ah, one sane person left in the planet
December 2, 1998
Today's 'Net Winners May All Be Losers
By Rivka Tadjer
For the last few months, investors have been obsessed with picking the
potential winners among Internet stocks.
The prices of any stocks with an Internet 'story' have skyrocketed without
rhyme or reason. Wall Street analysts -- perhaps hungry for the investment
banking business of what they hope will be the next Microsoft -- have thrown
away their HP 12C calculators and Graham and Dodd texts from business
school to join the Internet party. The result: absurd valuations based on
"price/fantasies multiples," as Alan Abelson put it in Barron's this weekend
("Virtual Delirium," November 30th).
But as the Internet matures as a retail distribution channel,
some old warning signs are sure to take on new meaning
for long-term investors, such as, how hard is it to compete
with the company in its own core business? If there's no
real barrier for competitors, then today's leader is bound to be tomorrow's
loser.
"Amazon.com is the first such stock that comes to mind, but others, such as
eBay, and Theglobe.Com also fit this profile," says Lawrence York,
co-manager of the WWW Internet Fund, based in Lexington, KY.
Though Amazon.com now sells CDs and videos and aspires to be more than a
bookstore, that's what it's known for -- nothing unique there. eBay is an online
auction house and Theglobe.com is an online "community."
Yet, as everyone knows, these stocks are trading at astounding multiples with
little prospect for solid profitability soon. Still, many of them get strong Buy
recommendations across the board.
Following Wednesday's selloff in the sector, Amazon.com changed hands at
199 ½ -- but a consensus of Wall Street analysts thinks it will lose $1.66 a
share in 1998 and $1.80 in 1999. eBay is at 203 ¼, which means it's trading
at a whopping 1,127 times 1998 earnings of 18 cents a share and at 1,194
times projected 1999 earnings of 17 cents.
Theglobe.Com, which went public on
November 12th at 9 and closed at $63
½ on the first day of trading, is now at
33 5/8, up almost 300% since its
offering, despite red ink projected well
into the future.
Of course, anyone who sold or shorted
Internet stocks six months ago would
have left a lot of money on the table -- if
they're still solvent, that is. But ironically,
the sooner the Internet matures as a
retail channel, the sooner the pioneers will face big competitive threats to their
leadership.
For Amazon.com, hailed as one of the first great brand names on the 'Net, the
threat is huge, adds York, because it now faces deep-pocketed competition
from the likes of Bertelsmann, the German media giant that recently bought
half of barnesandnoble.com.
"The Internet is hitting a new level of maturity," says York. "By the time the
masses of consumers go onto the Internet to shop, the brand names they
know will be there waiting -- Barnes & Noble is the prime example."
Amazon.com may be a household word for veteran Internet users, he argues,
but most consumers still don't know them. And as Netscape Communications
learned the hard way, "brand equity" on the Internet can be flimsy protection
indeed against the onslaught of a rich, tenacious competitor.
York also thinks that Internet leaders America Online and Yahoo! are
overvalued in terms of the looming risk they face. "Yes, they are actually real
companies with a real business model -- what I call the 'blue-chip stocks of
the Internet,'" York concedes. "But they are too highly priced, and when
the…new competitors crop up, their stock prices will adjust."
AOL, now trading at 88 1/16, sells at
157 times expected 1998 earnings of
56 cents and at 104 times 1999
earnings of 85 cents -- more than twice
its projected earnings growth rate next
year. Still, 25 analysts surveyed by
Zacks Investment Research rate it a
Strong Buy and seven more give it a
moderate Buy rating. Not a single soul
on Wall Street even suggests holding
this stock -- much less selling it.
Yahoo!, priced at an astronomical 197 1/16, is trading at 469 times 1998
estimated earnings of 42 cents a share and at over 300 times projected 1999
earnings of 62 cents -- more than six times its growth rate.
These companies will have to keep growing like crazy to sustain these
phenomenal valuations. Any signs of a slowdown in traffic or revenue growth
for one of these leaders could send apocalyptic shock waves throughout the
sector.
"Theglobe.com, for instance, will have to sustain a 300% growth rate," says
York.
"Doing that without competition is hard
enough." And Theglobe.com does face
real competition from Geocities, Lycos
and other existing Internet
"communities" -- not to mention future
players.
"There's nothing fundamentally unique
about this company to make anyone
believe it is worth the $5 billion stock
prices would suggest," he concludes.
Kathleen Smith, portfolio manager for the Renaissance IPO Fund, based in
Greenwich, CT, says she finds the degree of speculation incredible. "Put the
word Internet in a company name, and it will rocket at its IPO these days,"
she says. Even non-Internet companies like Books-A-Million have seen their
stock prices soar at the mere hint of an online angle.
That's why she thinks individual investors' insatiable appetites for anything
Internet just can't continue. "You must think back and remember [when]
Amazon IPOed," says Smith. "A couple of days after its debut, it was below
[the] offering [price] again. The difference now is that there's been a long IPO
dry spell and investors are hungry."
Of course, valuation is in the mind of the buyer, and even the Internet skeptics
think that companies like AOL, Yahoo!, and even Amazon.com could
maintain their leadership and brand identities.
But Smith, York and other analysts who still remember their Graham and
Dodd think that these stocks may not truly reflect their companies' business
prospects until the prices get much, much lower.
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