YAHOO: Sum of the parts

In 2010, the investment thesis that David Einhorn of Greenlight Capital had on Vodafone was as straightforward as it was strange. He argues that the market is ignoring the fact that Vodafone owns 45% of Verizon Wireless. While such an opportunity could be expected from small companies without institutional following, Vodafone is a massive entity.

The very same situation is occurring right now with Yahoo.

As you know, Yahoo is a technology search engine company with $4.6 billion in revenue in the LTM. At the current $42 billion market capitalization, this represents a 9.2x Price to Sales ratio. This is an exceedingly high ratio for a company that has mid teens digit EBIT margins and is losing revenue for the last 6 years.

The reason is because investors aren't valuing Yahoo solely on its operating assets, but also the assets that Yahoo owns.

Yahoo owns 35% of Yahoo Japan, an entity separate from Yahoo that operates in Japan. In addition, it owns 401.8 million shares of post-ipo Alibaba.

At current market capitalization, the market is implying that Yahoo Core is worth NEGATIVE $3.6 billion.

In my opinion this is ludicrous and represents an attractive opportunity.

With the sale of 127.1 million shares of BABA and Yahoo current balance sheet makeup, Yahoo Core Est. EV is NEGATIVE $12.47 billion. For a company that made $337M in EBIT in the LTM, this represents an amazing opportunity. 

So, how can one take advantage of this discrepancy?

An illustration: 

For every 1000 shares of Yahoo purchased, one should sell short 1932 shares of Yahoo Japan and 389 shares of Alibaba. By doing this, one can isolate Yahoo's core operating business. 

What is the right price? 

It is hard to say considering that Yahoo Core is in the midst of attempting a turnaround. However, I believe that ascribing a 0.3x EV/Revenue would be more than conservative. This would imply that Yahoo is trading at ~4x EBIT. 

At $54.36, buying Yahoo now represents a 33% upside. HOWEVER, if one executes the hedge and isolates Yahoo Core business, one can theoretically obtain an infinite IRR. Why so? Because at current valuation, the market is ascribing Yahoo Core at less than 0.