When you’re hunting for shares to buy, it’s often good to start with companies where the share price has already had a good run. When a company gets momentum behind it and starts turning itself around, gains can go on for longer and further than anyone expects.
One current example is Yahoo! (Nasdaq: YHOO). Shares in the tech giant have doubled over the last year. Many people have put that down to the arrival of a new CEO last year, Marissa Mayer.
Now Mayer has done a good job so far. But I don’t think the markets have fully appreciated the significance of the changes she’s made yet. So she’s not the main reason the shares have done well.
There’s much more to Yahoo than a simple change of management – and that also could mean it has a lot further to rise…
The secret behind Yahoo’s rising share price – China
If you want to know the real driver of Yahoo’s rising share price, you have to look to China.
Most companies that depend on China in any way for their revenue have suffered since the start of this year. But we’re not talking about any sort of natural resources play here.
No, at least part of Yahoo’s rising share price is down to the fact that it holds a 24% stake in Alibaba, a Chinese e-commerce company.
Think of Alibaba as a cross between eBay and Amazon for the Chinese market. In the first quarter of this year, profits at Alibaba soared 190% to $680m. An IPO (initial public offering – the company is still private) is expected within the next year or so. The Techcrunch blog cites several analysts who believe Alibaba could be worth as much $120bn.
If that valuation is accurate, then Yahoo’s stake in Alibaba is worth $30bn. Yet Yahoo’s current market capitalisation is no higher, at just $30bn!
Now, in fairness, Yahoo will have to pay tax on any sale proceeds. And not all commentators think Alibaba is worth as much as $120bn – you never know what these things are going to go for until IPO day arrives.
But even if we reduce Alibaba’s valuation to $80bn, and dock some repatriation tax, Yahoo’s stake is still worth around $13bn.
If you break Yahoo down, it looks really cheap
This isn’t the only ace Yahoo has up its sleeve. For one thing, the company has a cash pile of $4.8bn. Then there’s its 35% stake in Yahoo Japan. This is conservatively worth about $5.5bn, after adjusting for tax.
Take those two, plus the $13bn for Alibaba, and the core Yahoo business outside Asia is valued at around $6.5bn.
Granted, there are problems with the core business. The search engine business was eclipsed by Google many years ago, and the brand feels tired and old-fashioned. A poorly received logo redesign probably won’t change that fusty image. What’s more, revenue is still falling.
However, there is some good news coming through. I believe that Mayer’s changes will improve the business, and this is what markets aren’t quite appreciating.
She has been investing heavily, and has made several promising acquisitions. For example, she has revitalised the Flickr photo platform and bought the trendy Tumblr blogging site.
Yahoo has also been investing in video. You can now see the archive for US favourite comedy show, Saturday Night Live, via Yahoo Screen.
Mayer is focusing on getting users to visit Yahoo several times a day, so that their ‘daily habits’ are done through Yahoo. Those habits could include checking share prices, reading about the latest fashions or joining discussions on forums.
Early signs suggest this new strategy is having an impact. The number of monthly visitors to Yahoo sites has risen by 20% since July 2012. And that excludes Tumblr users.
Yahoo is also seeing a big jump in mobile email usage. All of this extra traffic should enable Yahoo to eventually generate more advertising revenue.
What will it do with all that cash?
We’ve already seen that Yahoo is sitting on a big cash pile. That may grow if the Alibaba stake is sold. Some of that money would almost certainly be used for share buybacks. But Mayer will also probably use some of it for further investment in mobile and acquisitions.
And so far, the signs are that her strategy is sensible and will pay off. That suggests to me that the share price has further to go from here.
Markets might have at least partly woken up to the value of the Yahoo’s Alibaba stake, but I don’t think they’ve yet realised that the core business also looks set to grow.
There’s potential profit here for patient investors. If you buy now, I suspect you won’t regret it.
• This article is taken from our free daily investment email, Money Morning. Sign up to Money Morning here.
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