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Yahoo Japan Key to YHOO Treasure

Yahoo's (NASDAQ:YHOO) earnings on Monday garnered a lot of attention because of the star power of new CEO Marissa Mayer and a focus by most analysts and journalists on the state of the comeback of the Yahoo's core business.

What didn't get a lot of attention was Yahoo Japan (TYO:4689). It should have.

Yahoo Japan is the leading Japanese portal and a huge e-commerce player. It's jointly owned by Yahoo and SoftBank (TYO:9984) -- the new owner of Sprint (NYSE:S). Yahoo's stake in Yahoo Japan is 35%.

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When it comes to Yahoo's "Asian assets," most Americans think only about Alibaba. There's good reason. Alibaba will probably be worth $60 billion when it IPOs (as early as this year perhaps). But Yahoo Japan isn't chopped liver.

Yahoo Japan is actually worth more than Yahoo: $24 billion vs. $23.3 billion. Surprised? That's thanks to Tuesday night's trading, which sent YJ up on the news of a great quarter.

A year ago, you might remember that then new Yahoo CEO Scott Thompson was trying to unload the stake in Yahoo Japan. He and CFO Tim Morse telegraphed a couple of times on their earnings call that they were actively trying to sell their stake in Yahoo Japan. However, later in the year, they sheepishly admitted that the valuation gap between the two sides was too big and a deal couldn't be completed.

Thank goodness Yahoo shareholders were able to avoid that fate. A year ago, Yahoo Japan's shares traded in Tokyo for JPY23,000 per share.

Wednesday morning, Yahoo Japan's shares are trading for JPY37,000 per share.

What happened?

Yahoo Japan has a new and younger management team in place who have been doing a great job in their first couple of quarters. Tuesday, they released their financial results and they demonstrated an acceleration in growth at the company and the best financial results since 2007. Here's a taste:

  • Revenue up 16% vs. a year ago
  • Operating income up 20%
  • Ordinary income up 18%
  • Quarterly net income up 22%

But the big news was that the company announced a very large stock buyback: 6% of the float or 25% of the average volume when they'll be making the purchases on the open market.

The company pointed out that all these shares will be retired. Why? Because suddenly earnings per share will increase significantly.

So the good news for Yahoo shareholders is that their stake in Yahoo Japan is worth $8.2 billion today vs. $5 billion a year ago. Net of taxes and fees, that Yahoo Japan stake is worth $5.07 per Yahoo share vs. $2.83 per share a year ago.

So why would Yahoo Japan want to do a deal now with Yahoo for their 35% stake? Well, I'm sure if they had their druthers, they would have loved to do a deal with Scott Thompson at that discounted price. But even paying off Yahoo at current prices, Yahoo Japan would be crazy not to do it.

Just today, Yahoo Japan's stock was up 15% on good earnings and news of a planned stock buyback to retire 6% of their float. What would it do on news that Yahoo Japan was going to retire another 35% of their shares -- the equivalent of 244x the daily volume of shares traded? It's worth it to Yahoo Japan to do a deal with Yahoo.

What would Yahoo do with another $5.5 billion of cash net of taxes and fees? Probably buy back a lot of shares.

Yahoo just retired almost 7% of their shares outstanding in the last quarter for a price of $1.5 billion. They will probably be spending another $1.5 billion this quarter on stock buybacks which -- at say an average cost of $22/share -- would retire another 68 million shares or 6.2% of the shares outstanding.

If a Yahoo Japan deal happens this year and Yahoo earmarks $4 billion of the $5.5 billion due to it for buybacks, you are talking about another 150 million shares that could be retired within a year from now (assuming a $26/share average cost). The share count would drop from 1.2 billion as of the end of Q3 to 850 million in a year from now.

At the moment, the analyst consensus on Yahoo is that it will do $1.27 in EPS in 2014. They're using the old 1.2 billion share count number for that.

Let's assume that Yahoo can actually show some double-digit revenue and earnings growth next year and do a Yahoo Japan-type 22% growth in net income. That's $1.55 in EPS at the old share count or $1.86 billion in earnings.

On an 850 million share count, that $1.86 billion in earnings becomes $2.19 in EPS or almost double the current estimate.

At a 10x multiple of $1.86 billion in earnings, Yahoo would be worth nearly $11 billion. At the moment, net of its Alibaba stake (at a $60 billion valuation and post taxes), its Yahoo Japan stake, and its cash, Yahoo's core business is being valued at $1.43 billion.

Yahoo's stake in Yahoo Japan is nothing to sniff at. And it might be a key catalyst for Yahoo this year.

At the time of publication, the author was long YHOO.

This article was written by an independent contributor, separate from TheStreet's regular news coverage.

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