Yahoo shares bounce back as spinoff tax fears recede

Shares of Yahoo (YHOO) bounced back after a steep late day sell-off on Tuesday, as investors debated whether tax concerns might delay a planned spin-off of the company's stake in Chinese e-commerce giant Alibaba (BABA).

Reports that the Internal Revenue Service was halting approvals for future tax-free spin-offs amid a review of its rules sent Yahoo shares into a rapid tumble on Tuesday. The stock dropped as low as $39.12 before closing at $40.98, down 8% on the day. The shares made up some of the loss on Wednesday, gaining 3% to $42.25 in morning trading. Yahoo is the parent company of Yahoo Finance.

The stock plunge came on reports from Washington, D.C., of remarks by Isaac Zimbalist, senior technician reviewer at the IRS Office of Associate Chief Counsel. The IRS lawyer said the agency was concerned that some companies might be abusing the rules for tax-free spin-offs to avoid paying capital gains taxes. While the IRS reviews the rules, new requests for private letter rulings to approve tax-free spin-offs would be delayed, he said, but requests already filed would move forward, at least for now.

Yahoo, which paid more than 40% in capital gains taxes when it sold shares of Alibaba in the past, has made plans to avoid the tax hit for its remaining 15% stake in the Chinese company. Instead, CEO Marissa Mayer said in January that Yahoo would spin off its remaining stake in Alibaba, valued at almost $34 billion, along with its small business unit in a tax-free distribution to shareholders. The deal would be completed in the fourth quarter, Yahoo said.

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“The issue comes down to whether we’ve dropped a hot-dog stand or a lemonade stand into a business that is primarily publicly traded stocks, cash and other wonderful things that I call appreciated property,” Zimbalist said, according to a Bloomberg news report of his talk.

After Zimbalist spoke, Yahoo said it had already filed its request for a private letter ruling from the IRS and didn't expect the agency to delay its plans. "Yahoo understands that the IRS’s statement is not specific to Yahoo’s planned Q4 2015 spin-off of its remaining stake in Alibaba Group and Yahoo Small Business, reflects no change in applicable law, and does not affect previously filed ruling requests," the company said in a blog post. "Yahoo continues to work toward completing the planned spin-off in Q4 2015."

Before Zimbalist made his comments, Mayer spoke about the Alibaba spin-off at a JP Morgan investor conference in Boston Tuesday morning, assuring investors that it was on track for the fourth quarter. "The decision has been made, but there's a lot of work to do to make sure that that entity is ready and to really make sure that we achieve the tax efficiencies that we want. So things are on track, but there are a lot of people at Yahoo who are working very hard," Mayer said.

Yahoo's take fit the narrative of Wall Street analysts who are bullish on the Internet company.

"We believe that ambiguous statements from a non-senior employee at a DC event is not how the IRS would communicate breaking or 'material news,'" Suntrust analyst Robert Peck, who has a $59 price target on Yahoo shares, wrote in a report on Wednesday. He said the drop was a buying opportunity.

"Even conservatively assuming that the IRS would not permit the currently planned spinoff structure, we believe a number of alternative structures exist," Nomura analyst Anthony DiClemente wrote.

Scott Kessler at S&P Capital IQ actually raised his rating on Yahoo shares from "hold" to "buy" on the late plunge. "We view the sell-off as a buying opportunity," he wrote.

Several analysts calculated that Yahoo's current share price wasn't giving the company credit for much tax savings from the spin-off. UBS analyst Eric Sheridan said Yahoo would be worth $40 a share even if it paid full capital gains taxes on the Alibaba stake and a smaller stake in Yahoo Japan. "Our analysis suggests that in this scenario, the fair value for Yahoo would be ~$40/share – only 3% below its current trading price in the after-market," he wrote.

The $39.12 intraday price was the lowest for Yahoo shares since Oct. 20, 2014, before the company announced its Alibaba share spin-off plan.

(Correction: This story was updated on May 20, 2105 to correct the name of Scott Kessler's firm. It is S&P Capital IQ.)