Yahoo’s Failed Deal With Alibaba: What Went Wrong?

The complexity of crafting a $17 billion asset swap with its Asian partners proved too much for Yahoo (NASDAQ:YHOO), as negotiations with China’s Alibaba Group and Japan’s Softbank broke down on Tuesday, two months after the parties agreed to a basic outline for a deal that would have returned Yahoo’s stakes in the companies to their owners.

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The actual valuation of the deal, which would have Yahoo swap its stakes in the companies for unspecified assets, did not come up during recent negotiations in Hong Kong, but apparently the rapid growth of Taobao, a fast-growing online retail business owned by Alibaba, caused Yahoo to have second thoughts about the valuation agreed to in December when they signed a term sheet.

“Taobao was definitely the main problem causing talks to break off,” said one person with knowledge of  the matter, lowering the volume on speculation that the halt in negotiations was simply a tactic employed by one of the parties involved in the transaction.

And it’s no wonder — Taobao is considered one of the most valuable businesses owned by the Alibaba Group. Though Alibaba does not disclose financial details for Taobao, analysts say the website dominates consumer-to-consumer online retail in China — much like eBay (NASDAQ:EBAY) or Amazon (NASDAQ:AMZN) in the United States — and is growing rapidly as the country’s online population, already the second largest in the world, continues to swell.

“In the period we have been in discussion with them, Taobao has performed well,” said a second person close to the situation. Taobao’s rapid growth made it difficult to agree on its value, he said, with Yahoo wary of getting the short end of the stick.

The hiccup in negotiations could certainly prevent the deal from going forward, which should please the factions within Yahoo who have been hesitant about the prospects of a tax-efficient deal because of its inherent complexity and the uncertainty of satisfying the U.S. Internal Revenue Service.

By spinning off Yahoo’s 40 percent stake in Alibaba and its 35 percent stake in Yahoo Japan, which it jointly owns with Softbank, the deal would have effectively allowed Yahoo to avoid paying billions of dollars in taxes, but the political ramifications of a deal that publicly sought to skirt tax law may have contributed to the deal losing some of its appeal.

Sources say Yahoo and its Asian partners could still strike another deal — one that’s taxable — though they have yet to reach an agreement on the price at which Yahoo should sell.

“It was an extremely complicated deal to get done given the multi-jurisdictions and the size of the assets in play,” said a third source familiar with the matter. “Yahoo was just completely ineffective, unable to execute a deal. It comes down to them being in turmoil with a new president, a board change, et cetera.”

Yahoo’s incompetence aside, both groups have strong incentives to find a deal that works. Alibaba founder Jack Ma has been trying to buy back Yahoo’s stake in his company for years, only to have his clumsy advances rebuffed by Yahoo CEO Carol Bartz, who was fired in September of last year, ultimately to be replaced by the much more obliging Scott Thompson.

After a “strategic review” of the company following Bartz’s involuntary and over-dramatized exit, Yahoo likely discovered that monetizing its Asian assets would allow Thompson to focus on reviving the company’s core operations, according to analysts. However, that realization wasn’t enough to carry them through negotiations, and now the cash-rich split deal appears to be kaput.

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To contact the reporter on this story: Emily Knapp at staff.writers@wallstcheatsheet.com

To contact the editor responsible for this story: Damien Hoffman at editors@wallstcheatsheet.com