Yahoo’s Shopping Spree: Tactical Brilliance or A Sign of “Desperation”?

On a Friday morning (September 19, 2014), when China’s biggest online commerce company, Alibaba, filed for, what turned out to be a blockbuster IPO at the New York Stock Exchange, a certain technology company was yelling “Yahoo! Yahoo!” in jubilation. This chant, coincidentally, was its name too.

Yes, Yahoo had sold about 122 million shares of Alibaba in the IPO, and had coolly netted the proceeds, which amounted to $5.1 billion after taxes. And it continues to maintain a 16.3% stake in Alibaba, which is valued in the region of $37.7 billion. In short, the bet Yahoo made when it bought a 40% stake in Alibaba for $1 billion has paid off big, so big that it has shifted the focus from the struggles of its core business to its acquisition strategy in general.

Yahoo has acquired 41 companies in the last two years, according to a recent article in Business Insider. And CEO Marissa Meyer and M&A & HR Chief Jacqueline Reses have no plans of slowing down. Last month alone, it acquired advertising start up Luminate, and document handling start up BookPad. We are barely a week into October, and Yahoo has already announced its acquisition of MessageMe, a mobile messaging service that competes with Whatsapp Inc. And according to a recent article in Wall Street Journal, Yahoo is planning to re-invest some of the proceeds from Alibaba into Snapchat, which is valued at $10 billion. The figure below shows the number of acquisitions per year by Yahoo.

Source: CB Insights

Some would say Yahoo’s shopping spree has been nothing short of tactical brilliance. And they would happily point their fingers at Alibaba to make their case. Furthermore, post Alibaba’s blockbuster IPO, I would expect Yahoo to adopt an even more aggressive acquisition strategy.

However, a word of caution: there is a possibility that Yahoo’s shopping spree could lead to purchase of overvalued companies, which could prove hurtful to the company in the long run. There are two theories, which could explain this possibility: the Hubris Theory and the Desperation Theory.

The Hubris theory was put forward by Richard Roll in 1986, and it states that hubris on the part of individual decision makers in bidding firms can explain why they overpay for the acquisition. The windfall from Alibaba’s IPO could make Yahoo a victim of hubris, and it could end up overvaluing targets and paying lofty premiums for them, a scenario that would hurt its investors.

The Desperation theory can provide a clearer explanation for the possibility that Yahoo might end up overpaying for future acquisitions. The desperation theory was put forward by Ji-Yub Kim, Jerayr Haleblian and Sydney Finkelstein in 2011. According to this theory, there are two drivers of overpayment for acquisitions: low organic growth and high relative acquisition dependence. According to a recent article by Jeremy Quittner in Inc., Yahoo’s market capitalisation stands at almost $41 billion, and its 16% stake in Alibaba is valued at $37 billion. Remove Alibaba, and we have a company whose valuation is only $4 billion, which places Yahoo in the same league as AOL (market cap: $3.5 billion) and online daily deals retailer Zulily (market cap: $4.5 billion). No surprise then that hedge fund activist Starboard Value LP has urged Yahoo to merge with AOL. Its struggling core business could force Yahoo to continue to depend on acquisitions for growth. And this could result in venture capitalists, hedge fund activists, and other target company shareholders demanding lofty premiums, which a “desperate” Yahoo would have to end up paying. 

At present, Yahoo can afford to sit back and continue its shopping spree since it has the cash and a safety cushion in its stake in Alibaba. However, in the long run, whether its shopping spree eventually leads to overpaid acquisitions and a worrisome scenario in general remains to be seen.