceled plans to spin off its 384 million shares in Alibaba (NYSE: BABA) on concerns over a tax bill that could amount to as much as $10 billion. Then, in February, the company announced it was exploring “strategic alternatives” and hired three investment banks to manage the sale of its core business, which includes search, mail and news.
Evidently, this wasn’t enough, because the following month activist hedge fund Starboard Value LP launched a campaign to replace every member of the board in a very public letter.
On April 22, Yahoo announced it had received 10 initial offers for its core business ranging from $4 billion to $8 billion and would be narrowing the field. These included strategic bids from companies like Verizon Communications (NYSE: VZ) and YP Holdings LLC, as well as private equity bids from a consortium led by Bain Capital LP. SoftBank Corp. also expressed an interest in working with bidders to acquire Yahoo’s 35% stake in Yahoo Japan, a wholly separate company.
The fact that bidders see both strategic and investment value in the assets leads me to believe that, when all is said and done, the company will get closer to $8 billion for them, or possibly even more.
Yahoo will still have some assets in apps and services like Tumblr, along with sizeable investments in Alibaba and Yahoo Japan after the sale. As has been the case in the past, the market doesn’t seem to be able to value these assets.
Yahoo’s stake in Alibaba is currently worth $29.8 billion. But based on analysts’ mean 12-month price target of $93.40 per share, that stake could be worth $35.9 billion. The stake in Yahoo Japan is worth approximately $9 billion.
Even assuming Yahoo makes only $6 billion from the sale of its core assets — though it’s likely to be higher as the bidding process escalates — the company will have net cash of $10.6 billion on the balance sheet after removing debt.
The Asian assets should be discounted but are worth at least $26.8 billion on a 31% tax rate, assuming the company can’t find some way to reduce the tax burden. Add this to cash and you get $37.4 billion, or $39.50 per share, with no value given for other parts of the business like apps and services.
How to Cash Out Early for a 78% Annualized Gain
We can conservatively say shares are worth around $40 each, so traders who get positioned now should benefit, especially when investors learn how much money they’ll be getting for the core business.
While I imagine Yahoo will want to keep a sizeable cash hoard to build the new company through acquisitions, there will still be billions left to return to shareholders. But rather than wait for that income, we can create our own income stream immediately with a covered call strategy.
With YHOO trading at $36.95 at the time of this writing, we can buy 100 shares and simultaneously sell one YHOO Jun 40 Call, which is trading around $0.87 ($87 per contract) for a net cost of $36.08 per share, which is 2.4% below the current price.
If YHOO closes above the $40 strike price at expiration on June 17, our shares will be sold for $40 each. In this case, we will make $3.05 in capital gains, plus the $0.87 we received for selling the call, for a total return of $3.92 per share.
This represents a profit of 10.9% over our cost basis of $36.08. Since we’d earn that in 51 days, it works out to an annualized return of 78%.
The decision on the asset sale may be completed by the June expiration, but there’s also a good chance the process will get extended. This could mean shares stay below $40 and we get an opportunity to generate cash with another covered call.
Yahoo may still try to spin off its Asian assets, but it would have to wait until the core asset sale is completed. So, investors may have a year or more to generate cash from the position before the market realizes the full potential in Yahoo’s assets.
One last thing: As I write this, investors are skimming hundreds and even thousands of dollars in additional income from Yahoo and other stocks just like it. The money is there for the taking; they’re just beating Wall Street to it. If you want to learn how you can collect an additional $850 a week in income by doing the same, click here.