The Yahoo Problem

In 2012, with her appointment as CEO, Marissa Mayer had an ambitious plan to bring Yahoo back to its glory days and it was a theoretically sound one.

The majority of online users spend their time on smartphones engaged in activities like reading email, checking sports scores, getting weather and news updates, watching videos, chatting with friends, and connecting on social media. Most of these activities are traditional strong holds of Yahoo on the desktop. But Yahoo had not made the transition to mobile with its users.

So Mayer had a plan to bolster Yahoo’s mobile offerings and once again make it a top internet destination. However, a plan like this has three drawbacks: 1) Developing desirable well-trafficked mobile properties requires lots of hard-to-hire-for mobile design, engineering, and product talent. So Mayer chose to acquihire promising mobile startups instead. 2) It takes lots of time and money to market these products and convince users of their benefits. 3) Internet attention is now a zero sum game. If people spend more time on Yahoo properties, then inherently, they are spending less time on Facebook, Instagram, Youtube, Gmail, Snapchat, and BuzzFeed. So it’s obvious that taking on both large tech companies as well as well-funded upstarts in their primary revenue stream (eyeballs) is going to result in an expensive prolonged user acquisition back alley knife fight.

Thus Yahoo faced two major constraints: time and money. Fortunately, with a new management team, Yahoo had at least 2 years to prove itself. And even more fortuitous was Jerry Yang’s investment in Alibaba, which created one of the “most lucrative bet[s] In Silicon Valley history.” This meant Yahoo also had the cash firepower necessary to bring a gun to the knife fight.

Unfortunately, it was precisely this Alibaba bet that would be Yahoo and Mayer’s undoing. In the last 4 years, Yahoo did acquire some great mobile startups including Tumblr for social media among teens (for $1.1 bn), mobile analytics firm Flurry (for $200 mm), Summly for news aggregation (for $30 mm) which eventually led to the great Yahoo News app, and the creation of the Yahoo Weather app which prompted the venerable Johnny Ive to write a congratulatory note to Mayer for its outstanding design. Later, Yahoo earnings did show a large uptick in mobile users across their portfolio. However, it was all a little too late. In late 2014, Alibaba IPO’d and suddenly it became crystal clear where Yahoo as a conglomerate derived its value from. In fact, the market valued Yahoo’s core business below zero. In other words, the prevailing sentiment was that Yahoo’s management team would take the Alibaba assets and basically burn them pursuing low return on investment strategies like buying more unprofitable mobile startups.

With large amounts of Alibaba value locked up inside Yahoo, it painted a target on Yahoo and Mayer’s back. There was too much money being left on the table for activist investors not to jump in and demand a separation of Alibaba and Yahoo. However, this was antithetical to the Mayer strategy of spending cash now to build a large portfolio of mobile properties that would (hopefully) bring in a multiple of ad revenue in the long run.

Perhaps this perfectly illustrates the agency problem in corporate governance.

In corporate finance, the agency problem usually refers to a conflict of interest between a company’s management and the company’s stockholders. The manager, acting as the agent for the shareholders, or principals, is supposed to make decisions that will maximize shareholder wealth. However, it is in the manager’s own best interest to maximize his own wealth [and prestige]. While it is not possible to eliminate the agency problem completely, the manager can be motivated to act in the shareholders’ best interests through incentives such as performance-based compensation, direct influence by shareholders, the threat of firing and the threat of takeovers. - Investopedia

Part of the conflict is that management like Mayer want to preside over ever larger businesses, and in return be compensated for managing a $25-50 billion dollar tech/media conglomerate as opposed to a small $0-5 billion tech dinosaur. But the real issue at play in this case is the difference of opinion on what will maximize shareholder value in the long run. Investors lost confidence in Mayer’s ability to turn BABA stock into YHOO ad revenue. Part of this is simply investors’ extreme short termism; they wanted a quick return fast, but part of it was also just being tired of seeing the value of the company decline despite being handed the Chinese golden goose. But, I would go further to say that perhaps building a portfolio of mobile internet properties was not the way to go. It was too obvious a strategy, that had frankly already been done. Perhaps, the way Yahoo grew itself out of a death spiral was investing in completely new innovations like it did with its big data technology, Hadoop, which eventually became Hortonworks, a public company worth half a billion dollars.

Regardless, eventually Mayer and the Yahoo board acquiesced to a separation of YHOO & BABA, but again it was a little too late. Selling off its Alibaba holdings and paying a dividend to shareholders would have incurred an unacceptable 35% tax on the proceeds (considering shareholders would then be double taxed on their personal gains). So the only course of action was to spin off Alibaba into its own holding company that investors would then receive stock in. However, the IRS took issue with the spin off and did not give its blessings on the deal, despite having approved dozens of such deals in the past.

So now here we are today Q1 2016. Yahoo is looking at “strategic alternatives.” Which means Yahoo is now looking to sell or spin off its own core business and leave the Alibaba stock in the shell of the company. A rather disappointing end to what looked like such a promising start with Mayer’s appointment in 2012.

But this begs the question, how could the story have unfolded any better? I’m not sure there was anything anyone could have done other than spin off the BABA or YHOO core earlier and thus force Yahoo to act more like a small cap company with a low profile and low cash balance. Meaning Yahoo would have acted more like a startup, forcing it to justify its plans in order to raise more money from the capital markets. However, as they say “hindsight is 20/20.” I applaud Mayer and the Yahoo management for their ambition and hard work attempting a bold plan to revive the brand, and I also applaud Starboard Value and the shareholders for forcing Yahoo to take a hard look at where the value of the company really lies and the likelihood of success. In the end, maybe the stock market worked like it was supposed to.

 
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