Behind Marissa Mayer’s SpinCo, a company that does nothing but hold Chinese Internet stock and keep investors off her back
You head an Internet company. It has a billion users. Your social product alone has over 400 million users and is actually kind of hip. You bring in four billion dollars of revenue a year, a billion of that in mobile. You make a profit! You’re the third biggest search engine. You are Katie Couric’s boss.
And yet…your company is worth less than zero.
That financial version of an Escher-esque contortion is familiar turf to Yahoo CEO Marissa Mayer. The Yahoo market cap is around $44 billion. That valuation includes its ownership of 15.4 percent of the Chinese e-commerce giant Alibaba. That’s worth about $38 billion. Yahoo also has a longstanding investment in Yahoo Japan, a separate company it co-founded in 1996. It’s worth around $7 billion. Those numbers can fluctuate. But there are days when you add those up and you can reach the odd actuarial conclusion that Yahoo’s core business—which has been looking a lot better since Mayer got there—has negative value.
On one hand, it’s nice to have such huge stock holdings. If the share price of the other company goes up, your own value increases, and you didn’t have to do a thing. Having that nest egg gives you a lot of breathing room.
But it can also be a problem when the value of your company has nothing to do with the things your company actually does. It means your shareholders are not banking on your company, but making a sideways investment in those other entities. They are guests at your dinner table who don’t care about the meal and are really thinking about the Picasso in your bedroom. They’re not interested in what you serve—they just want to make sure you don’t sell the Picasso to buy more truffles.
Ultimately, the situation might destabilize your business. Or at least your job. Mayer did not want that to happen. So in January she announced a plan to spin off a separate company that does nothing but hold the Alibaba shares. That may solve her Alibaba problem, but cause other problems.
But before we get to that, let’s roll back to how all this came to be.
It started with Jerry Yang, the co-founder of Yahoo. Very early in the company’s history, in 1996, he had made the aforementioned Yahoo Japan partnership with Japanese entrepreneur Masayoshi Son of Softbank. It proved very successful. Almost a decade later, Yahoo wanted to do the same sort of thing in China. But it was failing in its original efforts.
“China turned out to be a very different place,” says Yang. “We were not doing well, struggled with acquisitions there. We were looking to parlay an operational role, where we rely on a partner, invest and be along for their ride.”
Yahoo’s CEO at the time, Terry Semel, and his COO, Dan Rosensweig, told Yang to pick a partner. One Chinese company in particular was beating Yahoo soundly in e-commerce — Alibaba, led by a hustling businessman named Jack Ma and his chief financial officer, Joe Tsai. “It was fairly obvious to choose,” says Yang. The deal was cooked up on the Pebble Beach golf course in 2005, with Yahoo investing $1 billion for 40 percent of Alibaba. “We were in the right place in the right time,” he says. “It was probably good that we had been failing in China.”
That’s for sure. Because over the next few years, as Yahoo’s fortunes and stock price faltered, Alibaba grew bigger and bigger. And the value of Yahoo’s stake skyrocketed. As the roles reversed, the relationship took on a “Star is Born” aspect. Alibaba naturally was unhappy that a declining enterprise owned such a huge share of its value. And Yahoo became more and more dependent on its Alibaba stock. In 2008, when Microsoft made a hostile bid for Yahoo, Yang was determined to fend it off—largely because he knew how valuable the Alibaba stock would be. “I am happy that the company had an asset, a buffer to allow its reinvention,” he says.
But in some ways the Alibaba stake became a mixed blessing, and in recent years the struggles over it have changed the cinematic analogy to “The Treasure of the Sierra Madre.” Because Yahoo held such a valuable, yet undervalued asset locked within its corporate balance sheet, some investors jumped in, sensing a bargain. But they had specific ideas on what Yahoo should or should not do with the money. Those ideas generally tilted towards giving money back to shareholders like themselves; often these new investors found themselves at odds with the people trying to run Yahoo’s actual business. There were fears that they were actually plotting with Alibaba to take over Yahoo. And each subsequent Yahoo CEO would find that trying to thwart those investors was a dangerous game.
One investor came early to the realization that Yahoo’s Alibaba holdings eclipsed its actual business. He was a small stakeholder named Eric Jackson who had been a thorn in Yahoo’s side for several years: in 2007, he had led a shareholder revolt that arguably hastened the departure of then-CEO Terry Semel. In 2010, Jackson visited Hong Kong and won a rare meeting with Alibaba’s CFO, Tsai. “His ulterior motive was that he was having difficulties with Carol Bartz [who had become Yahoo’s CEO],” says Jackson. While Tsai railed against Yahoo’s refusal to sell back shares to Alibaba, Jackson was able to learn about Tsai’s company. “My eyes were as big as saucers,” he says. He realized that this Chinese company was about to become huge—and Yahoo’s holdings were way out of proportion with the value of its core business.
Jackson joined forces with a much richer player, hedge fund manager Daniel Loeb of Third Point. Loeb took a big share of Yahoo and began pushing for Yahoo to sell shares back to Alibaba and give cash back to shareholders. This synced perfectly with Jack Ma and Joe Tsai’s desires.
The CEO of Yahoo at that point was Scott Thompson. (Yes, we have moved only a few months in our narrative and there is another Yahoo CEO. Scorecards sold in the lobby.) Because Thompson was resisting a sell-off, Loeb wanted him out—and by discovering and exploiting inaccuracies in Thompson’s resume, Loeb succeeded. Thompson resigned in May 2012.
The interim CEO who took Thompson’s place, hoping to pacify Loeb and perhaps prevent a takeover, then agreed to the deal that Loeb and Alibaba wanted. For Yahoo, it was a catastrophic arrangement. Yahoo would sell back 535 million shares, around half its stake, at $13 a share, for a total of around $7 billion. Had Yahoo not sold, the value of those shares would eventually have been worth $45 billion. Worse, it was a taxable transaction and almost half of Yahoo’s proceeds evaporated instantly. Eighty-five percent of the after-tax amount went to shareholders. Only the remaining crumbs went to Yahoo’s cash reserves.
That wasn’t all. The deal specified that when Alibaba went public, as was expected in a few years, Yahoo would be bound to sell 261 million more shares, half of its remaining stake. At that point the shares would be on a steep rise; selling at that point would violate investment wisdom. And once again, Yahoo’s proceeds would be taxable.
The deal was completed in September 2012. By then Marissa Mayer was CEO. To say her team was chagrined at the arrangement was an understatement. “Being forced to sell half our stake at the IPO was an unmitigated financial disaster,” says Jackie Reses, whom Mayer hired as Yahoo’s chief development officer.
Mayer knew how important it was for Yahoo to repair its relationship with Alibaba, which in Reses’ description “had gone down a toxic path and fractured.” Mayer appointed Reses to be Yahoo’s representative on Alibaba’s board. Reses previously had been with a private equity firm, so she had experience in high finance.
“I focused on Alibaba everyday,” says Reses. “Very few days would go by—very few hours would go by—where I wasn’t paying attention to what was happening to Alibaba.” She regularly flew to China, honoring the Alibaba team by seeing them on their home turf.
Alibaba went public last year, and that dreadful 2012 pact indeed required Yahoo to sell half of its stake. But because of the good relations that Mayer’s team had established with Alibaba, Yahoo was able to negotiate a smaller sell-off. When Alibaba debuted on the NYSE on September 19, 2014, Yahoo sold 140 million shares for around $9 billion. It was still a bad deal—Yahoo’s preference would have been to sell no shares at all, leaving its stake untaxed and growing in value. But the renegotiation saved Yahoo billions.
Mayer returned half of the after-tax money to shareholders in the form of a share buyback. The other half went to Yahoo’s cash reserves. None of it went to buy a company like Pinterest.
This still left Yahoo with about $40 billion worth of Alibaba buried in its valuation. It was a sufficiently tempting prize to draw more activist investors. Last year a notorious hedge funder named Jeffrey Smith of Starboard Value bought a stake. Just like his predecessors, he wanted Yahoo to divest its Asian holdings and give the proceeds to shareholders. He expressed his feelings in a letter to Yahoo. He also felt that instead of wasting money restoring an Internet icon, Yahoo should merge with AOL and lay off what would then be redundant employees. And Yahoo should make no more acquisitions, he declared.
Other investors with similar sentiments tried to put pressure on Yahoo. They wrote one essay after another in various magazines, attacking Mayer and urging her to unlock the value of the Alibaba stake so shareholders could feast on it. Mayer could ignore essays. But she did not want these wealthy malcontents to run riot at Yahoo’s next shareholder meeting. And apparently, she was now willing to separate Alibaba from Yahoo’s valuation.
So in January 2015, Mayer announced what she hopes will be the resolution to the struggle.
Yahoo will take all its remaining Alibaba shares and put them in a brand new company that does nothing but hold those shares. Because it is a spin-off company, Yahoo is calling it SpinCo. Current shareholders will get one share each of SpinCo and Yahoo. From the time the arrangement begins, late this year, the two companies will be entirely separate.
The plan was set up in that fashion so as to separate Yahoo from its Alibaba shares without a big tax bill, unlike the previous deals where much of the proceeds were eaten up by the government. (The new company will also include a unit called Yahoo Small Business, which makes custom websites. It’s in there because of regulatory reasons I won’t go into.)
Investors who don’t care about Yahoo but care very much about Alibaba can simply buy shares in SpinCo. The remaining core business, Yahoo, will then have a valuation reflecting what the world thinks the actual company is worth. Well, not exactly. Yahoo will still own the $7 billion Yahoo Japan stake.
Still, Yahoo’s valuation will be more reflective of its actual worth. Mayer thinks it should be a lot. “It’s sort of funny,” she says, “because as I was preparing my earnings script for the Q4 earnings call, I put a line in saying that, if broken out on its own, [Yahoo] would clearly be one of the fastest growing startups in the world. And legal asked, are you sure? I told them, I’m not sure that I can point to anything that’s growing faster than that.”
Mayer professes to be pleased with the situation. “As a company we want to stand on our own two feet and be recognized for our accomplishments and also be held accountable for our shortcomings,” says Mayer. “That’s just something that as a healthy, thriving company we should be able to do and we should welcome.”
Alibaba also seems fine with the outcome. In a television interview earlier this year Tsai remarked that the way Alibaba sees it, a 15 percent stake owned by one company will just be owned by a different company. As far as Alibaba is concerned, there’s no difference. He did give a nice shoutout to Mayer and Reses.
But there are downsides for Yahoo. By divesting the Alibaba shares, Yahoo will never be able to use them as a war chest for acquisitions or even operating expenses. That “buffer” that Yang referred to earlier is gone. Jackie Reses explains that it is no longer needed. “We still have significant cash resources on our balance sheet,” she says. “That’s what our job is—we have to build a successful company and provide returns to all our stakeholders.”
The arrangement may also affect Yahoo in other ways. With the inevitably lower valuation of the core business—Will it be ten billion? Twelve? Higher? Lower?—Yahoo may be more prone to takeover bids. The curse of the Alibaba stake may yet claim another victim.
“That’s not something that I spend my time thinking about,” says Mayer of that issue. “I spend my time thinking about how can we build the best possible products and services for our users. And the right outcome will come from that.”
Eric Jackson, the investor who originally discovered the Alibaba treasure in the cave of Yahoo’s valuation, supported Mayer for a while, but now he’s critical of her decisions. Still, he thinks that Yahoo without Alibaba is an extremely viable company. In fact, he hopes that Mayer will make some of the moves he prefers—such as cutting costs with layoffs—and revive the business in other ways. He thinks it’s possible.
“I hope Marissa figures it out—she has a chance to be a real hero,” he says. “If she’s able to turn the company around, it’s possible that she could take the share price to $80. I hope she does the right thing. I’m still a shareholder.”
Helpful sources for researching this story included Parmy Olsen’s story in Forbes, “Finding Alibaba: How Jerry Yang Made The Most Lucrative Bet In Silicon Valley History” and Nicholas Carlson’s book, Marissa Mayer and the Fight to Save Yahoo.