Yahoo’s Pricey Purchase

With one apt quote, Warren Buffett exposes the danger of any model: “I’d rather be approximately right than precisely wrong.”

These dangers often apply in acquisitions. Investment bankers have every incentive to make the deal close, which means the acquisition model will inevitably spit out a favorable result. We don’t have to look any further than Yahoo’s (YHOO) acquisition of Tumblr. At $1.1 billion, YHOO is paying 85 times revenues for the micro-blog site. Even at a multiple reserved for historically disastrous acquisitions, I’m sure YHOO models made the purchase “work.” The question is which came first: the decision or the model? Often a CEO or investment banker makes a deal, then tweaks the model to justify it. Welcome to “acquisition math.”

Financial models are prone to the danger tagged by Buffett: “false precision,” whereby an all-too-exact number, dressed up with lots of variable guesses, somehow garners unjustified reverence. A valuation model is no different than any other. Garbage in, garbage out: it’s only as good as its assumptions. No matter what the output, it has to be viewed with requisite skepticism. Far from naming an exact value, it really represents the weighted average of a realm of possibilities. Less a number than a guide, any model is should be viewed with a weather eye. Worship it at your own risk.

So is the Tumblr model being made to fit the deal, or the deal to fit the model? With $13 million in 2012 reported revenues, Tumblr will have to grow sales by a multiple of 10, just to arrive at a price-to-sales ratio on par with other social networking companies. On the other hand, Tumblr is at the early stages of monetization (and has proven it can sell ads) so $100 million within a year’s time may be wholly realistic. Understanding whether YHOO just squandered a billion or not can help us value YHOO itself.

A Trefis Interactive Portfolio Report

June 2013

James Berman

James Berman, the president and founder of JBGlobal.com LLC, a registered investment advisory firm (SEC registered), specializes in asset

management for high-net-worth individuals and trusts. Mr. Berman is a faculty member in the Finance Department of NYU SCPS. He has

appeared on CNBC and the Fox Business Channel and has been quoted and published in a variety of publications, including Barron's, Fortune,

Bloomberg, The Huffington Post and CNN Money. Mr. Berman holds a B.A., Magna Cum Laude, Phi Beta Kappa, in English & American Litera-

ture from Harvard and a J.D. from Harvard Law School.

CONTENTS

Access interactive Trefis analysis to get the most from the Folio:

Test our assumptions Run your own scenarios Read forecast rationale Access Trefis research Analyze company value drivers

THE BERMAN VALUE FOLIO

Yahoo’s Pricey Purchase 1

YHOO: Will Tumblr Add Value? 3

Company Highlights 5

BP 5

Lowe’s 6

BNY Mellon 7

Pfizer 8

The Berman Value Folio 9

Is YHOO’s purchase of Tumblr a well-reasoned acquisition, likely to right the ship? Or a move of abject desperation, indicative of just how few options remain for the beleaguered internet giant?

At $27 per share, YHOO is already deemed a little rich by Trefis, which pegs fair value at $23. Gorging on an overpriced blog site would do nothing to improve intrinsic value, but could easily destroy it.

Like Facebook at its IPO price, to justify the nutty deal value, everything must go right. Assuming the models showed Tumblr reaching $100 million in sales by 2015, and then doubling again by 2016, the price might be justified. To get the model to work, the rosy assumptions would have to come true. Since YHOO boss Marissa Mayer can have zero exactitude on growth rates, she must have a terrific instinct that Tumblr has the right stuff. With no room for error at these Himalayan valuations, her level of conviction must be great. Or she’s desperate. Time will tell.

YHOO saw fit to acquire Tumblr, but should you see fit to acquire YHOO? The answer lies in an objective look at the model, using conservative assumptions to allow for Ben Graham’s famous “margin of safety” — something they don’t seem to teach in I-banking training programs.

Trefis already deems YHOO overvalued. So a look at their inputs is required to evaluate the output. It’s possible that Trefis assumptions are too punishing, even for a cautious approach. With companies that are out of public favor, analysts tend to assume the worst.

The Trefis Dow

Ticker

Trefis

Market Price Price

IBM 209 208

CVX 143 125

MCD 95.62 101

MMM 110 110

XOM 95.33 91.94

CAT 86.08 86.56

KO 39.10 41.74

UTX 109 95.14

BA 88.09 96.68

WMT 80.06 76.65

JNJ 85.01 87.36

PG 70.77 78.43

TRV 93.70 83.13

AXP 65.01 74.48

HD 65.04 78.67

DIS 66.17 65.03

DD 55.54 54.87

VZ 46.07 51.46

MRK 48.34 46.70

UNH 70.22 61.93

T 40.03 36.61

JPM 53.18 53.17

MSFT 40.91 34.28

INTC 27.58 24.06

PFE 31.40 29.08

GE 22.16 23.52

HPQ 17.86 23.99

CSCO 27.07 23.33

AA 7.25 8.52

BAC 13.53 13.22

DOW

Trefis Market

Price Price

15,376 15,249

Undervaluation as of 5/23/13

1%

The Berman Value Folio A Trefis Interactive Portfolio Report June 2013

YHOO: Will Tumblr Add Value?

The Berman Value Folio A Trefis Interactive Portfolio Report June 2013

YHOO is an odd bird for a tech company; the bulk of its value comes from investments in other businesses. A full 47% of its worth stems from its holdings in Yahoo Japan (YAHOY) and Alibaba, plus the net cash on its books. As far as wholly owned operating divisions, YHOO’s main sources of value are search and display advertising, at roughly 14% each.

Trefis assumes YHOO’s market share in search will trend down from 5% to nearly 4% while revenue per search will fall by a few pennies:

I think these figures are accurate. I wouldn’t want to be more optimistic, given the move to mobile and the likelihood that YHOO’s share is likely to shrink, not grow, as disruptors continue to challenge all corners of YHOO’s business model. We can look at two different scenarios: one where the Tumblr purchase works, adding significantly to the bottom line — and one where it just doesn't. Were Tumblr able to sell ads that amount to 40 cents in annual ad revenue per each and every one of YHOO ‘s 700+ million average users, it only adds $600 million to YHOO’s intrinsic value, which implies that YHOO should have paid half as much as it did for Tumblr. The Tumblr deal has likely destroyed $500 million in value, and that’s pricing in optimistic revenue projections of $250 million by 2019 (with firm wide margins remaining the same):

Trading out the $1.1 billion in cash leaves a value of $24.4 billion or $22.97 per share, well below the market price of $27.11 Even under a rose-colored scenarios, it appears Marissa Mayer has overpaid.

A Waste of a Billion?

The Berman Value Folio A Trefis Interactive Portfolio Report June 2013

If Tumbr doesn’t work, either because users flee (anecdotally, there are some rumblings of this, but always beware of the anecdotal) or because monetization sinks in the social media mud, YHOO will be worth less than $22 per share. Assuming a nickel per user in annual expected ad revenues accruing from the deal, YHOO’s value should be $25 billion.

Subtracting the $1.1 billion acquisition price leaves $23.9 billion, or $22.59, a full 13% below the market price. If the deal fails outright and Tumblr atrophies into the next Friendster or MySpace, YHOO will have truly squandered a billion. Wasting that much cash is hardly a fatal error, but one that is large enough to lead to massive goodwill impairment charges down the line. And one that would reduce YHOO’s net cash position from $4.9 to $3.8 billion, a mere trifle compared to GOOG, AAPL and other competitors.

COMPANY HIGHLIGHTS

BP

Market Capitalization

Annual Revenues Dividend/Yield 52 Week Range

$138 B $375 B $2.16 / 5% $36.25—45.45

Berman’s Take: BP’s quarterly earnings of $16.6 billion were goosed by the sale of their stake in TNK-BP to Russia’s state controlled oil company Rosneft. Stripping out this $12.5 billion windfall and other one-time gains, BP had a more meager $4.2 billion, which was down 9.4% from the prior year. Still looming over BP are legal claims from the Macondo disaster, which are running higher than the initial estimate of $7.8 billion. Management cannot say for sure the top limit to these liabilities, but $15 - $17 billion would not be impossible. BP now holds a significant stake in Rosneft as a result of the TNK sale. This holding could present opportunity, but could also be a disaster. Business in Russia is often a tricky prospect. Business with a state-owned Russian firm could be doubly tricky. Regardless, BP continues to be underpriced by the market in the wake of the Macondo spill.

Trefis Key Drivers:

Trefis recently increased its price estimate for BP to $47, largely on the back of an improving production outlook. The company started production from five new projects in 2012 alone, and plans to bring as many as 10 new projects online by the end of 2014. Accordingly, Trefis expects production volumes to bottom out in 2014—they have been declining as a result of BP’s divestitures following the Macondo incident — before rebounding on the back of these new projects. Coupled with an expected long-term rise in oil prices, Trefis believes this increased production should more than offset any concerns surrounding spill-related costs.

The Berman Value Folio A Trefis Interactive Portfolio Report June 2013

COMPANY HIGHLIGHTS

Lowe’s

Berman’s Take: Despite slightly higher net income, Lowe’s (LOW) saw sales fell by 0.7% from the year ago quarter. Any recovery in the home improvement market was obscured by poor weather, according to Lowe's management. Strangely, Home Depot (HD) put up much stronger results on milder weather. There might be some legitimacy to what at first glance looks like a trumped up excuse: LOW does not own HD’s extensive store network in the balmy climate of the West Coast. I would have thought recovery in the housing market would have given a bigger boost by now to LOW revenues, but eventually LOW will reap the rewards of a resumption in home equity loan volume and other normalization of housing trends. On the other hand, LOW has become fully priced as the real estate market has improved. Above $47, I would consider selling.

Trefis Key Drivers:

Despite the relatively soft sales reported in the first quarter, Lowe’s is still well-positioned to take advantage of the rebound in the housing market. The U.S. housing market posted some impressive gains in 2012, and new home sales were well over 400,000 per month (seasonally adjusted) through the first four months of 2013, including a year-over-year increase of nearly 30% in April. If management is correct about weather-related delays in home improvement spending, then the company’s sales should bounce back in a big way in Q2. Additionally, Trefis expects a near-term rebound in gross margins as the company’s “Value Improvement Plan” progresses.

The Berman Value Folio A Trefis Interactive Portfolio Report June 2013

Market Capitalization

Annual Revenues Dividend/Yield 52 Week Range

$47 B $50.5 B $0.64 / 1.5% $24.76—43.84

COMPANY HIGHLIGHTS

Market Capitalization

Annual Revenues Dividend/Yield

52 Week Range

$35.7 B $14.6 B $0.60 / 2% $19.30—30.79

Berman’s Take: I believe that BNY Mellon (BK) has the strongest balance sheet of any global bank. Of course, BK gets most of its revenue from asset services, such as providing custody, rather than traditional lending. This business model makes BK much safer compared to other large money center banks. Yet, BK still sells at a discount foisted upon it by the financial crisis: BK trades at book value, much lower than its customary 20%-50% premium to book. I believe BK is worth far more than the Trefis estimate of $28. I would put fair value around $39, which represents a 30% premium to book value. BK is positioned well to take advantage of a global recovery in financial markets. I would buy it at any price below $36.

Trefis Key Drivers:

BNY Mellon is looking to grow its wealth management business in the coming years, in a

move that looks like a reaction to the low interest rate environment that is throttling revenues

from its primary custody business. The bank is looking to boost the wealth management

division’s sales force by about 50% over the next two years, in an attempt to add to its $632

million in wealth management revenues. This will be an important initiative for the bank in

the near-term, as the assets under custody for its largest business, asset servicing, have

remained largely stagnant since last year.

The Berman Value Folio A Trefis Interactive Portfolio Report June 2013

BNY Mellon

COMPANY HIGHLIGHTS

Pfizer

Berman’s Take: Pfizer (PFE) has decided to spin off the remaining 80% of its animal healthcare division Zoetis to Pfizer shareholders. This will mark the continuation of PFE's focus on core pharma — a diametrically opposed strategy to companies like Novartis (NVS) and Johnson & Johnson (JNJ), which are maintaining their highly diversified portfolios to complement pharmaceutical revenues. At 5% of PFE’s value, and as a division which clearly no longer seemed to fit with the rest of the product line, Zoetis stood out like a sore thumb. But there’s no question that PFE’s strategy is risky. If PFE can get back to delivering novel, effective compounds to supplement its ailing post-patent Lipitor franchise, this approach will work well. If not, PFE will have cast off a valuable asset for nothing. Regardless, I think PFE is worth at least $33, even higher than the Trefis estimated fair value of $31.40 per share.

Trefis Key Drivers:

Pfizer’s Q1 revenues declined by 9%, primarily due to the weak performance of its specialty

care, primary care and established products divisions. The company’s cardiovascular revenues

continue to plummet following the expiry of the patents for Lipitor—once the world’s largest

selling drug—and Caduet. Pfizer does have some potential blockbuster drugs in its pipeline,

which it will need to prioritize in order to offset the aforementioned revenue declines. The

company’s expansion into emerging markets - management expects 2013 emerging market

sales growth in the high single digits—should also help in that regard.

The Berman Value Folio A Trefis Interactive Portfolio Report June 2013

Market Capitalization

Annual Revenues Dividend/Yield 52 Week Range

$197 B $57.6 B $0.96 / 3.3% $21.40—31.15

Ticker Name

Buy Hold Sell Purchase Date Purchase Price

Market Price

Total Return Since Purchase Date

Trefis Estimate

Basic Materials

AA Alcoa Buy 12/21/2011 $8.87 $8.50 (2.5%) $7.25

DOW Dow Chemical Buy 12/21/2011 $26.98 $34.46 34.0% $34.26

MT

Arcelor-Mittal Buy 9/21/2012 $16.06 $12.66 (20.4%) $16.62

Consumer

LOW Lowe’s Hold 07/20/2012 $25.63 $42.12 67.4% $39.46

PG Procter & Gamble Buy 12/21/2011 $65.84 $72.37 15.4% $70.77

Energy

BP BP Buy 12/21/2011 $41.33 $42.9 8.7% $47.26

Financial Services

BK BNY Mellon Buy 12/21/2011 $19.43 $30.07 59.8% $28.25

C Citigroup Hold 12/21/2011 $25.74 $52.00 102.37% $50.04

JPM JP Morgan Buy 12/21/2011 $32.12 $54.61 77.1% $53.18

Pharmaceuticals

PFE Pfizer Buy 01/21/2012 $21.90 $27.23 30.2% $31.40

Tech, Media, Telecom

ADP ADP Buy 12/21/2011 $53.21 $68.72 34.6% $65.38

AAPL Apple Buy 2/21/2013 $444.99 $449.68 1.8% $626

EBAY eBay Hold 12/21/2011 $30.18 $54.10 79.3% $56.35

PAYX Paychex Buy 12/21/2011 $29.14 $37.23 35.8% $31.85

Industrials & Transportation

CSX CSX Buy 12/21/2011 $20.80 $25.20 24.9% $23.12

UPS UPS Buy 12/21/2011 $72.40 $85.89 24.01% $86.37

UTX UTX Buy 04/21/2012 $80.40 $94.96 20.4% $109

Total 44.1%

Total return is calculated since inception date of 12/21/2011, including reinvested dividends, on an equal dollar-weighted portfolio.

THE BERMAN VALUE FOLIO

The Berman Value Folio A Trefis Interactive Portfolio Report June 2013

PORTFOLIO CHANGES

No changes this month, but con-

sidering a sale of LOW above $47.

Disclaimer

The Berman Value Folio (TBVF) is published monthly and provides information and investment ideas on stocks. All material in TBVF is Copyright 2011-13 by Trefis and JBGlobal.com LLC and may not be reproduced in whole or in part in any form without written consent. TBVF is intended for experienced investors, who understand the risks, costs, mechanics and consequences of investing. None of the content in this newsletter is intended to be, nor should be interpreted as, a solicitation to buy or sell securities. The selection of portfolio stocks is based on rigorous fundamental analysis. There is, however, no assurance that these securities will produce profits.

Performance results are based on model portfolios and do not reflect actual trading. Actual performance will vary based on a variety of factors, including market conditions and trading costs. TBVF results may not reflect the impact that material economic and market factors might have had on the adviser's decision-making if the adviser were actually managing clients' money in this portfolio. TBVF contains stocks that are managed with a view towards capital appreciation. James Berman and JBGlobal.com may manage other portfolios with different strategies and returns that materially differ from TBVF results. TBVF model results do not reflect the deduction of any advisory fees, brokerage or other commissions, bid-ask spreads, tax consequences, and any other expenses that a client would have to pay or actually paid in a real portfolio. All return figures assume the reinvestment of all dividends. Returns quoted are for an equal dollar-weighted portfolio, where each holding is purchased in equal dollar weights. Past performance does not guarantee future results. Any forward-looking statement is inherently uncertain and cannot be relied upon as a statement of actual performance. Investment in stocks can result in serious loss. It should not be assumed that recommendations made in the future will be profitable or will equal the performance of the securities in this list.

Although all content is derived from data believed to be reliable, accuracy cannot be guaranteed. James Berman, JBGlobal.com LLC, Insight Guru Inc., Trefis, TBVF’s publisher and distributor(s) and their employees assume no liability whatsoever for any investment losses as a result of securities purchased on TBVF recommendations. TBVF is not intended to provide personalized investment advice. Readers and subscribers should consult their financial advisor before investment.

James Berman is an investor in Insight Guru Inc., the parent company of Trefis, both personally and through the venture fund he subadvises. James Berman, therefore, has a financial interest in Trefis aside from his interest in TBVF. Employees of TBVF, Insight Guru Inc., JBGlobal.com L.L.C. and Trefis may hold positions in some or all of the stocks mentioned here. James Berman and JBGlobal.com L.L.C. may hold positions in some or all of the stocks mentioned here, both personally and in the accounts and funds they manage for others. No compensation for recommending particular securities, services, or financial advisors is solicited or accepted. If you are unwilling or unable to abide by any conditions of this disclaimer, then you may obtain a refund for the unused portion of your subscription at any time.

The Berman Value Folio A Trefis Interactive Portfolio Report June 2013