ABRACADABRA: Altaba

Yahoo is no more. Having sold its core business to Verizon, all that’s left is a stub, now called Altaba. You can think of Altaba as a magic box containing some goodies and some baddies. Goodies are: the 15.4% stake in Alibaba, 35.5% stake in Yahoo Japan, cash & securities, and some legacy intellectual property and other assets. Baddies are: the deferred tax liability on the pregnant gain attached to its holdings in Alibaba and Yahoo Japan, potential liabilities from class action claims, and a bit of debt & other liabilities.

I estimate asset value per share for Altaba of $86; the current share price is $57.23, equating to a 33% discount to asset value. The market expects the baddies to eat away $28.78 per share of value. After you take out Altaba’s known debt and other liabilities, the market discount works out to be $26.56 per share.

The question is if the market discount is mispriced? 

Altaba’s liabilities

Altaba’s material liabilities fall within the three main buckets: Deferred tax liabilities; Class Action Claims; and debt and other liabilities.

Deferred tax liabilities attached to Altaba's investments in Alibaba, Yahoo Japan and the other assets is significant. Yahoo had invested in Alibaba and Yahoo Japan at a very early stage and the gain since then has been astronomical. Based on the 36.5% effective tax rate used by Altaba, and using information in the legacy Yahoo financial statements for cost basis in in Alibaba and Yahoo Japan shares, the potential tax deferred liability works out in the region of ~$23 billion or ~25.64 a share. My calculation is a conservative estimate and assumes no cost base for the intellectual property or other assets; the actual liability if full tax is paid on all of the assets, is likely to be lower assuming Yahoo had some cost base on its other assets.  

Based on the estimated deferred tax liability, if all of Altaba’s gain is taxed, then the market’s opinion of value is more or less correct. However, two factors could materially reduce Altaba’s tax burden:
1) any reduction in the US corporate tax rates under the Trump tax reform should be a clear upside for Altaba; and
2) the way Altaba’s goes about monetizing its assets could materially reduce its tax burden (in particular, on the Alibaba shares).

On the tax reform front, there is no way to clearly predict the outcome or timing. But the odds look good any reform is likely result in a reduced US corporate tax rate; may be not the 15% the Trump administration wants or even the 20% Paul Ryan has spoken about, but there is a good chance of the rate falling to to 25%. Now the timing of when this happens is anybody’s guess, but many predict a good chance of the tax reforms happening in FY18.

Whilst the tax reform is not in Altaba's control, it has some things it could control to reduce the tax burden. The best case scenario would be something as follows:

1. Altaba first sells all of its intellectual property and other assets in a taxable transaction;

2. It then sells its 35.5% Yahoo Japan stake in either a taxable transaction, or, if a deal could be reached with Yahoo Japan, then look to achieve this via a tax free cash-rich split. A cash-rich split could be structured via Yahoo Japan transferring a subsidiary containing ~67% of the agreed price in cash and ~33% the price in an operating asset currently held by Yahoo Japan in exchange its 35.5% shares held by Altaba. There should be appeal in structuring the sale as a cash-rich split for both parties, provided they are able to meet the strict conditions under the US tax code. The appeal for Altaba is clearly in achieving a higher cash outcome than if the sale is fully taxed, and the appeal for Yahoo Japan is in buying back its shares at a discount to open market value.

3. Finally, having sold all its assets bar its 15.4% Alibaba stake, Altaba could do a deal with Alibaba to buy out Altaba in exchange for issue of new Alibaba shares. Such a transaction shouldn’t trigger the tax on the latent gain inherent in Altaba’s Alibaba shares. There should be clear appeal for Alibaba to do a deal on the basis that it could buyout its shares at a decent discount.

Altaba's board has indicated that it would seek to monetise its other assets before monetising its Alibaba stake, so the above scenario is not unreasonable. 

The table below shows my estimate for Altaba’s tax liability under the various scenarios.

As can be seen, reduction in tax rates and/or mitigating tax on the Alibaba stake (and potentially on Yahoo Japan stake) offer significant cash tax savings for Altaba.

Class Action Claims: The other big unknown for Altaba is the quantum of exposure on the various legal claims its faces related to security breaches. Altaba obviously hasn’t disclosed a number for the contingencies. One thing we do know is that as part of its deal to sell its core business to Verizon, Yahoo agreed to be responsible for 50 percent of any cash liabilities incurred post-closing related to non-SEC government investigations and third-party litigation related to the breaches. Liabilities arising from shareholder lawsuits and SEC investigations will continue to be the responsibility of Yahoo, now Altaba. Verizon chipped $350m from its agreed price for the legal contingencies. If one assumes that Verizon did its due diligence and its price chip was a reasonable estimate for potential liabilities faced by Yahoo for the non-SEC government investigation and third party litigation, then Altaba has $350m exposure on these. Now, there is no way of knowing what the quantum of exposure will be on the shareholder lawsuits and SEC investigations, but assuming that these are 3 times that of the non-SEC and third-party litigation, then the total exposure faced by Altaba would be in the region of $1.5 billion (or $1.67 per share).

Debt and other liabilities: Based on filings Altaba has ~$2.2 per share of other liabilities, including its convertible loan notes.

Discount: In addition to the above liabilities, one also ought to build in a discount for the stub. In the scenario where Alibaba sells all of its assets in a fully taxable transaction, this discount should account for any costs at the Altaba level - e.g. advisor’s fees and management compensation. I expect this to be ~1% to 2% max. However, in the event Altaba does a deal with Yahoo Japan and/or Alibaba, it is most likely that they will want a reasonable discount for the deal (likely 10% - 15%). 

Valuation

Accounting for the various scenarios, I calculate an intrinsic value per share for Altaba of between $69 and $74. This would equate to a return in the region of 22% to 30% on current price.

Risk

One material downside risk for a Altaba shareholder is that the shares are heavily exposed to Alibaba; and Alibaba is by no means cheap, trading ~60 times TTM PE. This exposure could be reduced by shorting Alibaba (each Altaba share holds ~0.43 Alibaba). However, shorting Alibaba could be a risky proposition given Jack Ma’s track record of smashing growth estimates every investor day. The average price target for Alibaba from 43 analysts tracking the share is $167 against its current share price of $151 and most have a Buy or a Strong Buy rating. Having Alibaba exposure via Altaba may well be worth it given the current significant discount at which Altaba trades and all the different ways in which value could unlock.