San Francisco-based hedge fund manager John H. Burbank III, the chief investment officer of $4 billion Passport Capital, made a case for why it’s attractive to own Yahoo’s (YHOO) stock.
In an investor letter dated August 1 and seen by Yahoo Finance, Burbank said one of the themes in Passport’s portfolio right now is the Chinese consumer and China’s internet.
“This year, especially, it has become clearer to us that China has reasonable medium-term control over its macro destiny, and we expect consumption, and particularly demand for dominant internet services, to grow steadily. For context, China’s per capita household consumption is similar to what it was in the U.S. around 1970, which then proceeded to grow at a CAGR of 9% for the next 10 years, 8% for the next 20, and 6% for the next 40. More importantly, while China may be at a consumption per capita level of the U.S. in 1970, the technological sophistication of the Chinese consumers is on par with leading developed markets globally and such tech savvy consumers tend to leapfrog inefficient traditional services for readily available, more efficient online services. Consequently, the dominant Chinese consumer internet companies have far more enormous opportunities ahead than the U.S. ‘equivalents’ in the 1970s.”
Burbank views Yahoo as a way to own Alibaba Group with “an additional layer of expected return in the tax-efficient dissolution of Yahoo in the near-to-medium term.”
In late July, Verizon (VZ) announced it’s buying Yahoo for $4.8 billion.
“In our view owning Yahoo is similar to owning Alibaba (BABA) with a call option on tax-efficient divestiture. We believe that Yahoo’s management has lost credibility, and expect a chain of events already in motion to lower the holding discount of its assets and unlock value. We have long held the view that Yahoo should and could be dissolved in a tax-efficient manner. We believe that current valuation implies a capital gains tax rate of 35%, while we expect a much better outcome,” Burbank wrote in the letter.
He continued: “We opportunistically bought back into the shares earlier in 2016 as we saw the market obsession with the problems of Yahoo core and Chinese macro concerns clouding a picture we thought would be driven by imminent restructuring and Alibaba’s great value growth opportunity. We also believe that Yahoo is a very efficient way to own Alibaba, a company that we think could become one of the world’s most valuable. Globally, most consumer internet companies are a one-trick pony, excelling at their core businesses but nothing else. Amazon is an exception excelling at both eCommerce and cloud. Alibaba dominates three diverse businesses in China: eCommerce, cloud, and online financial services.”
Passport believes that Alibaba’s eCommerce in China is “superior to Amazon’s in the U.S.” The hedge fund also thinks Alibaba is the “dominant leader” in China’s public cloud (similar to Amazon AWS in the US), which is still in its “infancy” in China. Alibaba also owns a third of the mobile/online financial services group, Ant Financial Group, which was recently valued at $60 billion and expected to IPO in a few quarters.
“Adjusted for equity stakes worth approximately $30 billion, we believe BABA’s valuation is compelling at an estimated 13x our fiscal 2017 EBITDA (ending March 2018) and under 11x our fiscal 2019 EBITDA.”
Passport has held a stake in Yahoo since the second quarter of 2014, a securities filing shows. During the first quarter, the fund added just over 3.32 million shares of Yahoo, bringing its stake to just over 4.68 million shares. Passport’s second quarter holdings are expected to come out in the next few days when funds start to release their 13-F filings.
Passport Special Opportunities, which has about $404.1 million in assets, fell 9.8% in the second quarter, compared to the MSCI AC World Index’s 1.2% rise and the S&P 500’s 2.5% gain.
Disclaimer: Yahoo is the corporate parent of Yahoo Finance.
Julia La Roche is a finance reporter at Yahoo Finance.