$YHOO Q1 Earnings Preview

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Event:  YHOO reports Q1 earnings today after the close.  The options market is implying about a 6% move, which is above the 4 qtr avg move of 5.0%, and the 8 qtr avg of about 4.25%.  YHOO declined almost 9% on its January earnings report, its worst decline on earnings since 2006.

Sentiment:  Wall Street analysts are relatively neutral on YHOO, with 19 buys, 18 holds, and 1 sell, and an avg 12 month price target of $41.50.  Short interest is relatively low, at 2.5% of the float.  The stock is down 17% so far in 2014, though YHOO is still up around 40% in the past year.

Options Open Interest:  Total open interest is skewed towards calls over puts by a ratio of about 1.85 to 1.  Similarly, the one month average volume is also skewed to calls over puts, by a ratio of 2.5 to 1.  The Apr19th 35 calls have been the most active line over the past 2 days, trading over 25k on Friday and again on Monday.  In terms of total open interest, the weekly 35 and 37 calls, and the weekly 35 and weekly 34 puts all have over 40k of open interest.  Farther out, the 40 call strike has the most open interest, with the Jan15 40 call strike has over 50k in open interest.

Fundamentals:  When YHOO reported their Q4 results back in January, the results were essentially inline with consensus expectations, but they guided Q1 margins (7% year over year decline) and EBITDA well below consensus (mid point $310 million vs consensus of $365 million).  The core business of YHOO (excluding investments in YHOO Japan and Alibaba) is nothing short of bad and declining.  The case to own YHOO has had little to do with their US business despite some of the headlines that Marissa Mayer has received since taking over as CEO in mid 2012.

Obviously the driver for YHOO’s share value is their 24% stake in China’s Alibaba, which some very optimistic expectations place at a pre-tax value of $40 or $50 billion upon its impending iPO later this year.  In YHOO’s quarterly reports the company releases some limited disclosures as to Alibaba’s quarterly results and not surprisingly the stock is likely trade more on this than their core.  Last quarter Alibaba’s revenue growth showed some deceleration, but with higher margins.  Many analyst remain wildly bullish, and many see re-acceleration in the quarters to come.

Bernstein Research internet analyst Carlos Kirjner had the following to say re: Alibaba back on January 29th in a note to clients:

-Alibaba Group margins came much ahead of our expectations. We are increasing our margin forecasts and as a result our 2015 net income estimate is now $6.2 billion (vs. $6 billion before).
– our pro-forma estimates for Alibaba Group for the next several years. We now
believe these estimates could be quite conservative, and Alibaba could beat our $6.2 billion 2015 net income. Despite that, we will retain our valuation at about $190 billion until we see 4Q13 results and  get another data point on the revenue growth trajectory.

For those who want to see how many analayts are backing into Alibaba’s value to YHOO, here is Kirjner’s quick and dirty sum of the part:

We believe this $190 billion valuation for Alibaba implies at least $24/share for Yahoo! shareholders. This assumes that (1) Alibaba IPOs at a roughly 40% discount to our Alibaba fair value. Importantly, given the agreement between Yahoo! and Alibaba, Yahoo! is compelled to sell 40% of its stake at the IPO price. We then assume (2) the transaction is fully taxed at 38% (potentially a very conservative transaction), and (3) that Yahoo! will keep 30% of the roughly $7B of IPO cash proceeds, distributing the rest. Finally, (4) we apply a 50% discount to the cash proceeds Yahoo! keeps for the risk that it will not be fully returned to shareholders.

Price Action / Technicals:  YHOO broke its 200 day moving average last week for the first time since mid-2012:
YHOO daily chart, 50 day moving average in pink, 200 day moving average in yellow, Courtesy of Bloomberg

YHOO daily chart, 50 day moving average in pink, 200 day moving average in yellow, Courtesy of Bloomberg

The stock nearly tripled in that period, but has had a tough time in 2014.  The 50 day moving average is downward sloping for the first time since mid-2012, and is now around $37.  The $35 is the first line of resistance on the upside.  On the downside, the $30 level is the next reasonable support level to watch.

Volatility Snapshot:   

The combination of the recent selling in the stock combined with this critical earnings release has implied volatility at 2 year highs:

Screen Shot 2014-04-14 at 12.16.04 PM

2 year IV30 from LiveVol Pro

Depending on the move look for implied vol in May to go from the high 40’s to the low to mid 30’s following the event.

Our View:  We have been on record on more than one occasion over the last few months that given the limited disclosures from Alibaba, and the fact that they do most of their business in a fairly opaque business environment of China, that some of the valuations thrown around for Alibaba seem a bit cavalier.  This is just our slightly contrarian opinion, but given the stagnant gdp growth in China, the potential for a bursting credit bubble in the nation it just doesn’t make a whole heck of a lot of sense to us that investors are so quick to assign Alibaba one of the largest market capitalizations on the planet.

All that being said, YHOO’s core business woes are well known at this point, and the higher YHOO trades into an IPO filing the quicker YHOO investors will have to contemplate what YHOO management will do with all that cash (they have to sell half of their stake on the IPO).  Massive share buybacks will obviously be considered, and I suspect some expensive speculative acquisitions, and continued acqu-hires.

With YHOO down 20% from the multi-year high made in early January, we think the stock is a tough press on the short side in the low 30s, and we would be very inclined to take a shot on the long side, with defined risk at or below $30, despite our reservations on Alibaba’s value.  Primary reason is that we see few large liquid situations with such an identifiable catalyst as we see for the monetization of the Alibaba stake.  Large hedge funds will get behind this idea as they did in 2013 on a wash out in the stock.

All that being said, price action in Chinese internet stocks and high growth/valuation stocks in the U.S. could be the beginning of the end, (not predicting, but could) and if so, the likelihood of Alibaba coming public in line with some of the base case bullish scenarios could be challenged.   This is exactly why we would want to define our risk on bullish strategies.

ESTIMATES/FORECASTS FROM BLOOMBERG:

  • 1Q adj. EPS 36c (range 26c-48c)
  • 1Q rev. ex-TAC est. $1.08b (range $1.06b-$1.1b); YHOO forecast $1.06b-$1.1b
  • 1Q oper. profit est. $157.3m (range $133m-$174m); YHOO  forecast adj. oper. profit $130m-$170m
  • 2Q rev. ex-TAC est. $1.09b (range $1.06b-$1.11b)
  • 2Q oper. profit est. $176.8m (range $136m-$231m)
  • 2014 rev. ex-TAC est. $4.5b (range $4.38b-$4.67b)
  • 2014 oper. profit est. $792m (range $696m-$900m)