January 31, 2012 4:25 pm

Yahoo: Alibaba remains in complicated split talks

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Alibaba Group is in discussions with private equity firms to find an asset that would facilitate a transaction with Yahoo (NASDAQ: YHOO), two people familiar with the matter told dealReporter.

In December, Yahoo agreed to sign an initial term sheet with SoftBank and Alibaba to discuss options for its stakes in Alibaba and Yahoo Japan, according to a report by All Things Digital. The parties would explore a “cash-rich” split-off of the Asian assets in transactions that could be valued around USD 17bn and minimize Yahoo’s tax bill.

Yahoo owns 40% of Alibaba Group and a 35% interest in the Japanese portal. Yahoo Japan is in talks with Yahoo on how to avoid a substantial tax bill if Yahoo sells its stake, Yahoo Japan’s CFO Akira Kajikawa said at a press conference last week. Alibaba did not respond to a request for comment on Friday.

A process to complete a cash-rich split would take between six and nine months, said industry lawyers and an industry banker. The size of the transaction would probably necessitate a request for a private letter ruling from the IRS to ensure the tax status of a transaction, they said. This could take 10 weeks, one of the lawyers added.

Given these factors, reaching a deal for a cash-rich split by mid-February would be an aggressive timetable, the first banker said, but added that a cash-rich split was the most efficient way for Yahoo to sell its Alibaba stake.

The most recent and noteworthy execution of a cash-rich split was Liberty Media’s acquisition of DirectTV (NASDAQ: DTV) from News Corp (NASDAQ: NWS), one industry lawyer said.

In this transaction, announced in 2006 and completed in February 2008, Liberty exchanged its 16% stake in News Corp for a 38% stake in DirecTV, three regional sports networks and roughly USD 550m in cash. Receiving a letter from the IRS on the tax ruling took about nine months. Receiving FCC approval took up the balance of the time.

Another cash-rich split-off was completed earlier last decade by Janus Capital Group (NYSE:JNS) and DST Systems (NYSE:DST).

Detail-rich structure

New corporations, or Newcos, will need to be formed to handle the transactions for both the Alibaba and Yahoo Japan stakes to execute the cash-rich split-offs, said three lawyers.

Tax expert Robert Willens, a long-time follower of complex corporate transactions, said these newly formed companies will have to be to be capitalized with no more than two-thirds cash and the remaining one-third of assets.

The assets, said Laurence Bambino, co-head of Shearman & Sterling’s global tax group, should consist of a trade or business that has been actively conducted throughout the preceding five-year period ending on the date of the split-off. At least 5% to 10% of the assets that are contributed should be the five-year active trade or business assets with the balance consisting of non-investment assets such as equipment, licenses, stock or debt, subsidiaries and other business assets.

Willens noted there is an exception to the five-year active business rule for cases in which the purchased business is “in the same line of business” as the acquirer. In that event, the purchased business is treated as merely an “expansion” of the historical business and is viewed as sharing in the five-year history of the historical business.

New CEO’s fresh direction

In a possible deal structure, a private equity firm or a strategic third party could contribute the asset to Alibaba, which would put it into the Newco. The main challenge to closing a deal is finding an asset that would fit with Yahoo, two bankers said.

A number of companies would fit, including Hulu, TripAdvisor (NASSDAQ:TRIP) and The Weather Channel, but Alibaba does not own these assets so may need to work with financial sponsors who can acquire or already own them, the first banker said. He added that he believed Hulu would make the best fit for Yahoo.

However, an industry source said he predicted recently appointed CEO Scott Thompson will try to make Yahoo into a technology company instead of a media company. “It’s all about the data,” he said. “He will try to mine the data interesting ways.” The Weather Channel, one of the many targets mentioned in news reports, is viewed as old media company and is unlikely to garner the interest of Thompson, the industry source said.

Thompson’s vision for the company may narrow the possible field of strategic fits, the industry source said. As a former eBay executive, he may be excited by Alibaba’s Alipay asset. Taobao, the online retailing businesses, is another Alibaba asset that could interest Yahoo, though it is not in Yahoo’s core business, he noted.

The new CEO provided few details about his thinking on Yahoo’s 4Q earnings call earlier this week. A Yahoo spokesperson did not respond to a request for comment on Friday.

A second industry banker said that Alibaba has long complained that Yahoo was not the partner it believed it would be when it sold an equity stake to the US company. Their perspective may change with Thompson heading up the company, he noted.

A person familiar with The Weather Channel said its CFO Perley McBride and other senior staff had been told by the Weather Channel’s top management in a recent meeting that the rumors of a Weather Channel-Yahoo deal were speculation. The person qualified the statement by saying the deal negotiations could be happening further up among the company’s ownership ranks.

The Weather Channel is owned by Comcast/NBC, Blackstone and Bain Capital. Both Blackstone and Bain Capital have been rumored to be trying to work with Alibaba towards a deal. The Weather Channel’s new CEO, David Kenny, also serves on Yahoo’s board of directors.

Minimizing taxes for the long haul

Two lawyers noted that to ensure the tax advantage of the transaction, Yahoo may need to hold the asset for one to two years, so that the transaction is not viewed by the IRS as one with the sole purpose of avoiding a taxable event.

Others said Yahoo could turn around and sell the asset immediately. But it is unlikely that Thompson would enter a transaction with a potential of having an open-ended tax liability, a few of the lawyers noted.

Holding onto the asset will mean Yahoo will need to ensure this asset maintains its value in the rapidly changing world of technology. This is where the search for an asset could prove difficult, the second banker said.

At the end of the day, structuring a transaction where Yahoo can minimize the tax bill and still own a sizable interest in Alibaba is a favorable deal structure for Yahoo’s shareholders, the first lawyer noted. Absent a deal, Yahoo would have to pay considerable tax bill on a USD 14bn sale price that has a USD 1bn cost basis.

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