Yahoo China!

And Alibaba Merger in 2005

&
Buy back by Alibaba and the impact of stake sale on Yahoo share prices

Submitted in Oct, 2014
by
Jigar Desai 13
MMS Finance (2013-15)
___________________________

The Deal: Alibaba and Yahoo China Merger
Yahoo forayed into China by launching platform for email and instant messaging, translation of U.S. content
(news, finance, weather) into two Chinese languages, and directory access to 20,000 web sites, an approach that
the company had adopted elsewhere in 1999. This company was called Yahoo China.
The number of internet users in China stood at roughly 5 million in 1999 but grew to 40 million in 2002, by which
time it was clear that Yahoo was not getting the traction that local Chinese internet companies were seeing.
Revenue was only a few million dollars, and we were drawing just 5 million to 10 million users each month. With
the ad market under $70 million, many of our local competitors were rapidly experimenting with new types of
revenue and business models and were far ahead of us. As a result, they amassed much larger user bases and
were collectively generating close to $100 million.
The solution, Yahoo decided, was to acquire a local company that had already gained traction in the market and
that could provide them with proven local management as well as help us with web search, which had become a
priority after they bought U.S. search engine company Inktomi in 2002.
In November 2003, after due diligence, Yahoo announced its agreement to purchase 3721 for $120 million.
However due to cultural gap and open leadership disagreements this acquisition soon failed by 2005.
During the first half of 2005, Yahoos executive team studied the landscape carefully, looking at companies to
acquire or partner with. Most of the companies they met with were publicly held, but Alibaba was still private.
The company was owned by management, venture capitalists, and SoftBank. Yahoo team met with founder Jack
Ma and his chief financial officer at the time, Joe Tsai, and they immediately felt a strong cultural alignment.
Alibaba was based in the south, in Hangzhou, and had about 2,400 employees. The previous year the company
had generated more than $4 billion in gross merchandise sales through its platform, yielding about $50 million
in revenue. It also had two start-up business lines, Alipay, a new payment system designed to work like Paypal;
and Taobao, an auctions site. Both were offered free to consumers and merchants.
Yahoo was impressed by Mas visionary and principled management philosophy, and they also liked how the
two companies might fit together. Yahoo had the financial resources to help Alibaba weather the days of
offering auctions for free as it attempted to compete against eBay.
Yahoo thought there might be a window of opportunity to build a leadership position in search and commerce in
China to complement our portal offerings. Then began an intense two-month period of negotiation to craft what
became the joint venture with Alibaba. Yang had struck up a good relationship with Ma, which greatly facilitated
the negotiations. On the finance and deal side, Yahoo also felt a strong kinship with Tsai. The deal was
complicated to structure, but we eventually decided that Yahoo would own 40%, SoftBank would hold 30%, and
existing management would keep 30%. Ma and the Alibaba leadership team would retain management control.
The deal was valued at just over $4 billion, with Yahoo putting in $1 billion in cash and our Yahoo China assets,
which were then valued at $700 million.
While Yahoo China was tracking toward about $40 million in revenue in 2005, Alibabas consumer business
alone was poised to do more than double that for the year, so it was valued at close to double our operation. At
the time this seemed like a big leap of faith: More than half the value of the venture more than $2 billion
was attributed to Taobao and Alipay, both of which were losing money and had announced that their services
would be free for at least the next few years.
Comments
Yahoos forays into China started with a build strategy, which later became a buy strategy and ultimately
morphed into a partnership strategy. In each phase Yahoo tried to seek the best use of their existing products,
with the knowledge of hindsight we can say that this was far less important than leadership, structure and trust
factors. The real key to our ultimate success in China was the match with Alibabas leadership team. Yahoo had
seen hierarchical, top-down management systems in place in many Chinese companies. Ma, by contrast,
displayed a distinctive humility and openness. Although he didnt have a U.S. education, he was an avid student
of U.S. management and leadership practices, as was evident in their earliest meetings.
Unlike other Chinese leaders, Ma was willing and eager to hire executives who had more skills and experience
than he did in areas where he was less strong. Tsai, for example, clearly understood U.S. business practices and
had strengths that complemented Mas in strategy and setting the vision.


A 2010 Harvard Business School case
1
by Julie M. Wulf noted that Ma studied Jack Welchs approach and was
inspired by GEs decentralized decision-making. Like Welch, Ma wanted his executives to be free to do whatever
was needed to make their units the best businesses in their fields.
The Journey since 2005

1
Accessed http://hbr.org/product/alibaba-group/an/710436-PDF-ENG on 8th Oct, 2014
With its $1 billion investment from Yahoo, Alibaba held off on charging for listings, prompting merchants to flee
EachNet for cheaper, faster Taobao. By spring 2007 Taobao had taken 82% of the online auction market, leaving
EachNet with just 7%.
Things were not going as well at home for Yahoo, with its share price slipping and momentum shifting to Google.
Semel was ousted in June 2007 with Yang in as interim CEO, but before he could even hatch a turnaround Yahoo
got drawn into one hellish negotiation after another. Microsoft in February 2008 announced a $44.6 billion, $31-
a-share tender offer, representing a 62% premium to Yahoos market value at the time. Investors such as Carl
Icahn fumed after Yang refused to sell for less than $37. As Yahoos stock tanked, Yang was forced to resign in
January 2009, replaced by former Autodesk CEO Carol Bartz. Microsoft yanked its offer that May.
Yang held on to his board seat and kept relations going with China, but critics blasted him for not stopping Ma
from spinning out the Alipay business in 2011. Investors started to doubt Yahoos ability to maximize the value
of its Asian assets. Activist investor Dan Loeb won a proxy skirmish and grabbed three board seats. He called for
Yangs head and got it in January 2012, when Yang finally stepped down from the boards of Yahoo, Yahoo Japan
and Alibaba.
Ma all along had been agitating to buy back the equity he had sold to Yahoo (and SoftBank). New Yahoo CEO
Scott Thompson was happy to oblige, if only to appease Loeb and keep his job. He told his CFO, Tim Morse, who
had replaced Yang on Alibabas board, to work out a sale.
Thompson wouldnt last long enough to see the deal done, though; Loeb ousted him for fibbing on his rsum.
Yahoo sold half its stake in September 2012 for $7.1 billion before tax, or $13 a share. (Alibaba would close at
$94 exactly two years later.)
Alibaba never really emphasized the products of Yahoo China in the market; Alibabas interest in the Yahoo deal
was largely to secure cash to help fund operating losses at Alipay and Taobao and to leverage the Yahoo brand
for Alibabas global business. The core structure of the transaction empowered Ma and his team to make the
decisions to drive long-term value. Yahoo felt it could live with this arrangement. But Yahoo never would have
structured a deal this way on its own.
Nine years later, the venture has gone through a number of changes. For example, Alibaba was listed on the
Hong Kong stock exchanges in November of 2007, raising $1.5 billion the worlds biggest internet offering
since Googles IPO in 2004. The company subsequently went private in early 2012. There have also been
changes in the framework agreement around the ownership of Alipay in both 2011 and 2012, as well as a
buyback of almost half of the Yahoo stake in May of 2012 for $7 billion.
Today Alibaba is ranked beside Google, Facebook, Twitter, and TenCent as among the titans of the internet.
With the filing of Alibabas registration statement in early May of 2014, the company is set to tap the U.S. capital
markets in what is estimated to be one of the largest IPOs ever. With knowledge of hindsight again we can say
that it indeed has been the largest IPO ever grossing nearly $21.8 trillion
2
.
That works out to 40 times the value of the deal Yahoo had struck in 2005. Had Yahoo held its entire 40% stake
from the time of the deal, the value of its pretax share in Alibaba would be worth $80 billion, or more than $78
per Yahoo share. Even though Yahoo has sold close to half that position and currently holds a 23% stake at lower
valuations, the company will be reaping huge returns.
While Alibaba has been growing, Yahoo has been shrinking. The contraction has occurred even as the
advertisers that provide most of Yahoo's revenue have been spending more money on the Internet. Most of that
online marketing has been flowing to Internet search leader Google Inc. and, to a lesser extent, Facebook Inc.'s
popular social network.
Since beginning its discussions with Alibaba in 2010, Yahoo has had five CEOs, including two interim leaders. The
deal head already been agreed upon in May, while Yahoo was being run by Ross Levinsohn, who left shortly
after the company hired Mayer in July.
Although Mayer is highly regarded in the Internet industry, investors still seem skeptical about whether she can
find a way to pump up a stock that has been stuck below $20 for the past four years. The stock was trading
around $35 when Yahoo invested in Alibaba seven years ago
3
. The windfall follows Yahoos earlier sale of some
Alibaba shares. In 2012, the company unloaded 523 million ordinary shares for about $7.1 billion.
The Buyback
Yahoo closed on the sale of half of its stake in the Alibaba Group of China, the company said Tuesday, giving it $3
billion to return to its shareholders.
It has already spent $646 million on stock buybacks since May, in what it called a down payment to its
stockholders.
In selling about 20 percent of Alibabas stock back to the company, Yahoo will reap about $7.6 billion before
taxes. The $3 billion represents about 85 percent of the net cash proceeds from the sale, with Yahoo also
receiving preferred shares in its partner.
The deal, struck in May, is part of a comprehensive agreement worked out between Alibaba and Yahoo,
beginning the transformation of a partnership that has often proved contentious.

2
As accessed from http://www.usatoday.com/story/money/business/2014/09/19/alibaba-surges-in-first-day-
trading/15828389/ on 12
th
Oct, 2014
3
As accessed from http://finance.yahoo.com/news/yahoo-closes-7-6-billion-deal-alibaba-group-161614948--
finance.html on 1st Oct, 2014.

The two companies alliance began when Yahoo bought a 40 percent stake in Alibaba in late 2005. As of Tuesday
afternoon, Yahoos remaining stake in Alibaba was valued at about $8.1 billion, representing about 43 percent of
the American companys $18.9 billion market value.
Over the last few years, both sides have engaged in on-again, off-again talks about the return of that stake.
Under the terms of the agreement, Yahoo will sell half of its stake back now. It will sell an additional 10 percent
of Alibaba when the Chinese Internet company files to go public in the next few years, and then divest the
remainder sometime after that.
For Alibaba, Tuesdays announcement is the biggest step yet toward its long-held goal of regaining full control of
its future. Still privately held, it has taken a number of steps toward becoming publicly traded, including finally
striking a deal with Yahoo.
Alibaba has spent the last several months crisscrossing the world, raising the requisite financing for the stock
buyback from investors like the China Investment Corporation, the Chinese private equityfirms Boyu Capital and
Citic Capital and the China Development Bank. Existing investors like Silver Lake, DST Global and Temasek also
participated. And it arranged $2 billion in financing from a number of international banks.
Comments: Buying Back Rationale
Yahoo's financial funk has depressed its stock for years, increasing the pressure on the company's management
to extract money from its Alibaba investment to reward its shareholders.
Buying back stock could boost Yahoo's stock by reducing the company's outstanding shares. With fewer shares
trading, it will be easier for Yahoo to increase its earnings per share one of the yardsticks that investors rely
on to evaluate a company's value.
The payout would punctuate Yahoos long investment after Alibaba pushed up the value of the Sunnyvale,
California-based Web portal over the years. A new war chest of cash would enable Yahoo to do more buybacks
and potentially more acquisitions. Yahoo has long leaned on its Alibaba stake to give it breathing space as Chief
Executive Officer Marissa Mayer tries to turn around the company, which is dealing with competition from
Google Inc. and Facebook Inc. in online ads and for user attention.
The new proceeds would also triple Yahoos cash hoard, which stood at $4.3 billion as of the end of June,
according to data compiled by Bloomberg.

After the Buyback
Yahoos stake in Alibaba after the recent buy back stands at around 16.3% of the total Alibabas outstanding
shares
4
.
Yahoo Inc will pay investors at least half the proceeds from its Alibaba share sale when the Chinese Internet
retailer goes public, and retain a larger stake than expected, helping to offset the U.S. Companys disappointing
results on Tuesday. Shares of Yahoo were roughly flat at $35.57 in after-hours trading.
Finance Chief Ken Goldman also said in a statement accompanying Yahoo's results on Tuesday that the company
was committed "to return at least half of the after-tax IPO proceeds to shareholders."
Yahoo is trying to revitalize a stagnant online advertising business as Chief Executive Marissa Mayer marks her 2-
year anniversary at the Internet Company.
The former Google Inc executive has revamped many of Yahoo's Web products but its ad sales are still weak
while rivals such as Google and Facebook Inc continue to post strong, double-digit revenue growth. Yahoo's net
revenue, which excludes fees paid to partner websites, decreased 3 percent year-on-year to $1.04 billion in the
three months ended June 30. Analysts polled by Thomson Reuters were looking for net revenue of $1.084
billion.
Revenue in Yahoo's display advertising business decreased 8 percent to $436 million in the second quarter. The
average price per ad decreased 24 percent, while the number of display ads sold increased 24 percent.
The internet giant is in talks to sink $20 million into the photo messaging startup in a deal that would value
Snapchat at $10 billion
5
, according to the Wall Street Journal.
The move would mark Yahoo CEO Marissa Mayer's latest attempt to keep shareholders happy while she works
to revitalize the company. Yahoo's bet on Alibaba paid off big. It provided a massive windfall of around $5 billion
(after taxes) from the Chinese conglomerate's IPO, which was the largest in history. It also gave Yahoo much
needed buzz and momentum. Yahoo's stock has soared 20% in the past six months, often jumping whenever
Alibaba's IPO was in the news.

Yahoo has stated it intends to buy back more shares of its stock. It has had one of the most aggressive buyback
strategies in the past couple of years, which was the primary reason for the increased stock value.

Comments

4
As accessed from http://www.buzzfeed.com/mattlynley/alibabas-colossal-ipo-has-minted-a-huge-profit-
for-yahoo#3b84vgw on 2
nd
Oct, 2014.
5
As accessed from http://money.cnn.com/2014/10/06/investing/yahoo-snapchat-stake/ on 3
rd
Oct, 2014
The Yahoo story highlights the reach and the limitations of mergers to a Companys future and share prices.
While Alibaba stake has been milked by Yahoo and helped it remain afloat despite its poor performance Yahoo
has had to follow an aggressive buy back of its own shares to keep the share prices from plummeting still hardly
ever sustaining over its pre Alibaba values. With the stake in the new technology giant at just about 16% and the
valuation of Yahoo a fraction of that of Alibaba the possibility of a takeover by another of company looms large.
However as seen currently the cash rich company might just buy itself more time by leveraging on currents
mergers and acquisitions in future just as it continues to do with that of the one it made in 2005 in a little known
Chinese firm Alibaba.

References
1. http://blogs.hbr.org/2014/08/an-insiders-account-of-the-yahoo-alibaba-deal/
2. http://www.forbes.com/sites/parmyolson/2014/09/30/how-jerry-yang-made-the-most-lucrative-bet-in-
tech-history/
3. http://in.reuters.com/article/2014/07/15/us-yahoo-results-idINKBN0FK2DN20140715
4. http://www.marketwatch.com/story/why-your-alibaba-bet-may-be-better-placed-on-yahoo-2014-09-15
5. http://www.investing.com/analysis/what-happens-to-yahoo-stock-after-alibaba-ipo-225893
6. http://en.wikipedia.org/wiki/Alibaba_Group