Eric Jackson of Ironfire Capital has a superb article at Forbes (How a “Cash-Rich Split” Could Take Yahoo! to $41/Share) setting out his “cash-rich split” analysis of Yahoo! Inc. (NASDAQ:YHOO). Here’s Jackson’s analysis:

A “cash-rich split” is the ideal way that Yahoo! should deal with its Asian assets. Furthermore, Yahoo!’s advisers – Goldman Sachs (GS) — must know this. They are smart guys and this is so obvious. If Yahoo!’s board is not yet convinced of this, they should be. Any leveraged recap plan or selling only a small piece of Yahoo! to private equity would be highway robbery of the shareholders by the board compared to a “cash-rich split.” What is a Cash Rich Split? Here is a definition.

Here is a definition. A cash-rich split-off is an M&A technique whereby the Seller exchanges stock of the Company for stock of a “cash-rich” subsidiary of the Company (“SplitCo”) on a tax-free basis



Benefits of cash-rich split-off for Company:



Opportunity to tax-efficiently dispose of a non-core asset





Opportunity to repurchase shares at attractive price





Company should seek to negotiate a share of Seller’s tax savings through a discount in the valuation of the shares repurchased



Benefits of cash-rich split-off for Seller:



Tax-free disposition of Company’s low tax basis stock by Seller, substantially for cash





Seller can negotiate with Company to contribute operating assets which Seller seeks to acquire





Alternative use: can also be used to unwind a stock-for-stock monetization structure on a permaently tax-free basis (e.g. Time Warner Cable/Comcast)

How would this work for Yahoo? The pre-tax value of Yahoo!’s 40% preferred stake in Alibaba Group is around $14 billion based on related transactions over the past two months (and Yahoo!’s last earnings call). The pre-tax value of Yahoo!’s 35% stake in Yahoo! Japan is $6.5 billion at Yahoo! Japan’s current market price of Y25,000. Let’s discount this to $5.5 billion as Yahoo! Japan might need an incentive to participate and liquidity. Only 66% of the compensation involved in a “cash-rich split” can be in the form of cash. So for their $14 billion of Alibaba Group stock, Yahoo! would receive $9.2 billion in cash and $4.8 billion of “other” assets. The $5.5 billion for Yahoo! Japan shares would be roughly $3.6 billion in cash and $1.9 billion in “other” assets.

The pre-tax value of Yahoo!’s 40% preferred stake in Alibaba Group is around $14 billion based on related transactions over the past two months (and Yahoo!’s last earnings call). The pre-tax value of Yahoo!’s 35% stake in Yahoo! Japan is $6.5 billion at Yahoo! Japan’s current market price of Y25,000. Let’s discount this to $5.5 billion as Yahoo! Japan might need an incentive to participate and liquidity. Only 66% of the compensation involved in a “cash-rich split” can be in the form of cash. So for their $14 billion of Alibaba Group stock, Yahoo! would receive $9.2 billion in cash and $4.8 billion of “other” assets. The $5.5 billion for Yahoo! Japan shares would be roughly $3.6 billion in cash and $1.9 billion in “other” assets. Where do Alibaba Group and Yahoo! Japan get billions in cash for this transaction? Jack Ma could sell shares of Alibaba Group to Temasek (main contributor) and perhaps other interested parties (such as DST, Silver Lake) also participate. Yahoo! Japan already has around $2.5 billion in cash today. The rest can come from Softbank (who’s also involved in both Alibaba Group & Yahoo! Japan) or a secondary offering.

Jack Ma could sell shares of Alibaba Group to Temasek (main contributor) and perhaps other interested parties (such as DST, Silver Lake) also participate. Yahoo! Japan already has around $2.5 billion in cash today. The rest can come from Softbank (who’s also involved in both Alibaba Group & Yahoo! Japan) or a secondary offering. What are the “other” assets that Alibaba Group & Yahoo! Japan can contribute? This looks like a key issue with Alibaba Group’s tangible assets of only a $2 billion and Yahoo! Japan without a non-core asset of significance. The key is that only 5-10% of the total contribution has to be from an asset owned for more than 5 years. The remaining assets (23-28% of total spin value) can be acquired as part of the deal. Hulu might be an interesting asset for $3 billion (or whatever the market price is) and would be a great strategic fit. There are many other content, video, and social acquisitions that could be additive to Yahoo!’s core business.

This looks like a key issue with Alibaba Group’s tangible assets of only a $2 billion and Yahoo! Japan without a non-core asset of significance. The key is that only 5-10% of the total contribution has to be from an asset owned for more than 5 years. The remaining assets (23-28% of total spin value) can be acquired as part of the deal. Hulu might be an interesting asset for $3 billion (or whatever the market price is) and would be a great strategic fit. There are many other content, video, and social acquisitions that could be additive to Yahoo!’s core business. What restrictions would Yahoo! have with the SplitCo proceeds? Yahoo! would have access to the cash the day the transaction closes.

Yahoo! would have access to the cash the day the transaction closes. What would Yahoo! look like post the 2 “cash-rich splits” of their Asian assets? You’re waiting for $41/share. We’re getting there. This is where it gets very interesting. Post split, Yahoo! would have close to $16B in cash ($3 billion of their existing cash + $9.2 billion from Alibaba Group + $3.6 billion from Yahoo! Japan). Yahoo! would also control almost $7 billion of “other” assets contributed as part of the splits. And Yahoo! would still have their core search and display biz worth $7.5 – 12 billion (based on a 5x – 8x multiple). It’s hard to see this portfolio of assets worth much less than $30 billion vs. the current market cap of $20 billion. That translates to fair value of $25/share.

You’re waiting for $41/share. We’re getting there. This is where it gets very interesting. Post split, Yahoo! would have close to $16B in cash ($3 billion of their existing cash + $9.2 billion from Alibaba Group + $3.6 billion from Yahoo! Japan). Yahoo! would also control almost $7 billion of “other” assets contributed as part of the splits. And Yahoo! would still have their core search and display biz worth $7.5 – 12 billion (based on a 5x – 8x multiple). It’s hard to see this portfolio of assets worth much less than $30 billion vs. the current market cap of $20 billion. That translates to fair value of $25/share. What is the bull case if this plays out as described above? Yahoo! would be advised to use their cash to conduct a massive equity shrink, using a series of tender offers. And, of course, the lower the buyback price, the more shares they could buy back and the higher Yahoo!’s fair value rises. Let’s say Yahoo uses the $16 billion in cash to buy back as many shares as they can for $18/share. The number of the shares outstanding will go from 1.25 billion to 350 million. Yahoo! would still own the $7.5 billion core business + $7 billion of assets (not including any value for the patents which is ludicrous). $14.5 billion/350m shares = $41 stock. And the board — if they were really channeling John Malone — could conceivably lever up and buy back more shares. Simple sensitivity around the average buyback price and leverage is a very interesting exercise for one to play with. You can get to above $45 and $50/share very quickly.

Yahoo! would be advised to use their cash to conduct a massive equity shrink, using a series of tender offers. And, of course, the lower the buyback price, the more shares they could buy back and the higher Yahoo!’s fair value rises. Let’s say Yahoo uses the $16 billion in cash to buy back as many shares as they can for $18/share. The number of the shares outstanding will go from 1.25 billion to 350 million. Yahoo! would still own the $7.5 billion core business + $7 billion of assets (not including any value for the patents which is ludicrous). $14.5 billion/350m shares = $41 stock. And the board — if they were really channeling John Malone — could conceivably lever up and buy back more shares. Simple sensitivity around the average buyback price and leverage is a very interesting exercise for one to play with. You can get to above $45 and $50/share very quickly. What are the risks? 1) I’ve said it before and I stand by it — this is the worst corporate board in America. They could make a dumb decision. Fortunately their advisers understand the “cash-rich split” potential and Dan Loeb is standing at the ready to ensure the board makes no bozo moves. 2) They could name a new CEO first, before explaining the rest of the plan. This gets back to point 1 and a dumb board. 3) There are obviously many parties involved and all have to agree on price, timing, etc.

The YHOO situation is starting to get very interesting with Dan Loeb and Third Point holding a position and agitating for change. With a potential $41/~$15 payoff, it’s worthy of further consideration.

No position.