COPENHAGEN BUSINESS SCHOOL M.Sc. in Finance & Strategic Management Executing the spin-off to tackle low valuation: the case of Yahoo! Giovanni BARTOLLINO Supervisor: Domenico Tripodi Number of Pages: 75 Number of Characters (incl. spaces): 141,534 Number of Characters (excl. spaces): 118,811 Hand in date: 17th May, 2016 1 To this School, for all the great and unexpected opportunities it gave me 2 Abstract The choice of this specific topic bases on the personal preference to improve the knowledge of two particularly attractive areas: “divesture strategies” and “company valuation”. According to the most personal opinion, the decision of divesting a business unit, a division, or the whole corporation is one of the toughest decisions a CEO has to make. By involving both emotions and rationality, divesting is a crucial choice that in many cases it changes a firm’s physiognomy irreversibly. The specific case of Yahoo Inc. offered the opportunity to analyze a situation in which a firm that is negatively valued by the market is trying to solve the low valuation problem by spinning-off its core business. This work initially hypothesized that the spin-off was the correct course of action for Yahoo, and then tried to demonstrate it by reviewing the related literature and by running a valuation of the core business as a spun-off entity. The methodology followed in the valuation bases on the Probability DCF approach introduced by Nygard & Razaire in 1999, which was expected to bring some advantages over more classic methods such as the Discounted Cash Flow approach. This work, however, doesn’t want to show the prevalence of one method over the other. The analysis of the literature review revealed how the spin-off can effectively solve some of the problems related to the specific case of Yahoo, while the valuation demonstrated that Yahoo’s core business, as a standalone entity, is worth more than as a part of the company. Besides the reasons above, this work offers the opportunity to be “in the shoes” of consultants and tackle the problem under their perspective. It is one of the last news that Marissa Mayer, CEO at Yahoo since 2012, has hired consultants to solve the tricky situation. 3 Table of Contents 1. Introduction................................................................................................................................. 6 2. Problem definition ..................................................................................................................... 8 2.1. The problem .......................................................................................................................... 8 2.2. Research question ................................................................................................................ 9 3. Methodology ............................................................................................................................. 10 3.1. Scientific view .................................................................................................................... 10 3.2. Research approach ............................................................................................................ 12 3.3. Case approach ................................................................................................................... 13 3.4. Structure ............................................................................................................................. 14 4. Literature review ...................................................................................................................... 16 4.1. Spin-off ................................................................................................................................ 16 4.2. Probability Based DCF ...................................................................................................... 19 4.2.1. Introduction to DCF approach ............................................................................. 19 4.2.2. Probability Based DCF approach ......................................................................... 20 5. Yahoo (the “Company”) .......................................................................................................... 22 5.1. History ................................................................................................................................. 22 5.2. The Company and its Parts .............................................................................................. 25 5.2.1. Yahoo Japan ............................................................................................................. 25 5.2.2. Alibaba ..................................................................................................................... 25 5.2.3. Yahoo’s Core Business ........................................................................................... 26 6. Analysis ...................................................................................................................................... 29 6.1. Strategic analysis ................................................................................................................ 29 6.1.1. PEST analysis .......................................................................................................... 30 6.1.2. Porter’s Five Forces analysis ................................................................................. 31 6.1.3. SWOT analysis ........................................................................................................ 33 6.2. Performance analysis ......................................................................................................... 35 6.2.1. Stock analysis .......................................................................................................... 35 6.2.2. Financial statements analysis ................................................................................ 36 6.2.2.1. Income statement analysis .......................................................................... 37 6.2.2.2. Balance sheet analysis ................................................................................. 38 6.2.2.3. Cash flow statement analysis ..................................................................... 39 6.2.2.4. Key performance indicators analysis ........................................................ 40 4 6.2.3. Summary of the findings ........................................................................................ 41 7. Model .......................................................................................................................................... 42 7.1. Method ................................................................................................................................ 42 7.1.1. Adjusted Present Value ......................................................................................... 42 7.1.2. @RISK ....................................................................................................................... 44 7.1.3. Trinomial tree .......................................................................................................... 46 7.2. Forecast ................................................................................................................................ 49 7.2.1. Revenues forecast .................................................................................................... 49 7.2.1.1. Search advertising ....................................................................................... 49 7.2.1.1.1. First stage .......................................................................................... 50 7.2.1.1.2. Second stage ...................................................................................... 57 7.2.1.1.3. Third stage ........................................................................................ 57 7.2.1.2. Display advertising ..................................................................................... 58 7.2.1.3. Other revenues ............................................................................................. 60 7.2.2. Costs forecast............................................................................................................ 61 7.2.3. Capital Expenditures forecast ................................................................................ 63 7.2.4. Net Working Capital forecast ................................................................................ 63 7.3. Assumptions ....................................................................................................................... 64 7.3.1. Unlevered Cost of Equity Capital (Ku) ................................................................. 64 7.3.1.1. Risk Free Rate ............................................................................................... 64 7.3.1.2. Expected Market Risk Premium ................................................................ 65 7.3.1.3. Beta ................................................................................................................. 66 7.3.2. Market Cost of Debt ................................................................................................ 67 7.3.3. Long Term Growth Rate ......................................................................................... 67 7.4. Valuation ............................................................................................................................