From Briefing.com:
Updated 10-Sep-98
The End of Y2K Investing
The Y2K investing opportunity is over.
If you have just recently heard of the Year 2000 problem, (which is the inability of computers to understand whether a date of 01/01/00 is the year 2000, or 1900), and are considering investing in companies that will benefit from fixing this problem, forget it. The time is past.
Why?
First, the market looks further ahead than Y2K stocks allow. Stocks are priced according to their future value, not current conditions. The Y2K arena has the unique aspect of disappearing at some time after the year 2000 deadline. This makes "future value" a distinctly few number of years, and getting shorter every day.
Second, the market capitalization of pure Y2K stocks, companies whose sole business is solving Year 2000 problems, simply does not allow much room for a return.
Market Capitalization
Market capitalization is the total value of a company, set by the stock market. Calculated by multiplying the stock price by the number of shares outstanding, market capitalization represents the "price" you would pay if you bought the entire company, one share at a time.
Buying shares of a company is simply a proportional way of "buying" the company. If you wouldn't buy the entire company at its market capitalization price, you shouldn't buy the stock. This is one of the most basic principals of fundamental investing.
What do you expect when you buy any investment? You expect, first of all, to get your investment back, then you expect a return. Pretty basic, right?
Pure Y2K stocks, at current market capitalizations, hardly return your capital, much less give you a return, based on market capitalization analysis.
The terrible unique thing about Y2K stocks is that their business goes away in just a few years. The Y2K business needs to recoup its entire investment, plus a healthy return in just two to three years. Would you buy a pure Y2K business in the year 2002?
Here is a look at the current market capitalizations of three "pure" Y2K stocks. All numbers are in millions.
StockMarket CapTotal Earnings 98/99/00Total Earnings + BookPeritus (PTUS)$44.5$16.7$45SEEC (SEEC)$27.0$16.2$24Alydaar (ALYD)$143$134$152
Source: Zacks earnings estimates for 98/99. 2000 was assumed by doubling 1999 earnings. Alydaar assumptions were 98: $1.00, 99: $2.50, 00: $5.00 per share. No data was provided by Alydaar for these estimates; these are purely hypothetical for purposes of calculation and should be considered as projections. No analysts currently cover Alydaar.
By the time the year 2000 is over, these companies will have just about returned investors capital, but with no return for over two years risk. At that point, the Y2K business will clearly be in decline. This assumes that all of the currently high earnings projections are met, and that nothing is spent acquiring new businesses, either by stock or cash. Any acquisition or new product development will be, by definition, in an area where the company has no experience. To make matters worse, none of these stocks has demonstrated a post-year-2000 business plan.
In essence, an investment in any of these stocks is really not a Y2K investment at all. It is an investment in a post-2000 strategy that is completely unknown! In old fashioned language, it's a "pig-in-a-poke."
Buying the Business
For example, imagine you are buying all of Peritus Software. You pay $44.5 million today.
Earnings, according to Zacks, will be -$0.01 for 1998, and $0.34 for 1999. Assuming no growth in number of shares, this is equal to total earnings of $5.5 million by 12/99. On December 1999, you have gotten $5.4 million back, and you have assets worth, at book value, $29 million (assuming no depreciation in assets). Your total return? Just $34 million, by December 1999. If you assume Peritus doubles earnings in the year 2000, and makes $10 million, the total return, again assuming no depreciation or growth in assets, is just $44 million. In other words, by the time the year 2000 problem is one year old, you have just what you started with. Except that you now need to find another line of business other than Y2K.
Why not just take the $44 million and start the new business now? Why bother buying Peritus and losing two years of returns?
Unless you can answer this question, and we can't, it doesn't make any sense to buy the stock.
Not Denying the Y2K Problem
We aren't denying the existence of the Year 2000 problem. It is real. We have high respect for Ed Yardeni, the renowned economist, who is now predicting a 50% chance of a recession, solely due to the Year 2000 problem. But the dire reality of this just doesn't justify the market capitalizations of these Y2K companies.
We are assuming that Y2K spending, and therefore revenue derived from it, will start to decline after the year 2000. Although it will probably go on for some time, there isn't any reason, currently, to assume it will continue to boom after the deadline. If a company can survive through 2000 without a full fix, it seems reasonable to assume it can fix remaining problems at its discretion.
The pure Y2K companies have to get the critical Y2K work done, then make the transition to a new business, all within the next two years.
The remarkable thing about this analysis is the fact that Peritus and SEEC have already lost 80% of their market capitalization over the past year, and Alydaar 50%. Y2K investing was dominated by emotional reactions throughout most of 1997, which drove them to incredible expectations. But as the expectations were not realized, and the timeline drew nearer, investors lost faith in 1998. Most never took the time to consider the market capitalization analysis technique.
Briefing Conclusion
Briefing has always been negative on the pure Y2K stocks, since we first started coverage in September 1997. Using fundamental analysis, we concluded that Y2K spending was benefiting the systems integrators only (companies like Keane (KEA), Mastech (MAST), and Information Management Resources (IMRS). These companies, while getting a boost from Y2K spending, have other ongoing businesses that will sustain them. But they won't likely see the same growth spurt they did last year when 1999 comes around. Readers who bought these stocks based on our November 1997analysis have had a good return. But they should not be thought of as Y2K investments anymore.
And for the pure Y2K stocks, just one year since we started coverage, things look even worse for the pure Y2K companies, whose only business is Year 2000 work.
You will probably start to hear more and more about the Y2K problem. Pat Robertson, the 700 Club television evangelist, is even talking about the doomsday it represents. And it may indeed turn out to be a major problem for the economy. We will keep watching these companies, in case some new development occurs. But Briefing won't again be writing about the Year 2000 problem as an investment idea. That era is over. |
