YHOO Stock Now Has to Wrestle with Taxes Post-Alibaba IPO

Yahoo! Inc. (Nasdaq: YHOO) stock rose 4% today, with Starboard Value LP reportedly buying up a large stake in the company.

The investment management firm's decision is a positive development for YHOO, which had seen its shares tumble for most of the week on concerns that as it sheds its portfolio of overseas investments, the remaining core business will be valueless.

YHOO stock has seen a nice two-year run. YHOO StockWith YHOO's more than 20% stake in Alibaba Group Holding Ltd. (NYSE: BABA), investors saw the U.S. company as a cheaper way to buy into China's booming e-commerce sector at a discount ahead of the much-anticipated Alibaba IPO. YHOO stock was just above $40 pre-BABA IPO, while BABA was trading at $68 before closing at $93.89 on its first day of trading.

YHOO stock gained 170% from the time of its initial sale of part of its once-40% stake in BABA in 2012, delivering an impressive $3.31 earnings per share (EPS) to shareholders.

But YHOO can't ride the Alibaba hype forever. At some point, the struggling U.S. tech company will have to stand on its own.

"The value infused by the Alibaba deal is a huge windfall for Yahoo shareholders and Yahoo management," said Money Morning Chief Investment Strategist Keith Fitz-Gerald. "Whether or not something can be done - whether Yahoo can actually grow its business - remains to be seen."

It's first challenge post-Alibaba IPO? Finding a tax-efficient way to sell its remaining stake in BABA - one that delivers on the true value of its almost decade-old investment and gives shareholders bang for their buck.

With Starboard taking a position in the company, one of its initiatives is to unlock "the substantial value from Yahoo's non-core minority equity stakes in Alibaba Group Holding Limited ("Alibaba") and Yahoo Japan in a structure that delivers value directly to Yahoo shareholders in a tax-efficient manner," according to a letter from Starboard managing member Jeffrey Smith sent to YHOO Chief Executive Officer Marissa Mayer.

YHOO held a 24% stake in BABA before the IPO, but sold about 140 million shares to reduce the stake to 16.3% on Sept. 19, all a part of a "proposed staged exit" of YHOO investment in BABA the two companies negotiated back in 2012 and amended twice. There are close to 400 million BABA shares remaining, valued at about $36 billion according to Barron's.

YHOO Chief Financial Officer Ken Goldman said that sale will be "fully taxed" in an earnings call in July.

"Regarding tax-efficient structures on the remaining equity holdings, we approach all transactions with the goal of maximizing long-term value for our shareholders," Goldman said. "These transactions are complicated, can take multiple years, involve multiple jurisdictions, and generally are not disclosed before completion."

Here's how Yahoo could approach the share sales in a way to benefit YHOO shareholders...

Tax Efficiency Will Determine True Value of YHOO

In order for shareholders to realize the profits of YHOO's holdings in BABA, YHOO is going to have to find a way to cut its capital gains tax bill, which could eat away significantly at the value of the sale.

When YHOO sold some BABA shares in 2012, the after-tax gain brought YHOO's income from the sale down from $4.6 billion to $2.8 billion.

Barron's suggested in a report earlier this week that YHOO could go the way of Liberty Interactive Corp. (Nasdaq: LVNTA) Chairman John Malone. In May, Malone spun off his company's 22% stake in TripAdvisor, and its 100% ownership of BuySeasons into a separate $3 billion company. This triggered a U.S. tax law that isn't subject to the same corporate-level taxes as an outright stock sell-off.

One analyst, however, wrote that Yahoo could do even better.

"There is a high likelihood that Yahoo! finds a way to avoid essentially all tax on the remaining... shares it will hold in Alibaba post IPO," Gene Munster, an analyst from Piper Jaffray's wrote in an analyst note, according to Barron's.

"For valuation purposes, we assume the remaining...shares are divested at $81 per share...and taxed at 10%. We arrive at the 10% tax rate by weighting our belief that there is a 75% chance they are able to pay no taxes with the 25% chance that they end up paying the full 38% tax rate on the second tranche," Munster wrote.

It's still up in the air just how YHOO will maximize these profits, but the consensus remains that it will take a while for YHOO to figure it out. YHOO stock had slipped 7.4% since the day before BABA hit the market - until Starboard's letter led to a gain of 4.4% today (Friday). YHOO shares closed at $40.66.

UP NEXT: That Alibaba could well be Yahoo's salvation is a bit ironic considering that a decade ago the two companies were rivals. And even after Yahoo bought that big stake in Alibaba, the relationship was often a rocky one. Here's the story of one of the more extraordinary partnerships in tech...

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