RD's Picks

Carl Icahn has decided to try and shake things up after Yahoo rejected Microsoft's takeover bid a little over a week ago. According to this Marketwatch report, Mr. Icahn has accumulated 50 million shares of YHOO and is mounting a proxy fight for control of the board of directors.

Presumably, Carl plans on restarting negotiations with MSFT to complete a sale. Good call to all who figured that the market overreacted on the apparent death of the deal. For the rest of us, it may be worth evaluating whether or not playing 'follow the leader' makes any sense.

First, I think it's safe to assume the upside is limited to $33, Microsoft's last offer. They made it pretty clear they weren't going to pay up beyond that for YHOO. Given all the press hype and shareholder anger, they might not even be willing to go that high anymore.

Next, I'd want to try and establish a downside to the trade. A reasonable floor would be Yahoo's value if there weren't anyone interested in buying the company. To get that, I compared YHOO to GOOG's valuation. For a quick and dirty, I used the PE multiple based on estimated 2009 earnings for the two companies. GOOG closed today at $576.30, 23.3 times estimated 2009 earnings of $24.74 a share. Estimated 2009 earnings for YHOO are 56 cents a share. Applying GOOG's 23.3 multiple results in a comparable value for YHOO of only $13 a share. And GOOG has a higher estimated earnings growth rate, so YHOO should trade at a discount to GOOG. $13 is a far cry from todays after hours where YHOO finished at $27.65. Unless I've missed something (always very possible), the market is currently putting more than a 100% premium on YHOO to account for a possible buyout.

Between the MSFT buyout blowup and today's close, YHOO has traded between the mid 23's and about 27. It's safe to assume Icahn acquired his shares somewhere in that range. The mid-point is in the low 25's. That's important, there's something like $2.50 a share difference between Icahn making a profit and anyone who bought in the after hours making a profit.

This isn't the type of trade I'm interested in getting involved with, even with play money. In this case, the risk-reward ratio looks backwards. In the best-case scenario, the upside is a little over five bucks a share. If it blows up, the downside could be over fourteen a share.

If I were going to make this trade, I'd wait and see if the price comes down to somewhere near Ichan's price point. It's a good bet his plan works at 25 a share, not so certain it works much higher than that.

Comments: View Comments |  Wednesday May 14, 2008  |  Stocks: YHOO,