Alley Insider pointed out that Capital Research Management owns 6% of Yahoo! and 11% of MSFT. CRM met with MSFT yesterday to assess what the impacts of this deal will have on its holdings in the companies. Obviously, with YHOO surging and MSFT falling in the past week, in the short-term, given CRM’s bigger holding in MSFT and MSFT’s larger market cap, CRM has had a rough time.
In fact, the figures are 5.95% and 11.36% respectively. So what has happened to their holdings in the past week?
In one week, they have lost $2.16B. It should be noted that buyers always see a pounding to their stock price initially… but over time, this would be a winner for CRM I think. Let’s assume the final price is indeed $44.6B, what happens to CRM’s stakes?
Rightfully or wrongfully, we’ll assume that the YHOO value climbs to $44.6B and MSFT falls by the same amount. You now see the loss narrowing:
Over time, I suspect that MSFT will get back - if not to the $330B levels - but at least to $300B within a quarter, the company’s core businesses are growing ferociously… as you can see, quickly, CRM would be in the black.
In the next year, I expect MSFT to get back to its pre-deal level of $330B. Now you see CRM making a $2B profit from the proceeds of its stake in YHOO:
Within 1 year, tops, the combination of MSFT/YHOO would create a powerful option for investors looking to invest in something less pricey than Google. Suppose the combined entity would grow to $400B in value, then CRM’s stake would look like:
Of course, by now some are wondering what I am smoking… but it’s not crazy to suspect that MSFT + YHOO would command much better growth prospects. In fact, by adding YHOO’s $7B revenue streams onto MSFT’s $51B 2007 revenue base, combined with YHOO’s higher P/S multiples pushing MSFT’s P/S and P/E up… MSFT being a $400B company is not out of the realm of possibility.
MSFT’s P/S is 4.52, YHOO’s is 5.81. Combined, the new company would have something near 5.25. Google’s is 9.50.
MSFT’s revenue grew from $44B in 2006 to $51B in 2007.
For 2008:
- without YHOO, just last week Microsoft raised its full-year forecasts for fiscal 2008. Revenue is now projected to be $59.9 billion to $60.5 billion, up from the Oct. 25 forecast of $58.8 billion to $59.7 billion, an increase of 1.3 percent on the high end. The average of $59.9 billion to $60.5 billion is $60.2B.
- Yahoo! alone will do $7.2B to $8B, according to their recent earnings call.
Combined this means a revenue range of $67.1B to $68.5B, or an average of $67.8B.
Using a 5.25 P/S multiple, this projects MSFT’s value to be $355.5B.
That’s just using the P/S and revenues. There’s a lot of cost savings (MSFT pegs this at $1B) and the P/E projection - while less obvious - is more interesting. MSFT netted $14B in 2007. Yahoo! only $600M. Combined you are looking at a company that nets $15B in profits. Google generated $17B in revenues!
More importantly, MSFT would be able to invest all more into IT to make Yahoo! competitive. MSFT’s current P/E is 16 (but this after the week-long slide after the YHOO deal was announced), YHOO’s is 60. YHOO’s is indeed distorted due to its holdings in Alibaba and Yahoo! Japan, but there is no way that investors won’t give a combined entity firing off all cylinders in software, entertainment and online advertising anything less than 30. Google’s P/E as a pure play online advertising/search play is 38 P/E.
MSFT/YHOO profits of $15B x a P/E of 30 is $450B.
Even if the P/E is a more sedate 25, then at $15B profits, you are looking at a company worth $375B.
At half of Google’s P/E, you get a multiple of 18, that yields $270B. But, that is way too low cause MSFT is right now at 16 and was above this before the YHOO was announced.
For this reason, a post-merger YHOO/MSFT would be worth near $400B (average of P/E and P/S basis) and more than offset any decline MSFT has faced this week.
To conclude, we think that Alley Insider is being foolish by maintaining a very short term horizon to assess CRM’s thoughts on this deal. CRM is probably urging MSFT to up the bid a bi, maybe even to $50B so that YHOO and MSFT amicably forge a partnership to usher in, or restart, the 21st century. In that case, we suspect the payoff table to look like this:
And based on our figures, in one year:
Disclaimer: Long YHOO
Subscribe: