Monday, May 16, 2011

Yahoo's Latest Problem & The Risks of Investing In China

By now the news regarding Yahoo's latest little problem has circulated for days. It's got to be bad news for Carol Bartz, if only because, in the best case, it would seem that she didn't divulge the information publicly for some weeks.

I won't waste a lot of space on the particulars. Basically, for years, Yahoo has been seen as valuable for its investment stake in Alibaba Group, the China-based online firm. The Wall Street Journal noted, in its Friday piece on this story,

"Hedge-fund manager David Einhorn, of Greenlight Capital, earlier this month disclosed a position in Yahoo while expressing interst in the Internet company's China holdings. He argued Yahoo's stake in Alibaba Group could be "ultimately worth Yahoo's entire current market value." "

In this recent post, I noted Einhorn's investment, and how it might actually represent the best exit opportunity that existing Yahoo shareholders were going to see,

"Einhorn has amassed a position in the company's equity and favorably commented on its China properties and recent 'shareholder-friendly' changes.

I'm sure remarks like that from Einhorn send chills through Bartz. Increased equity accumulation, requests for board seats, and a spinoff of Yahoo's Chinese interests can't be far behind, can they?

I suppose since Yahoo's equity price has been flat for so long, Einhorn is getting a bargain. Assuming, that is, his math on breakup values is correct, and he is able to effect that.

What I wonder, however, is how long his investors tend to wait for payoffs in these types of moves? Perhaps the patient, trusting nature of his investors gives Einhorn time to wait for Yahoo/Bartz to eventually come around to accept his type of bear hug.

But fellow hedge fund/company acquirer Eddie Lampert's Sears reported falling sales just the other day. His foray into retail hasn't had such a happy ending yet.

Of course, Einhorn probably doesn't want to run any part of Yahoo, so much as put pieces into play and hopefully make much, much more on the skyrocketing value of the Chinese properties than he will lose on the rest of Yahoo. In that regard, it's likely a safer play.

Assuming he can get the firm split up reasonably soon.

Then, again, I've argued that Bartz should just sell or liquidate the firm. This may be one of the last opportunities for a Yahoo CEO to create some value for shareholders from a position of any strength whatsoever. Maybe Einhorn's interest should be greeted with an accommodating attitude. It may be quite some time before another suitor with such manners comes calling. "
Now, it seems that my chance remarks about Lampert's Sears foray and the risks for Einhorn seem eerily prescient.
Stories differ on when Yahoo's board or CEO was informed of the event that is at the heart of the flap. It seems Alibaba sold its Alipay unit, according to the Journal report,
"to an entity controlled by Alibaba founder and Chief Executive Jack Ma in response to rules issued last year by the People's Bank of China, or PBOC, that could potentially bar foreigners from owning controlling stakes in Chinese Internet-payment services."
Alipay has been described as a Chinese version of PayPal. Most analysts and pundits were aghast that the crown jewel of Alibaba, itself the crown jewel of Yahoo, had been purloined by Ma.
Yahoo says it was notified of this on March 31 of this year, but Alibaba contends they informed Yahoo's board "in July 2009 that the "majority shareholding in Alipay had been transferred into Chinese ownership."
Oh dear. If Alibaba is correct, Bartz and her board learned of the Alipay sale only about six months after she took the reins of Yahoo in January of 2009. That would seem to mean that Yahoo's board and, probably, senior management team failed to disclose a material event affecting the firm's prospects and valuation for well over 18 months.
Even if Bartz' and Yahoo's version is true, they've waited about six weeks to disclose the surprise transaction. Regardless, the Journal article reported that yahoo shares fell some 13% on Friday in response to the news.
The nearby six-month chart of Yahoo's price, as compared with the S&P500 Index, is informative. It took the post-Einhorn stake price rise for Yahoo to match the index's performance, only to crater on the Alipay story. Given Yahoo's troubled history, I wonder if the May price rise was a function of investors deciding to join Einhorn in his play to extract more value from the equity. It would make sense.
Mind you, Yahoo's price was in the $16 range to start, so a 10% gain wouldn't even get it to $18. Prices were in the $17.48 range before it fell last week.
I have no idea what Einhorn's average cost is for the stock, but he must be seething to learn that such a key asset, and evidently the main reason for his Yahoo investment, is gone.
One Journal article suggested Bartz' exit may be imminent. I'd think Einhorn would be considering a lawsuit for the board's non-disclosure of such material information.
Never the less, this little episode nicely showcases the risks of turnaround investing, whether by ordinary retail investors or veteran hedge fund operators like Lampert and Einhorn. Not to mention that even an astute guy like Einhorn may have been too clever by a half when he bought into Yahoo by failing to realize that the management gang that got itself into such valuation straits may have also mismanaged their control over the China crown jewel for which so many investors evidently prized the company's equity. Especially, it would seem, Einhorn himself.
There's a reason why Yahoo's fortunes declined so in the past decade. Thus the risk of owning the shares of this mediocre internet has-been, hoping that something it once did might, amidst all its mistakes, turn out to rescue the company's valuation fortunes.
Then there's the provocative passage at the end of this weekend's edition Heard On The Street column concerning the Yahoo debacle,
"If investors thought Google had a problem in China with censorship, Yahoo just made it look trivial. China represents a huge chunk of Yahoo's value. Shareholders' hopes of realizing that are now in doubt."
I've never bought into the belief that investing directly in China is a good idea. The government and its economic and financial activities are simply too opaque and quixotic. Similarly, I've opined that, so long as this is true, the US dollar has comparatively little to fear from investors selling their greenbacks for Chinese yuan.
This is a classic example of how risky any Chinese investments, whether bricks and mortar, or financial as part-ownership of a business entity, remain.
What is a major issue for Yahoo could snowball, depending upon its resolution, into a turning point for global investors, whether they be businesses seeking to open or expand there, or simply viewing China as an financial investment opportunity.
The combination of the PBOC's unilateral rule which brought on the Alipay "taking" by Jack Ma demonstrates how tenuous outside investor possession of what they think they own in China to be.

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