THE GREAT YAHOO ARBITRAGE OPPORTUNITY
Hi everyone, Stephan Bach here.
I am a German student interested in arbitrage strategies.
Mainly I research the field of bonds but from time to time also with shares opportunities emerge. Today I want to reveal a currently present arbitrage opportunity with Yahoo! Inc.
Yahoo’s time as a star in the information technology sector probably is fading. However, at the moment I am writing this Yahoo is still valued at a whopping $31 billion. So you might wonder why I believe that still is greatly undervalued.
The answer to that riddle lies in Yahoo’s 15% stake in the Chinese Alibaba Group Holding Ltd. (which as a whole company is even after a recent price drop valued at $168.88 billion.
These above mentioned articles suggest simply buying Yahoo! Inc. shares (I will call the strategy Yahoo long). However, these articles fail to explicitly outline what has to be done to really “use” that undervaluation. Just the fact of a present undervaluation does not make a proper arbitrage strategy. If for example the undervaluation persists you might have to wait literally ages or could even lose money in the short run. Also, the price of Alibaba shares might drop and the 15% stake will in consequence lose value. Thus, just going Yahoo long is not the right option.
First, why is Yahoo undervalued?
There are 941.39 million Yahoo shares. Further, Yahoo! Inc. owns 383,565,416 Alibaba Group ordinary shares (see Yahoo’s 2014 Annual Report p. 121).
That means for every bundle of ~2.45 (precisely: 2.454314077158614) Yahoo shares bought the buyer de facto owns 1 Alibaba share.
The current price of a Yahoo Share is $32.93.
$32.93* 2.45 = $80.68 per bundle (de facto 1 Alibaba share).
$80.68 — $68.18 (bundle minus the price of 1 Alibaba share) = $12.50.
So this is the price for 2.45 shares of the “pure” Yahoo business without Alibaba. That is $5.10 per share.
The whole “pure” Yahoo company without Alibaba is accordingly valued $5.10 * 941.39 million shares = $4.801 billion.
What I am saying now is that this is undervalued because:
· Yahoo Japan
· and Cash
As of June 30, 2015 the fair value of Yahoo’s 35.5% stake in Yahoo Japan is based on the quoted stock price, was approximately $8 billion. Since then the price has rather increased than decreased.
Further, Yahoo holds cash and cash equivalents of $1.188 billion and short-term marketable securities of $4.636 billion. That sums up to total cash of $5.824 billion.
So for $4.801 billion it is possible to buy the Yahoo core business including Yahoo Japan and Yahoo’s cash which alone sum up to $13.8 billion! (On a per share basis: the investment of $5.10 in “pure” Yahoo acquires Yahoo Japan shares for $8.49 and a share of Yahoo’s cash of $6.17)
Again, the 2 main problems of the suggested strategy (Yahoo long) are:
If Alibaba shares drop in price the strategy won’t work.
If the undervaluation persists the strategy won’t work
So here come the fundamental improvements to that initial idea (Yahoo long) to transform it into an actually working arbitrage strategy:
1. First, the risk of Alibaba shares to drop in price needs to be hedged. Here is what needs to be done:
To buy the “pure” Alibaba business we need to go long 2.45 Yahoo! Inc. shares (or a multiple thereof) and go short 1 Alibaba Group Holding Limited share (or a multiple thereof).
What is hedged against is the dependency on Alibaba. Theoretically, it also would be possible to hedge against a possible price drop of Yahoo Japan. However, this is not done here because it does not have such a big influence on the overall trading strategy.
2. Second, how to eliminate the possibility that the undervaluation persists?
Here unfortunately, not every investor has the option to do so. However, if a large investor or a group of investors decide to completely takeover Yahoo they would get the option to solve that problem! The investor would even up the short-position in Alibaba with the shares Yahoo owns. By doing that the investor would indeed purchase the “pure” Yahoo business (including Yahoo Japan and the cash) for $4.801 billion only.
Finally, for your information and as a backup of the presented strategy here some institutional investors that are already invested in Yahoo (as of June 30, 2015):
Maybe you liked what you just have read and are able to realize that current arbitrage opportunity. Or you know someone that can get this to work. Let me know what you think of it and follow my personal blog: Thinking about money on ackro.com.
Cheers and best regards
The analyst recommendations exclusively represent his opinions. This article is for informational purposes only and does by no means represent an invitation or promotion to purchase, hold or sell Yahoo and or Alibaba shares. The analyst does not accept any liability whatsoever as to any disadvantages arising to third parties from the use of the non-binding information on this webpage.