New Internet valuation models-
Valuation in a Whole New World
By James J. Cramer
11/30/99
Akamai (AKAM:Nasdaq), Foundry (FDRY:Nasdaq) and Sycamore (SCMR:Nasdaq) changed my life. They made it impossible for me to spend as much time as I would like on the Old World (irreverently called the Dial (DL:NYSE)-Colgate (CL:NYSE)-Procter (PG:NYSE) world internally) and forced me to spend every spare moment on the New World.
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How did it happen? How did three challenging stories with very little revenue, almost no earnings and lots of concept force me to change my work habits as a hedge fund manager?
Simple: $50 billion worth of stock. That's right, these three companies in total add up to $50 billion in market cap, and that's just too big to ignore.
There used to be a process. A company with skimpy revenue and lots of promise would come public with a valuation parameter of hundreds of millions of dollars, and then try to earn the respect of Wall Street. As it blew away the numbers, it picked up endorsements and recommendations from investment houses. It garnered support from the mutual funds. It made its way through conferences and quarters. It did some great conference calls. It started a string of enthusiastic earnings reports.
It crept its way toward the billion mark.
After several years of tearing the cover off the ball, it hit respectability and began to be valued in the billions, always constrained by a price-earnings multiple that could only be as high as its company's growth rate. If it got too high it lost the support, carefully groomed, of the Street. It became too risky to own lest it make a mistake, trip up, blow a quarter.
Eventually it would be welcomed into the world of the Nasdaq 100, and then the S&P Mid-Cap and finally the S&P 500.
Man, talk about ancient history.
Right out of the chute these three companies crossed the $10 billion threshold. They aren't constrained by quarters, by conference calls or P/Es. Those measures seem downright quaint to the holders of these stocks.
Of course, one could argue that, with only less than 10% of the shares outstanding actually floating, all people are really trading are market caps of $1.7 billion for Schemer (as we all call Sycamore), $2 billion for Akamai (the Wall Street word for profits) and $1.2 billion for Foundry (undervalued anyone?). But we have seen secondaries and high-speed lock-up expirations in record time in this market so one has to expect abundant supply in no time flat.
How did this happen? How did the whole paradigm of valuation, a paradigm that we had all gotten comfortable with, go out the window in a year's time?
Let me give you some answers.
1. Microsoft (MSFT:Nasdaq). This company got to $500 billion, which changed the way we look at everything. If you could find the next Microsoft, you were golden. If you couldn't, you were history. So you place a lot of bets knowing that the worst thing that happens is you land a Visicalc or an Ashton-Tate or a Borland along the way.
2. Cisco's (CSCO:Nasdaq) purchase of Cerent. This acquisition of a $7 billion start-up by the masters of acquisition told you to loosen up on these public valuations. It validated a whole lot of craziness.
3. Market size. The markets that these companies play in are multi-billion-dollar markets and the companies that dominate this new world are going to make a whole lot of money.
4. Venture fund valuations got out of control. Before these companies ever became public, the venture funds were putting valuations on them that made the public markets sit up and take notice. You aren't going to have a down public round after a $2 billion private round, especially, if that is round No. 2 of three before the IPO!
5. The public controls the opening. When companies come public at huge valuations, the public's market orders often are behind the last $10 billion in market cap. The public wants the next Microsoft, Cisco or Yahoo! (YHOO:Nasdaq). The public doesn't care how much it costs or whether it is overpaying. It knows what it sees: It only takes one of these to get real rich.
6. The small float allows a couple of aggressive mutual funds to control the aftermarket and prop up the valuations. Given that a couple of fund families are up so huge that they can do what they want, they have sought to buy every share of some of these, making them extremely difficult to buy without paying up even further. Of the six points this is the most controversial because it smacks of a corner. I think it is occurring, but who is going to protest it? The short-selling lobby? Good luck.
Many other stocks now fit this pattern. But I wanted to focus on these three high-visibility ones to get the point across. If you don't believe this is a new world after reading this piece, I think you are in danger of being left behind. Forever.
Random musings: Many thanks to all of you who posted voluminous comments on our boards about these picks. Both Matt Jacobs and I found them extremely helpful and beneficiary. We may not have the 5 million posts a day that Raging Bull had (at least according to our site), but we have quality posts, which are actually worth something. Of course, on Wall Street, a pageview is a pageview, but one day people will ask, "Hey, what's on the pageview?" and we will win. |
