Merrill Lynch Surprise: Downgrade Google and Upgrade Yahoo on Alibaba

When was the last time you saw an analyst downgrade Google Inc. (NASDAQ: GOOG) and upgrade Yahoo! Inc. (NASDAQ: YHOO) in the same call? That is exactly what we have seen on Friday morning from Merrill Lynch’s media analysts Justin Post and Joyce Tran. The calls took Google down to Neutral and Yahoo up to Buy — largely on the Alibaba Group Holding Ltd. (NYSE: BABA) exposure.

With Google’s downgrade to Neutral from Buy, the Merrill Lynch team cut the price target to $580 from $600. The downgrade was based on the following: lower than consensus estimates; increased regulatory risk, particularly in the European Union; a strong Apple product cycle and search contract renewal uncertainty; competition from the likes of Facebook in ad networks and possibly in search; and reversal of U.S. online advertising market share gains from social media.

Merrill Lynch lowered its 2016 revenue and earnings estimates to $73.72 billion and $33.81 per share (from $74.44 billion and $34.15 per share). That $580 target is based on 17 times the lowered earnings estimate that is about 5% below consensus.

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On the upgrade of Yahoo, the rating went to Buy from Neutral and the price target was raised to $62 from $55 in the call. The upgrade was largely based on Alibaba and tax upside potential. The team said:

While we were bullish on Alibaba for most of 2015, post IPO we thought that it could take a year or longer to get visibility on potential tax savings of Yahoo’s remaining stake in Alibaba and that Yahoo could trade at a sum-of-parts discount to asset value. However, Yahoo’s CFO recently indicated that there is no change to the company’s stance on being optimistic on finding a promising tax solution and that Yahoo would communicate its plans by the next earnings call at the latest.

The Merrill Lynch team is using analyst Eddie Leung’s recently updated price objective for Alibaba at $132 per share (for Alibaba), an unchanged 19% tax assumption and a slightly higher 6.5 times the Yahoo core 2016 EBITDA. The downside case of $90 for Alibaba would generate a Yahoo target down at $43, but the base case and current price of Alibaba at $109 would generate a $55 stock price for Yahoo.

Google shares were indicated down 1.1% at $531.50 in Friday’s premarket trading, versus a $502.80 to $604.83 range over the past 52-weeks. The consensus analyst price target is $642.50.

Yahoo shares were indicated up 1.3% at $51.08, against a 52-week range of $32.15 to $52.62 and against a consensus analyst price target of $50.06.

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