INTERNET REPORT - Proof that the Internet works
February 16, 2001
By Greg Herbert, UK-iNvest.com
Technology was supposed to be the free lunch that launched the US economy beyond the paradigm of boom and bust. But then the new-mediaphiles' philosophy was ripped to the shreds with the resurgence of olde worlde economics. 1-0 to the Luddites.
Or maybe not. The Internet economy is still far too young to for any kind of grandiose claim to be proved or disproved. But occasionally new studies emerge that seem to prove the sceptics wrong.
Merrill Lynch's technology strategy team has picked up on a recent study by the University of Texas that comes up with yet another Netspeak abbreviation to wrap your tongue around: the R2E ratio, or revenue-to-employee. This neography (a new form of typography) has a difference, though: it is actually worth looking at.
The study found that the more revenue a company makes per employee, the higher its share price goes. With one or two significant exceptions.
Merrill looked at the six technology sectors that managed to post the highest growth in revenue per employee last year -- semiconductors, enterprise storage, semiconductor equipment, energy technology, communications technology and Internet. Four of them posted top share price performances.
The converse also proved true: sectors with below average R2E growth also saw their share prices fall too. The conclusion? Put your money into companies that have good growth in revenues per employee.
Exceptional dot coms
Now for the exception. Last year, R2E at Internet companies rose 81%, the best of the bunch. But, on average, their share prices fell 82%. Why the discrepancy? Because they have yet to prove they can turn revenues into profit.
Merrill reckons there are various short-term issues involved, such as the vast amount of money frittered away on advertising. This year, with dot com prices rising, if slowly, the correlation seems to have re-asserted itself.
More importantly, the fact that Internet companies posted the highest R2E growth of any sector in the technology business suggests that the Internet business model really has the potential to deliver on its hype -- that low costs and global distribution can combine to create a new way of doing business.
It would appear the failures have drawn attention away from the successes. Take a look at the companies that have got it right, like eBay (EBAY) and AOL Time Warner (AOL). (Have a look at last week's Internet report for more on AOL).
As Merrill suggests, the ones that get the model right can indeed scale up well and generate huge returns on invested capital. "So don't give up on the Internet yet," writes strategist Steve Milunovich.
Like any emerging industry, the rate of attrition is high as people try new things and get it wrong. In a few years time, when AOL or eBay is as global a brand as Coke or McDonalds, one suspects that the growing pains will seem like an awkward and best-forgotten adolescence.
Greg Herbert is UK-iNvest.com's Internet correspondent.
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