IRS, Treasury Unlikely To Approve Yahoo's Alibaba Spinoff: Capstone Analyst

In a report published Wednesday, Capstone analyst Max Reale commented that the U.S. Department of the Treasury and the U.S. Internal Revenue Service are unlikely to approve and could take action to block Yahoo! Inc. (NASDAQ: YHOO)'s proposed tax-free spinoff of its stake in Alibaba Group Holding Ltd (NYSE: BABA).

Reale discussed comments made by a senior technician reviewer in the IRS's Office of Associate Chief Counsel during a D.C. Bar Association event.

"He stated the agency is considering changes to rules concerning spinoffs and resulting taxation," Reale wrote. "Furthermore, he announced the IRS will temporarily suspend any ruling requests received starting as of the announcement to allow the agency to further study the issue."

The technician also said that requests already received would move forward, but that decision could be reversed. The analyst noted that Yahoo filed its pending ruling request with the IRS in the first quarter and stated it hopes to finalize the spinoff in the fourth quarter.

Reale continued that based on conversations with tax lawyers and lobbyists, the IRS official's comments were "carefully choreographed" by both the IRS and Department of the Treasury, and "were designed to send a message to Yahoo concerning the Alibaba spinoff, though neither company was mentioned by name."

Two Concerns

As such, the analyst is concerned about the potential for an adverse ruling for two reasons.

First, Yahoo's approximate stake in Alibaba is valued at $34 billion and a tax-free spinoff is designed to save nearly $11 billion. The analyst cited the law firm Wachtell, Lipton, Rosen & Katz who said there were 201 spinoffs announced in 2013 and 176 in 2012, with aggregate values of $33 billion and $41 billion, respectively.

Second, Yahoo "barely reacted" to the IRS comments and was "dismissive of the potential threat." Moreover, the company's only public reaction amounted to a two-sentence statement in which the company announced it will continue as planned with the spinoff and does not believe it will be affected by the comments.

Bottom line, Reale estimated an unfavorable change in the tax code could result in over $11 in tax expense per Yahoo share. The analyst also noted that "it appears that Yahoo shares are reflecting little likelihood that the transaction will not go through as planned."