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March 23, 1998
Benchmarks Can Be Elusive For Valuing Net Companies
By Nelson Wang
Multiples of earnings often don't exist; some dealmakers measure cost per user
When Microsoft spends an estimated $400 million for free e-mail provider Hotmail, and Lycos pays $58 million to obtain Tripod, the question arises as to whether there is an implicit valuation standard being applied in these cases. A look at some of the most recent deals, together with interviews with several analysts and Internet companies, shows that such a standard has yet to emerge in the evolving Internet space.
"We still don't know what the business model is that's going to work clearly, so there's a feeling that [valuations] are pretty wide open right now," said Michael Murphy, editor of the California Stock Technology Letter. "The industry hasn't converged on what a user is worth yet." Unlike the more mature cable and cellular phone industries, where the value of acquisitions is often tied to a bottom line of cost per subscriber, there is not yet an accepted measure in the Internet industry as to how to value a particular site or service and its users.
Numbers of users and page views form a guideline, but precise calculations of a company's worth based on these factors are seldom made.
Instead, to a large extent, the value of an Internet company is a highly individualized determination based on how essential that company's services are deemed to be, what an acquiring company feels a particular company's users are worth to them specifically, and how much money or stock the acquiring company has to spend. And, of course, dealmakers rely on more traditional benchmarks such as rate of growth and multiples of either earnings or revenues.
But both Yahoo's acquisition of Four11 last October and Microsoft's acquisition of Hotmail in January, for example, were driven by a desire to secure what had suddenly come to be viewed as essential for a gateway site to have--free e-mail.
"There's been a recognition that it's no longer enough to just have search or directory anymore," said Lise Beyer, an analyst with Deutsche Morgan Grenfell. "In order to really compete, you've got to have a variety of services, and then it becomes a make-or-buy decision." On a per-user basis, though, Yahoo wound up spending about $92 per user, while Microsoft paid about $44 per user in its acquisition, reflecting the different objectives and sizes of each deal.
Tim Koogle, Yahoo CEO, said Yahoo was looking for a scalable platform that it could simply drop into its existing service, as opposed to just trying to add as many eyeballs as possible. With the acquisition, Yahoo also received information on about 5 million to 6 million registered users through Four11's directory service. Though it set up a model to estimate what Four11's service and users might be worth, this only created a range of values that served as the basis for discussions, said Koogle.
Microsoft, meanwhile, was likely focusing on reach with its acquisition of Hotmail, which counts 9 million users. "Microsoft was going after the clear leader in the space," said Tim Draper, managing director of venture capital firm Draper, Fisher, and Jurvetson, which had invested in both Four11 and Hotmail. "They were looking at what the business might be worth in the future, not so much what it was now." Lycos' purchase of Tripod in February was also a strategic move, in that Tripod's members were seen as particularly attractive because they tended to return to the site and spend a lot of time there.
"Internet companies are looking for a way to boost their traffic in one fell swoop, but they're also looking at retention--these tools are ways to draw people to a site and keep them there over time," said Chris Charron, an analyst with Forrester Research.
Accordingly, Lycos CEO Bob Davis said his company didn't focus on how much it was paying for each Tripod user. "It's tough to look at a company's value as it relates to today," said Davis. "We look at what it's accomplished in the past, and what it could achieve in synergy with us." Finally, the prices paid for many companies have also been driven by what the acquiring company is able to pay, which depends largely on the price of its stock or the amount of cash reserves it's got.
"At some level, the economics for each individual [acquiring] company determines the pricing," said DMG's Beyer. She added that she expects the current high stock prices of many Net companies to fuel more acquisitions.
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