Internet stands at crossroads...
By Bambi Francisco, CBS.MarketWatch.com
Last Update: 12:09 AM ET Sept. 10, 2002
Commentary: There's still more to learn since Sept. 11th
SAN FRANCISCO (CBS.MW) - We've learned a lot about valuations, values, expectations, the markets, and our own nature in the past year. There is much to appreciate. But if we don't separate grand illusions of the '90s from reality, then we won't have learned anything.
Let's start with what to appreciate...
Only after Sept. 11, did we realize how invaluable the Internet is in dispersing news and enabling us to communicate.
For instance, the phones were down, and I on the west coast was on America Online's instant messenger with my dad on the east coast that morning when he typed: "A part of me just blew up."
And within less than a year, we saw how e-mail became "Exhibit A" in the Merrill Lynch conflict-of-interest scandal that cost the brokerage firm $100 million.
The adoption of the Internet is unprecedented. It's eclipsed other forms of fast-growing communications mediums or entertainment products.
It took fewer than three years for more than 10 percent of the U.S. population to be on the Internet. This compares to 12 years for color TVs, eight years for cell phones and roughly four years for personal computers and CDs, according to Pew Internet & American Life Project.
I reflect on these numbers and I can't remember how I managed without the Net. I'm perplexed at my habits. I never ran outside to check my mail in the morning. Yet now, I check e-mail before breakfast. I can't imagine how children will manage without this amazing source of information.
We've all become Cyrano de Bergeracs. We're poetic when we want to be. We're also well informed when we need to be. We're learning. We're gathering. We're buying.
According to the Census Bureau, there are 191 million adults in the U.S. Fifty-four percent of them are online. Of those online, 59 percent of them have bought something on the Internet.
On any typical day, about three percent of adult Internet users are buying something. About 16 million are conducting research to buy something. On any given day, 27 million get news while 25 million search for something.
Is it any wonder that we overestimated (and never questioned) how quickly business opportunities could expand, and how quickly real demand and real revenue, much less profit, could materialize?
Still wrestling with valuation, recovery...
So we temper our optimism and become happy realists. One day I'm listening to Google's Eric Schmidt attempt to foster a bullish mindset among tech investors and entrepreneurs by calling us part of some "Optimists Club." The next day, guys like Robert Prechter, devout Elliott-Wave theory follower and author of "Conquer the Crash," are calling for the Dow to fall below 1,000.
It's a green light for tech innovation, but my stock screen is all red. It's not such a dichotomy, actually.
As an innovative service, I really like Yahoo (YHOO: news, chart, profile). As an investment I'd probably begin to like Yahoo's stock only if the Dow goes down to 1,000.
Here's why. Yahoo is worth more only if its earnings grow substantially or if multiples expanded. And I don't see either happening.
Arguments supporting Yahoo point to its current comparable multiple to other media companies. Yahoo is trading at 16 times U.S. Bancorp Piper Jaffray's expectations for 2003 EBITDA. By contrast, radio media stocks trade at 15 times earnings, general broadcasting shares at 11 times and outdoor advertising at 13.8. But according to the investment banking firm Yahoo should be trading at an even greater premium because of its faster growth rate.
But wait! First of all, that Yahoo multiple is based on a very ambitious EBITDA estimate of $256 million next year, or $100 million more than this year. This is also based on assumptions that Yahoo will generate roughly the same sales as it did in 2000, or about $967 million, up nearly 30 percent from this year's sales expectations.
Is that optimistic? Well, considering the economy might just enter a double-dip recession, it's hard to imagine companies going on a spending spree for advertising. What's more, online advertising may not be steered towards big portals as it becomes increasingly apparent that online advertising works well in niche sites rather than on broad sites. Already, we've seen AOL Time Warner's (AOL: news, chart, profile) America Online unit continually temper its outlook. On Monday, it said its 2002 $1.7 billion in ad and commerce sales estimate might be off by 5 percent.
Let's also not forget that Yahoo bought its revenue when it acquired HotJobs and in its deal with Overture (OVER: news, chart, profile). "Yahoo might make those numbers if it buys growth," said Paul Kim, an analyst at Kaufman Bros. But if this is the case, then Yahoo shouldn't have a premium multiple, said Kim. "Multiples are set on organic growth."
Even if Yahoo were to generate and meet its sales and EBITDA figure, here's another thing to think about: What multiple should it be valued at?
According to Kim, Yahoo's operations actually look more like a newspaper, which generates revenue from classifieds, advertising and subscriptions. This is assuming that a newspaper's printing and fulfillment costs are similar to Yahoo's technology costs and backbone costs. A very mature newspaper business trades around 8 to 9 times EBITDA. Yahoo might also look like a radio company because a radio company has high margins. That means a blend of newspaper and radio multiples should put Yahoo's EBITDA multiple at about 12 times, and that may be too generous. Yahoo is currently trading far above that.
Unsustainable and unrealistic valuations are present in the software sector too. Goldman Sachs analyst Tom Berquist wrote this reminder to his clients recently: "The remaining obstacles [regarding valuations] would likely be the three-year growth rates, some of which may still be too optimistic, given the likely I-T spending growth rates vs. historical norms. We believe there is less urgency for I-T spending then there was in the '90s when the market moved from centralized mainframe systems to more modern client-server, distributed systems, before Y2K and then followed by urgency to implement Internet infrastructure to avoid being dot-commed."
What does this mean? The '90s multiples should not be a benchmark in determining value. What's more, if the decade's valuations were the best-case scenario, then current valuations should, at the very least, be at those levels. And they're not, even if we go back to 1990, when there was a minor bear market.
According to Fred Hickey, who pens "The High-Tech Strategist" newsletter, the average price-to-earnings multiples in 1990 for tech companies across a broad range, such as Microsoft (MSFT: news, chart, profile), Cisco Systems (CSCO: news, chart, profile), Intel (INTC: news, chart, profile) and Electronic Arts (ERTS: news, chart, profile), was 17. This compares to the current average multiple of 39 times for the same group of companies plus new entrants, such as EBay (EBAY: news, chart, profile) and Intuit (INTU: news, chart, profile)...
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Bambi Francisco is Internet editor of CBS.MarketWatch.com, based in San Francisco....
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