The long-term case for Yahoo stock

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Yahoo has been in the news more than any other corporation; the soap opera drama that exists with the corporate few and investor Carl Icahn was more than enough to fuel headlines. Now that the deal is finalized with Icahn giving up his proxy vote to overthrow the board and eventually sell out to Microsoft, Yahoo has given him three seats on the newly larger board of 11. This gives Icahn some sway in the Yahoo board, but not enough to push any serious changes.

Yahoo and Icahn seal the deal

It looked as though Yahoo had finally bought Icahn off, but second quarter earnings will likely bring a new look into a Microsoft buyout. Throughout the takeover struggle, Yahoo has noted that the business is extremely undervalued, given its potential on the internet. However, at $20 per share, Yahoo is priced accordingly. A PE of 29 is not high considering its industry; Google trades at a PE of 33 and Amazon a PE of 56. It should be considered that Yahoo’s growth rates are also lagging behind the others when compared to the earnings multiple. Yahoo shows a PEG of 2.33, while Google boasts a .8 PEG ratio and Amazon a 1.9.

Yahoo’s seemingly terrible second quarter results do put new hope into a Microsoft takeover. A buyout would add 50% to Yahoo’s value to shareholders if sold at the previous price of $31 per share. That bid is extremely high, granting Yahoo a earnings multiple of 45. On the free market, Yahoo could not achieve that kind of price, especially when its search engine earnings are falling rather than rising.

Yahoo’s dropping earnings

Yahoo showed eight straight quarters of negative growth before Microsoft’s takeover offer. If Icahn and the other two new directors can persuade the rest that a Microsoft deal is in its best interest, Yahoo stockholders have reason to celebrate. Yahoo stock could run up 50% in a matter of days if a new deal is reached. Surely Google shareholders will have reason to complain, but it's likely that the two merged engines will happily coexist with Google as they do now.

Microsoft’s bid far too much

From the stance of Microsoft, it's hard to see why it would be smart to ever pay a 50% premium for a company that is slowly losing its business. Microsoft has made billions doing what it does best – pumping out new software every four years and selling it to the same millions of clients. MSN continues to struggle in the search engine field, logging in at a distant third for total search volume. Microsoft’s $240 Million infusion into Facebook valued the new social marketing site at $15 Billion, but that investment has yet to even look rewarding. Even Microsoft’s internet browser is falling off the map; a free browser produced by Mozilla is sweeping the internet and its marketshare.

What Microsoft does right is creating software. Shareholders should be concerned that Microsoft is spreading itself too thin and may eventually raise prices on its software to help fund its efforts in dominating the internet. Yahoo is clearly not worth a 50% premium, but it seems that Microsoft wants it just so Google does not. The two have been in an acquisition war in businesses like AOL, and then dueled with Google’s investment in Myspace and Microsoft’s in Facebook.

Hold on for Icahn

Yahoo shareholders should hold on and see if Icahn can truly work his magic on the Yahoo board. Even as Yahoo reported that its earnings tumbled by 18% from this time last year, traders were nice to the internet portal and ate up guidance that its yearly figures will be near target. Short sellers have apparently made their cash with Yahoo and are uninterested in pushing it down. If Yahoo reports another bad quarter, let the Microsoft talks begin yet again.

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