Is Yahoo's core business really worth $0?

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Will Yahoo get hammered by the IRS, or is its core business worthless? Based on a simple analysis of the company, at least one of these unattractive assumptions is currently held by investors.

Yahoo was recently hit with some unwelcome news, as the IRS told the troubled Internet company that it would not make an advance ruling on whether a spinoff of its Alibaba shares would subject it to a hefty tax bill. That increases the uncertainty around Yahoo's $23 billion worth of Alibaba stock, and has caused analysts to lose some or all of their faith in a tax-free disposal of the shares.

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For instance, in a Wednesday note, Gene Munster of Piper Jaffray saw fit to "adjust" his price target on Yahoo from $54 to $32, "reflecting our assumption for 38 percent tax rates on both the BABA and Yahoo Japan stakes (previously assumed 0 percent)."

Judging by the price of Yahoo shares, however, investors have long believed that it is likely to be taxed on its Alibaba stake.

A company like Yahoo is generally evaluated based on a "sum of the parts" valuation, whereby the value of disparate businesses or holdings are added together to arrive at a value for the shares.

Some parts are valued straightforwardly. For example, Yahoo holds nearly $6 billion in cash and marketable securities; dividing by Yahoo's 941 million shares, one finds a value of about $6 per share. And using the assumption of Munster and other analysts that the Yahoo Japan stake will be taxed at 38 percent, that holding is worth a bit less than $5 billion, for a value of $5 per share.

Valuing Yahoo's Alibaba stake is where this exercise gets difficult. Assuming that Yahoo is able to dispose of the shares in a tax-free manner and realize their full market value, the 15 percent stake in Alibaba is indeed worth $23 billion. This would be good for a value of more than $24 a share.

Adding up these figures, one arrives at a share value of $35—well above where Yahoo is trading. And this is even before considering the value of Yahoo's core business, which is expected to generate about a billion dollars in earnings before interest, taxes, depreciation and amortization (or EBITDA) in the coming year. Actually, this would imply a value of negative $3.5 billion for Yahoo's core business.

If one assumes that Yahoo will be hit with a 38 percent tax bill, however, the picture changes. In that case, the $23 billion stake is worth just more than $14 billion, or $15 per share. And this would allow the Alibaba spinoff to trade in line with Alibaba shares; a generous assumption, given that such share spinoffs generally trade at a discount.

Summing the figures now, one arrives at a value of just $26 before the company's core is accounted for, which would mean that the Yahoo business is being valued at more than five times expected EBITDA.

Even Mizuho's Neil Doshi, who has a "buy" rating on Yahoo, only believes that Yahoo's core business should be worth three times EBITDA, or $3 per share. Meanwhile, the optimistic Munster believes a five-times-EBITDA multiple is appropriate, rationalizing that Verizon acquired AOL at an eight-times-EBITDA multiple (never mind Verizon paid a significant premium to market prices in the deal).

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So which is it—are investors expecting the Alibaba shares to be fully taxed, or do they think Yahoo's core business is worth less than nothing?

The truth probably lies somewhere in between. If investors grant a 70 percent chance that Yahoo will be fully taxed on the shares (which is Mizuho's current assumption) and believe that the spinoff will trade at a 5 to 10 percent discount to the company itself, that stake is properly valued at $17 per share. Adding in the value of the Yahoo Japan stake and the company's cash, current prices allow for a value just north of $3 per share, or $3 billion, on Yahoo's core business.

At less than 1 percent of the market value of Google , that's a price that, sadly, may make sense for the crumbling Yahoo core. Of course, if Yahoo continues to fail at mounting a turnaround, even that price may prove substantially too rich.