Analysis: Yahoo CEO Jerry Yang could be facing some dissension from board members who wonder if he is acting more out of emotion than responsibility to shareholders in rejecting Microsoft’s takeover offer, according to recent press accounts.
Given the recent stock performance, those dissident board members may have good reason to wonder.
Yahoo shares were at $19 and falling before Microsoft’s offer, which is currently worth about $42 billion, or about $30 a share.
At current prices, Yahoo trades at about 61 times last year’s earnings and 52 times next year’s estimates. Google, by comparison, trades at 38 times last year’s earnings — and 20 times next year’s estimates.
For that price, investors get 30-40 percent sales growth with Google, and sales growth at Yahoo that’s barely registered in the double digits in the last year or so. It may not get much above that in the next couple of years.
To put that valuation difference in perspective, we’ll use the PEG ratio, or price-to-earnings growth, a simple measure that is so common that Yahoo Finance provides it in its basic stock quotes. In a nutshell, the theory states that a stock’s price-to-earnings ratio, or PE ratio, should roughly equal its growth rate (for example, a company with a PE of 15 should be growing at 15 percent annually, for a PEG ratio of 1).
Yahoo currently trades at a PEG ratio of 3, which means the stock is valued at three times its growth rate. Google trades at a PE of 0.72, which means the stock needs to gain about 39 percent just to be fairly valued. The S&P 500 trades at a PEG ratio of about 1, which means that Google is undervalued compared to the market, and Yahoo very overvalued.
In other words, for the price Microsoft is offering, no wonder the company is hesitant to raise its offer. It’s going to be hard to get a good return on its investment even at the current offer.
Let’s dig a little bit further to see what Yahoo might be worth to investors as a standalone company, since that’s the direction Yang and company seem to want to take after Microsoft’s initial offer. Yahoo’s cash and investments have been valued as high as $12 a share, so we’ll add that figure to whatever price we come up with.
Yahoo grew at a 22 percent clip in 2006, then slowed to 8 percent last year. According to Thomson Financial estimates (also published on Yahoo Finance), analysts expect 11 percent growth this year and 13 percent next year. If we average that near-term growth out, Yahoo is currently growing at about a 12 percent annual rate. If the company’s shares were valued at 12 times earnings, Yahoo shares would trade at $7, then at $19 when the $12 in cash and investments is factored in, or right where Yahoo was trading when Microsoft made its offer. Don’t let it be said that Microsoft can’t recognize value.
For Yahoo to turn down the Microsoft offer or entice an improved one, it would need to return to something approaching its historical growth rate. Over the long term, analysts expect the company to return to a 22 percent annual growth rate, but long-term estimates are notoriously unreliable, and Yahoo will face a big uphill battle getting there.
If Yahoo can get to 22 percent annual growth, it would merit a $13 valuation without its investments, and $25 a share with. That’s still $5 a share less than Microsoft’s current offer.
Looked at strictly through the cold prism of numbers, the dissident Yahoo shareholders have reason to scratch their heads.
Yang understandably has an entrepreneur’s attachment to the company he founded, but if Microsoft gives him a graceful exit by raising its offer, he might consider taking the money.
Paul Shread is a Chartered Market Technician (CMT) and member of the Market Technicians Association.