Yahoo Inc's(YHOO.O) efforts to craft a complex $17 billion asset swap with its Asian partners stumbled over how to value Taobao, the fast-growing online retail business owned by China's Alibaba Group, according to sources familiar with the matter.
Negotiations between Yahoo, Alibaba and Japan's Softbank (9984.T) broke down on Tuesday, about two months after the parties agreed to a basic outline for a deal that would have returned Yahoo's stakes in those companies to their owners in return for a clutch of unspecified assets.
The actual valuation of the deal did not come up during recent negotiations in Hong Kong, according to one source familiar with the matter, but several people involved in the proceedings said the rapid growth of Taobao caused Yahoo to have second thoughts about the valuation agreed in December when they signed a term sheet.
The situation described by several people involved in the discussions appeared to downplay some analysts' views that the halt in talks was a negotiating tactic employed by one of the parties involved in the complex transaction.
"Taobao was definitely the main problem causing talks to break off," said one of the people familiar with the matter.
The e-commerce web site is considered one of the most valuable businesses owned by privately-held Chinese Internet giant Alibaba Group. Alibaba does not disclose financial details for Taobao, but analysts say the web site dominates consumer-to-consumer online retail in China and is growing rapidly as the country's online population - already the world's second-largest - swells.
"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 the business' value, he said.
While Yahoo never explicitly moved to revisit the price of the deal, the person said, "it certainly puts pressure on whether the deal ultimately makes sense or not."
Reports of the snag in the deal - a so-called cash-rich split-off that would have allowed Yahoo to shed its Asian asset in a tax-efficient way - sent Yahoo's shares down 4.7 percent on Tuesday. Yahoo owns roughly 40 percent of Alibaba Group shares and 35 percent of Yahoo Japan (4689.T), which it jointly owns with Softbank.
Several sources noted that some factions within Yahoo were always somewhat hesitant about the prospects of the tax-efficient deal because of its inherent complexity and the uncertainty of satisfying the Internal Revenue Service.
The risk of political fall-out over the deal, which would effectively allow Yahoo to avoid paying billions of dollars in taxes after spinning off its stakes in Alibaba and Softbank, could also have contributed to the deal losing some of its appeal, according to the first source familiar with the matter.
What's still on the table?
Yahoo representatives - including Chief Financial Officer Tim Morse - returned to the United States late on Monday after a week of negotiations in Hong Kong, and another call was set for this week, according to several sources.
The sources said Yahoo and its Asian partners could still strike another, simpler and taxable, deal, but there was no agreement yet on the price at which Yahoo should sell.
The convoluted nature of the cash-rich split-off transaction, and the internal changes at Yahoo - including the appointment of CEO Scott Thompson in January and a planned board shuffle that will see the exit of Chairman Roy Bostock - further complicated the negotiations.
"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, etc," that person said.
Representatives from Yahoo and Alibaba were not available for comment. None of the sources wanted to be identified given the private nature of the negotiations.
Despite the complexities, both Yahoo and Alibaba have strong incentives to work things out, according to some observers.
Alibaba founder Jack Ma has tried to buy back the 40 percent of his company owned by Yahoo several times in recent years, only to be rebuffed by Yahoo.
The U.S. company undertook a "strategic review" of its business after firing CEO Carol Bartz in September, and analysts have said Yahoo would want to monetize its Asian assets so Thompson can focus on reviving the company's core operations.
The pressure on Thompson increased on Tuesday with activist hedge fund ThirdPoint saying it wanted to nominate its own slate of four directors to Yahoo's board.
Some investors reckon the latest snag in the deal could prompt Alibaba to pair up with private equity and buy Yahoo outright.
For now, the cash-rich split deal appears dead in the water.
"The structure isn't going to work," said the third source. "They may still want to unload the assets. Everyone's going to go back and regroup and look to a possible alternate path forward."