Alibaba Seeks $21B in Highly Awaited I.P.O
dealbook.nytimes.com
dealbook.nytimes.com
Discussion: https://news.ycombinator.com/item?id=7606891
In fact it's the Alibaba, Yahoo Japan, and cash positions that are discounted down from their face value. Not the business of Yahoo (which receives a multiple).
Cash is ultimately what the Alibaba position represents. Cash is always discounted, sometimes heavily, on a balance sheet. It would be extremely rare to see a public company receive a $1 to $1 ratio on cash to market cap.
Let me give you a simple example of this premise as it would apply to Yahoo.
Let's say they have $35 billion in Alibaba, and a $39b market cap. And let's say they have $1.3b in earnings. They liquidate the Alibaba holdings, and disperse all that cash to shareholders. So the $1.3 billion in earnings is now receiving a market capitalization of $4 billion (3 times earnings)? Nope, they would probably trade for 15 to 30 times earnings still (depending).
It's the value of the Alibaba holdings that is discounted.
There are a lot of easy demonstrations of this in action. Apple is an ideal one. Their cash exploded like a rocket up to $150 billion, their market cap and multiple compressed such that cash was 40% of their market cap (but that's not what actually happened, the cash was heavily discounted).
Think of it like food for a body. It's nice to have plentiful energy availability in the form of food, a surplus of food around the house is typical. However there's only so much you can realistically do with it, and your body has an energy limit / potential limit. This is true about all businesses in any given period of time, they can only do so many things successfully. Cash is a required operational fuel, and sometimes it's useful for acquisitions, but each dollar of cash you possess beyond the bounds of your realistic capabilities or potential (the ability to put that cash to work for the business and yield a sizable return), is worth less and less and less.
That's why Amazon has been allowed to keep such a large market cap, despite the fact that for most of their history they had a terrible balance sheet, and very modest cash.
If Google had $10 billion in cash instead of $60 billion, what would not happen, is Google wouldn't see a ~12% discount applied to their market cap. It's all about the earnings, the business, the future growth prospects in advertising and mobile, and so on. Investors aren't primarily sitting around wondering what Google might do with the $3 billion dollars they add each quarter - they want to know how mobile search is doing.
Microsoft has been a great demonstration of how worthless cash often is to a cash rich business (except as a discharge to investors). They simply can't find anything sane (or permissible) to do with it all, and that has been the case for 15+ years.
That's why stocks historically are traded by a multiple of their earnings. That's why companies can have hilariously bad balance sheets, like Comcast or as GM used to, and still have a reasonable market cap.
(1) If the company is burning cash - This is self explanatory. Remember that the opposite is true as well - when arriving at the price target, investors will also give credit for any free cash flow (FCF) that they expect the company to generate over their holding period.
(2) If most of the cash is held overseas - Unless the US has a tax repatriation holiday, companies will face a "make-whole" tax bill based on the delta of the tax rate between the US and the foreign domicile. This is a big issue for large-cap tech companies that generate substantial cash overseas, but whose expenses / capital returns policies all use US cash. For example, Cisco has $51bn in cash, of which $46bn is held overseas. Cisco and most other companies facing this issue have publicly stated that they will not repatriate cash unless there is a tax holiday. They are generating enough free cash flow in the US where they have no need to. They could also raise domestic debt based on foreign cash balances to get around the need to repatriate. As a result, most investors do end up giving cash a 1:1 credit even in this scenario.
(3) If investors don't trust the management team's use of that cash - Cash is only valuable to equity investors in so far as it can eventually be returned to shareholders through share repurchases or dividends. Companies often get penalized if the management team has a history of using cash in inefficient ways - either investing in non-core / dilutive business adjacencies, or value-destructive acquisitions. Zynga is the perfect example here - the bull thesis on Zynga when it was trading at $2.50 was that the company was trading at cash value. The bears on the other hand felt uncomfortable giving Zynga full value for the cash because the management team had acquired a number of gaming studios (e.g. OMGPOP) that did not provide any long-term contribution and were eventually shut down.
Long story short, in most circumstances, you should operate under the assumption that investors are giving a company 1:1 credit for cash. What they're actually discounting is the denominator - the earnings if you're using a P/E multiple, or the EBITDA if you're using an EV / EBITDA multiple. They're betting that the projected earnings power of the company is overly optimistic. That's actually a double whammy - valuation multiples are dependent on growth rates, i.e. higher growth results in a higher multiple. If the denominator falls, the growth rate is lower, and thus the multiple contracts as well. Most retail investors fail to understand that a slight decrease in the denominator actually has a much larger impact on the valuation.
The case of Yahoo is a bit unique, but related to #2 above. The market is implying that Yahoo won't be able to liquidate it's Alibaba stake in a tax-efficient manner and will thus end up paying 20-35% taxes. Happy to run you through the full math, but after you account for taxes, you're paying ~5-6x EBITDA for a business growing single digits y/y. Arguably Google is a more tempting investment opportunity - it's trading at roughly the same multiple, but growing double digits y/y.
It's always about the earnings, then it's about the sales, then it's about the assets (unless the assets are staggering in size in relationship to the operating business, and in that case the market cap will get a severe discount vs the assets, which is why you end up with weak businesses trading at discounts to assets).
If investors almost always valued assets at a $1 to $1, you'd almost never under any circumstances see a company trading for less than either cash or net tangibles. When in fact this is historically frequent, and for the majority of the history of the US stock market it was quite common.
You can see the cash and asset discount demonstrated across companies including Berkshire Hathaway, Apple, Microsoft, Yahoo, Cisco, banks small and large, and classically in cable companies like Comcast or Time Warner.
It's fairly easy to prove this is the case. When companies with low multiples and tons of cash, drop that cash off their balance sheet, the operating business does not receive a hyper small multiple, and the market cap does not collapse in line with the cash dump. If Apple dumped $100 billion to investors with a one time dividend tomorrow morning, their stock would not plunge by 15%. There is case after case after case of historical examples to reference.
If investors valued balance sheets so strongly, Comcast would be nearly worthless. It's the operating business that is valued first and forecast. Investors know cash does not yield a great return (especially right now), and for most businesses it does not provide great growth opportunities period, it is thus investors heavily discount cash.
Institutional investors don't value tech companies based on tangible book - they use P/E or EV / EBITDA multiples (or FCF multiples for software companies). The only companies that trade on net asset value (NAV) are financial companies such as banks. For those companies, the balance sheet structure is the opposite of traditional companies - assets such as cash represent liabilities (they're funds individuals have deposited in their account). As a result, the NAV framework is inappropriate to apply to tech companies.
Two specific points on the above examples:
(1) Cable companies are valued using a different investment framework. They are highly capital intensive businesses, where cash today does not reflect cyclical future capital expenditures. Furthermore, these businesses have a tremendous amount of leverage, and thus you have to look at net cash balances, not gross cash.
(2) Your Apple example is absolutely correct. This actually happened when Microsoft announced a special one-time dividend in 2004. This goes back to my 3rd point above - when companies hoard a significant cash balance without any plans for capital returns, investors start to discount the cash. This was Icahn's thesis when he went activist on Apple. However, I would caution against extrapolating this to companies that don't have significant cash balances.
I know it sounds tempting to say that cash doesn't generate great returns and is thus logically undervalued. There are two reasons why that's not the case.
(1) Investors usually use EV / EBITDA multiples to arrive at an enterprise value. EBITDA is prior to the recognition of interest expense / income - the earnings generation of cash does not matter here at all. After arriving at the EV, they then add cash and subtract debt (at a 1:1 value) to arrive at the equity value, and then divide by shares outstanding to arrive at the target price.
(2) Investors that use P/E multiples need to normalize for variations in cash balances by using ex-cash P/E multiples. For most companies, cash is a small percentage of the market cap such that P/E multiples are a close enough approximation to ex-cash P/E multiples. For companies with large cash balances, that's not the case, and the valuation method needs to be adjusted appropriately.
If your argument is that some investors fail to do this, you're absolutely right. However, they are doing so based on an error of judgement - not because they really believe cash shouldn't be valued on a 1:1 basis.
How fast Yahoo! can see the cash is another matter, as there's some history of bad blood between Alibaba and Yahoo!
In short, because they can raise maximum money from the IPO.
http://blogs.wsj.com/moneybeat/2014/05/12/hong-kong-right-to...
Lasers http://www.alibaba.com/trade/search?fsb=y&IndexArea=product_...
Nuclear reactor gear http://www.alibaba.com/trade/search?fsb=y&IndexArea=product_...
and so on
As for Alibaba, I also don't understand how they generate much revenue as a non-fiduciary and non-risk-taking matchmaker that doesn't handle transactions themselves.