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The deal that was supposed to happen months ago finally did happen when Yahoo.com (Nasdaq: YHOO) agreed to sell back half of its holdings in Alibaba.com to Alibaba Group Ltd. (1688.HK). Dynamic and sometimes controversial Alibaba chairman Jack Ma had been pushing hard for this deal, and although Yahoo had been reluctant at first to sell, circumstances in its company made the deal more likely until the deal was reached.

The Deal

Yahoo, which owned a 40 percent stake in Alibaba.com, the Chinese e-commerce company, will now be able to sell half its holdings, or 20 percent, back to Alibaba for roughly $6.3 billion in cash and $800 million in Alibaba preferred stock. The total price tag of $7.1 billion includes the issuance of new preferred stock by Alibaba. When Alibaba.com goes public, Alibaba is bound to buy back another 25 percent of Yahoo’s stake at the IPO price, or Yahoo will be free to sell the shares in the IPO.

What Yahoo Gets

Yahoo gets plenty of cash, which it hopes to return to shareholders. It originally purchased its stake for $1 billion, so the $7.1 billion sale price is a terrific cash return. Although Yahoo currently has about $2.5 billion of cash on its books, the stock has gone nowhere as the business has languished in the last few years, going through a couple of messy management changes as well as falling behind the newer generation of internet competitors. Under its new CEO Ross Levinson, the company will now concentrate on content rather than search where it was weak and mobile where it would require a huge capital investment. Although a cash dividend is possible instead of or along with the stock buyback, analysts wonder whether Yahoo should have sold off such a valuable holding as Alibaba, since Yahoo still needs to find the operational answers to its problems. In other words, cash from this deal does not make Yahoo well from an operational standpoint nor does it improve its competitive position going forward.

Yahoo 5 Year Chart

Source: Yahoo Finance

What Alibaba Gets

Alibaba gets a good deal—or better—buying back valuable assets which still have great growth potential. The price was reasonable at least, especially when you factor in that the assets may be worth even more as they are folded back into the larger operational matrix for the Alibaba Group. Also, this fixes the problem of the soured relationship between Alibaba—meaning Jack Ma—and the Yahoo management. In addition, Ma won’t have to worry about Yahoo’s entire stake being sold to someone else, which might have resulted in a problematic relationship made even more complicated for Ma and Alibaba.

Alibaba 5 Year Chart

Source: Yahoo Finance

Where Alibaba Will Go

Alibaba has some great features. One of Alibaba Group’s holdings, Taobao Marketplace,, which is similar to eBay (Nasdaq: EBAY), has been a highly successful bidding site which Ma and Alibaba boldly developed. Although there have been reliability problems from both the sale of fake items as well as related intellectual property issues, Alibaba has expressed a willingness to resolve these. Although Taobao and Alibaba are thriving, they face the advent of stronger competition for the Chinese e-commerce market from among such strong companies as Tencent Holdings (0700.HK). Tencent has nearly 600 million users for its internet, mobile and telecom value-added services, including its popular instant messaging service, and hopes to become more of a one-stop destination online. Although it recently struggled with the effects of the slowing Chinese economy on its business as has Alibaba, this should be temporary. Alibaba, Tencent and other Chinese companies will battle for dominance in the e-commerce space in the next few years. With the entrance of new, strongly financed players such as 360buy.com, which has been backed with $1.5 billion by Hong Kong investors, Alibaba is also going to need more cash to compete and expand its position. To that end, it will likely have the IPO mentioned in the deal, perhaps by 2015.

Jack Ma, Alibaba CEO

Source: Google Images/en.Wikipedia.org

For Investors

The Chinese internet space is an exciting and dynamic one for investors. The most recognizable Chinese name is Baidu (Nasdaq: BIDU), which is dominant in search advertising, but the entire Chinese internet is still evolving, changing rapidly with the growth of online gaming, e-commerce, social media such as Weibo and mobile revolution. Alibaba’s re-purchase of Yahoo’s stake will allow it to remain a strong player.

Committed to your Global Profits,

Jim Trippon

Chief Investment Analyst