Briefing.com's take on the deal
Lycos: The Exit Plan
17-May-00 00:21 ET
[BRIEFING.COM - Robert V. Green] Terra Networks (TRRA) announced after the market close on Tuesday that they would buy Lycos (LCOS) in a stock exchange valued at $97.55. They must be breathing a sigh of relief over at Lycos. They've done it. They finally got an exit plan.
Jonah Swallows The Whale
This deal is remarkable in that Terra Networks is really a much smaller company. It has a fantastic "big daddy," in Telefonica, the Spanish telecom company, but Terra, as an internet company, is still taking on a bigger company, at least in terms of revenues.
Terra Networks did $34 million in revenue last year, and $33 million in Q1 of 2000. But it has a $16 billion dollar market capitalization.
Lycos did $204 million in the trailing twelve months, almost 4 times larger than Terra Networks' TTM revenues.
But LCOS has a $5 billion dollar market capitalization.
Terra has 200 employees, Lycos has 922, almost five times larger.
But Terra Networks expenses totaled $98.47 million in Q1, while Lycos expenses were $65 million.
In short, Terra Networks really is a smaller company than Lycos. It has a better growth curve, but it loses a lot more money. The only real thing it has going for it, from Lycos's point of view, is a better market capitalization
Lycos is taking extremely highly valued stock in exchange for its own highly valued stock. How can you blame them? They just increased the multiples on LCOS, which is always good for shareholders.
Put Aside the Deal, Look At The Business
But from the long term perspective, the whole deal is puzzling, from the perspective of Lycos.
For example, ponder this for a moment.
Assume that the marketplace was only giving Terra Networks a market capitalization of $1 billion, which would not be unreasonable, given their revenue levels.
Would Lycos buy them? Using their own stock? Would that be a good deal?
If you can't see the answer to this question, immediately, it means that the combined business plan for both companies isn't obvious. And frankly, despite all of the hoopla surrounding the deal, we don't see it.
All we really see is major backing behind Terra Networks. Telefonica will be guaranteeing $2 billion in additional capital. Bertlesmann, the European media giant, has agreed to some kind of agreement over 5 years for $1 billion in advertising, in exchange for providing Bertlesmann content. Details are not yet available.
An Acquisition From The Previous Era
Frankly, this looks like a deal from 1998, not one from 2000.
It is one entirely based on the promise of a future business plan, not a current book of business.
In fact, much of the attention is being paid to the number of unique users, a number which was extremely important in 1997 and 1998, but which means a lot less now. Terra has only 2 million users, while Lycos claims 46 million.
But "subscribers" and "registered users" are very different things. Terra has actual paying subscribers who buy ISP service. Why it gets a price/sales ratio so much higher than the four to six times sales that other ISPs gets is unclear.
The Unanswered Question
The real question, the one at the heart of the merger of two businesses, is this: How will owning Lycos increase the revenues of Terra Networks core business? Of course, Lycos' revenues will become part of Terra Networks revenues. But what additional synergy is there from this merger that makes the whole greater than the sum of the parts.
Global advertising? That's contrary to the trend on the internet, which is specialized advertising.
Higher ad rates? That's also contrary to the trend on the internet, which is towards lower rates.
We admit to not seeing the synergy. This doesn't mean it isn't there, but it isn't obvious.
The only really obvious thing is what most of the attention is focused on: "someone is willing to pay a lot of money for Lycos."
Remember Excite
As for not seeing the synergy, we never saw it when @Home bought Excite, either.
And as time has elapsed, it has become clear that there really wasn't any synergy between Excite and @Home. Neither company benefited much from being part of the other.
In fact, Excite, as an influence on the internet, has pretty much vanished.
Lower Price/Sales Ratios Inevitable
If the merger happens, the new company is worth $23 billion in market cap, on combined revenues of almost $100 in the most recent quarter.
But Lycos growth rate, at about 100% year-over-year, is far below Terra's growth rate, which is close to 500% year-over-year.
What the exchange really does for Terra Networks, the new company, is destroy the second derivative of their revenue curve.
With so much of TRRA's valuation based on its high growth rate curve, this deal is almost guaranteed to lower the multiples on the combined company, six months from now.
And with TRRA's price/sales ratio so extreme, at nearly 250 times sales, any major readjustment of the multiple will result in a severe drop in the stock price, of the new company.
After all, Lycos revenue is rising at a 100% rate, year-over-year, but it only gets a price/sales ratio of 23.
The combined entity will have a $500 million revenue (according to Terra Networks). Few companies that large double annually. (There are 53 actually, but only six of those have Price/Sales ratios above 20: BRCM, IMNX, JDSU, SEBL, VRTS, YHOO).
Is the combined entity the next Yahoo? It has to be to justify holding onto the TRRA shares you get for LCOS shares.
We just don't think Terra Networks, with Lycos, will grow fast enough to justify a $30 billion valuation a year from now. And without a reward of 30% (which is what a $30 billion valuation is), holding the new entity to find out what the synergies are, doesn't seem worth it.
Lycos Investors Should Sell
First, we admit to knowing very little about the details of the combined company's plans for expansion. If you know more, (as opposed to believing more), you may wish to ignore these comments.
But, much of the enthusiasm for this deal seems to be stemming from the "it's the first GLOBAL internet company!" which is very much a throwback to the internet days of last year. Forget looking at the real numbers. Just ponder the possibilities.
Given the valuations of the relative companies, and the possible valuation of the combined entity, we can only come to one conclusion.
This is the best possible outcome for Lycos investors.
And they should sell now, even before waiting for the closure of the deal.
Lycos' highest stock price ever was $93 5/8 on December 21. Lycos closed yesterday at $74. If it rises today, we think the best thing for most Lycos investors, particularly long term Lycos investors, is to sell.
Comments may be emailed to the author, Robert V. Green, at rvgreen@briefing.com |
