AT&T’s Interest in Yahoo May Doom Private Equity’s Buying Hopes

(Bloomberg) — AT&T Inc.’s decision to pursue Yahoo! Inc. could be a death knell to efforts by private equity firms hoping to acquire the beleaguered internet company.

The telecommunication giant’s presence puts pressure not just on Verizon Communications Inc. and Quicken Loans Inc. founder Dan Gilbert — backed by Warren Buffett — to raise their offers. It also adds another deep-pocketed strategic company to the mix of bidders for Yahoo’s core web assets.

Private equity firms, which often rely heavily on debt to finance buyouts, realize they would struggle to win a bidding war with well-capitalized acquirers while still generating the types of returns demanded by their investors, according to people familiar with the situation, who asked not to be identified because the information is private.

Yahoo’s core assets could fetch at least $4.5 billion, or six times adjusted earnings, according to Jason Helfstein, an analyst with Oppenheimer & Co.

Given Yahoo’s declining profitability and revenue, lenders aren’t likely to provide financing of more than four times adjusted earnings before interest, taxes, appreciation and amortization, people familiar with the matter said. Yahoo projects adjusted Ebitda of $700 million to $800 million this year. Using the midpoint of the range implies a ceiling of about $2.5 billion in debt based on that multiple.

Because buyouts are typically structured as two-thirds debt to give private equity firms a 20 percent return on investment, the firms will find it difficult to bid much more than $4 billion for the company, even allowing for their backers to make a co-investment contribution.

Declining Asset

Those firms can better compete with corporate suitors for a target business that’s growing. In Yahoo’s case, it’s an asset whose value is declining. While buyout firms do buy declining assets, it’s usually once strategic suitors have passed.

“A corporate buyer is in a more strategic position to win this asset,” Helfstein said. “I think ultimately this will get sold at some type of valuation that will make sense for the company.”

Yahoo’s adjusted Ebitda was about $950 million in 2015 — a decline of about 30 percent from the previous year. Revenue, minus sales passed onto partners, fell 7 percent last year.

TPG, Bain

Still, TPG, Bain Capital, Vista Equity Partners, Apax Partners and others are continuing to pursue the web portal during the sale process, said the people familiar with the matter. Second-round bids are due next week and a winner could be chosen in early July, people with knowledge of the matter said.

No decision has been made, and it’s possible that AT&T, Verizon and Gilbert could walk away or decide not to bid aggressively. Suitors also could team up. One group financed by Bain and Vista Equity submitted a first-round bid for Yahoo, people familiar with the matter said at the time. While joining together helps private equity firms lessen the risk for each party, the overall math would be the same from a return perspective.

“The sheer size of the equity check in this scenario may rule out solely a PE bid and may be easier for a hybrid PE/strategic bidder,”  Robert Peck, an analyst at Suntrust Robinson Humphrey Inc., said in a report Wednesday.

A spokeswoman for Yahoo declined to comment. Representatives for TPG and Apax declined to comment, while spokesmen for Vista and Bain didn’t respond to requests for comment.

Ready Cash

Verizon has $5.8 billion in cash and had a market value of about $206 billion at the close Wednesday, while AT&T has $10 billion and $239 billion, respectively.

Both companies could accelerate growth by combining Yahoo products with the devices and services the telecommunications companies already sell. For example, Verizon could add Yahoo to its digital video lineup or place the portal’s content on a smartphone.

At the same time, both companies already have key corporate expenses that could be taken out of Yahoo, such as human resources, finance and communications. Private equity wouldn’t be able to remove those functions wholesale.

Verizon went through this process recently, paying about $4 billion for AOL Inc., a longtime rival of Yahoo, just last year. The company, which had said it would be open to looking at Yahoo if it were for sale, submitted a first-round proposal, people familiar with the matter said in April.

Both telecoms could benefit from the infusion of online users. Yahoo still boasts about 1 billion, putting it among the largest online players in the world.

Privacy Benefit

And both companies could tuck Yahoo away within their quarterly earnings results, choosing not to break out the relatively small earnings the company may generate in the near term. This could help give Yahoo the cover it needs to refocus.

That’s something the private equity firms also offer: financial sponsors could restructure the business more quickly, unencumbered by pressure for top-line growth or to consider earnings per share.

Yahoo — more than three years into a turnaround process under Chief Executive Officer Marissa Mayer — put itself up for sale in February. 

Amid Yahoo’s profit and revenue declines, Mayer pushed back earlier this year and announced a shake-up to slash costs with hundreds of layoffs, several office closures and product shut-downs. Adjusted profit still fell in the first quarter.

During a call with analysts amid the cuts, Mayer talked about the sale process and said the benefits from the right transaction could deliver “strategic synergies” and accelerate growth.

“We’ve been very thoughtful about running a high-quality process, designed to keep interested parties engaged and highlight the tremendous value in Yahoo,” she said.