Yahoo’s Share Buyback Is Legal, but Timing Is Suspect

Is Yahoo damaged goods now that it has been abandoned by one of its biggest investors, Daniel Loeb and his hedge fund, Third Point?

It certainly seems so from investor reaction to the news that Yahoo has agreed to buy 40 million shares back from Third Point at $1.16 billion.

Yahoo’s stock declined 4.3 percent on Monday to close at $27.86 a share in the disclosure’s wake (it was down 1.8 percent more on Tuesday).

The share repurchase has the whiff of greenmail, with Business Insider’s Henry Blodget going as far as to call it “insider trading.” Greenmail is yet another relic of the 1980s that we’d rather forget, along with big hair. Back then, companies would repurchase the stock of corporate raiders at a premium simply to make them go away. Greenmail was quite controversial and some states banned the practice, though Delaware, where Yahoo and many other corporations are organized, did not. To see what exactly has happened to Yahoo under Mr. Loeb’s watchful eye, let’s look at a little history. Mr. Loeb disclosed his investment in Yahoo in 2011, calling th company “undervalued.”

He also sought to shake up the board and the management, which might have come from “The Gang That Couldn’t Shoot Straight.” Before Mr. Loeb stepped in, Yahoo had unsuccessfully held talks to sell itself to Microsoft for $45 billion, was struggling to attract talent and had a leadership that was viewed as bumbling. This was a problem, because Yahoo’s business model was also in decline.

At the time, Mr. Loeb demanded a shake-up of the board, stating that “we have distilled an all-star team of potential director candidates, who would be indispensable in working with the reconstituted board.”

What unfolded was in some ways a typical activist play, with the Yahoo board aiding in its own slide. The board initially resisted Mr. Loeb and, over his protests, hired Scott Thompson as the chief executive. When Mr. Loeb helped unearth the fact that Mr. Thompson had falsified part of his résumé, the game was over.

In the wake of Mr. Thompson’s departure, Mr. Loeb and two other directors designated by him were appointed to the Yahoo board. These were Harry J. Wilson, the chairman and chief executive of the Maeva Group, a turnaround and restructuring firm; and Michael J. Wolf, a consultant and former president and chief operating officer of MTV Networks. Max Levchin, an investor and former vice president for engineering at Google, was also appointed later in consultation with Third Point.

These were good directors, and they were part of needed change at Yahoo. The biggest change took place when Yahoo wooed Marissa Mayer away from Google to be its chief executive, a leadership change that Mr. Loeb took credit for.

Ms. Mayer is only about a year into her tenure, but she has started to reboot the business. The results are still uncertain, but she has certainly brought an enhanced image â€" while also spending over $1 billion to buy Tumblr as well as make 16 other acquisitions.

But Yahoo by all accounts still has a lot of work to do. As Carlos Kirjner, an analyst at Bernstein Research, said last July, “It is unrealistic to expect a turnaround of such a challenged business in 12 months.”

Yet, a year later, Mr. Loeb is ready to get out, and making a nice profit along the way.

Mr. Loeb, Mr. Wilson and Mr. Wolf have all announced their resignation from Yahoo’s board, a move that was in accord with the settlement that Yahoo had arranged with Mr. Loeb in May 2012. These directors agreed to resign once Third Point’s stake fell below 2 percent (which is what happened this week with the share repurchase). Yahoo could have asked for these directors to stay on, but either the company didn’t want them or the directors didn’t want to stay.

A spokesman for Third Point declined to comment.

These directors are leaving when Yahoo’s hard work is still left to be finished. It appears that Mr. Loeb and his cohorts are departing Yahoo midvoyage.

Not only that, but the sale is arguably suspect in terms of its timing. Right now, Yahoo’s valuation is floating on two pontoons. The first and biggest driver of Yahoo’s share gains over the last few years has been its stake in the Chinese Internet giant Alibaba Group. Yahoo still owns 24 percent of Alibaba, which is planning an I.P.O. that could value it at more than $100 billion. Analysts estimate that up to two-thirds of Yahoo’s approximate $30 billion market cap may simply be this stake.

Alibaba has driven up Yahoo’s share price over the last two years, as Yahoo’s main business still struggles, even under Ms. Mayer. Yahoo’s revenue in the quarter was down 7 percent from the previous year, and the company lowered its forecast, with ad revenue in particular declining 12 percent in this quarter compared with last year. To be honest, the rest of the premium in Yahoo’s stock is mostly based on the hope that Ms. Mayer can deliver.

In this light, Mr. Loeb’s departure is being viewed as riding the wave of hype over Yahoo. He is gaining from the unexpected Alibaba rise but not the restructuring he advocated, leaving just before things get hard and the wave crashes.

Mr. Loeb’s exit raises the question of whether he was out to create true value or merely stir the pot to get a quick hit and $600 million in profit so far from Yahoo. Mr. Loeb’s promise at the beginning was to provide “all-star directors,” not all-star directors for about a year. Sure, he still owns 2 percent of the company, but he is no longer required to report his holding and can quickly sell down this position whenever he wants.

Had Mr. Loeb sold directly in the market rather than via a corporate stock buyback, he would have been unlikely to get the same price. In addition, the volume would have meant that trading costs would have whittled away at some of his profit.

Yahoo’s move to buy back his stock is not illegal and certainly not insider trading, because Mr. Loeb was selling back to the company, which was aware of any such information.

However, it may be unfair to other shareholders. Yahoo could have asked for a discount, as Mr. Blodget suggested. It also was probably not greenmail in the truest sense because Yahoo didn’t really want Mr. Loeb to go away and the purchase wasn’t at a premium to the current share price. Still, the repurchase was arguably beneficial to Third Point.

In response to a request for comment, a Yahoo spokesman justified the repurchase by stating, “Yahoo already had a stock repurchase plan in place” and the Third Point purchase allowed Yahoo to “fulfill a substantial part of that commitment more quickly.”

At the end of the day though, I can’t really blame Third Point and Mr. Loeb. Third Point never explicitly promised to stick around for any period of time, nor did Yahoo seek such an agreement. And Third Point leaves the company in much better shape than when it arrived.

Perhaps the biggest lesson here is for other companies and shareholders. Just because an activist investor offers up directors and their services doesn’t mean they will stick around. If companies are truly looking for investors to stay for the long term, they should bargain upfront.

But Yahoo failed to secure such a commitment. It will instead continue to lick its wounds and fix itself up without the help of Mr. Loeb’s counsel.