Great posts, dodger.
Here's my 2 cents about the valuations of 'new economy' stocks.
I've worked for both a couple of startups and a couple of 'old economy' companies. I've always been a sucker for valuations. Actually, I shorted YHOO back in 1997 for a month before I came to my senses and admitted that there were forces beyond my comprehension. Lost about $300 on that trade, but it could have been much MUCH worse.
But, now, older and wiser, I've come to the realization that YHOO was actually *undervalued* at that time, for its P/E of 5000 or some such. Now, this is a radical statement, but hear me out on this one. My main consideration for shorting YHOO was that there was no *substance* to their little company. They didn't create anything and didn't have anything which some guy next door couldn't do. In fact, it was slightly lamer than a typical search engine, since it had to be entered in by actual humans or monkey-like equivalents, and thus had more overhead and had slightly out of date web sites.
However, this lack of *substance* was one of YHOO's strengths. One day they were a search engine, the next, they were a portal. Who knows what they'll be 3 years from now? They have the luxury of changing their business in a heartbeat. Those buggy-whip manufacturers have a harder time adapting to a rapidly changing environment.
The other strength of YHOO, and the other 'new economy' stocks, is that they're almost entirely people-powered. No longer is efficiency tied to the machinery and robotics of a Henry Ford style assembly line. If you increase the efficiency of your manufacturing by 20% that's a huge increase. In software development, you'd have to optimize 10 things before you resort to the mere 20% improvement.
So, in developing software, having a single ace programmer can not only reduce development time by 20%, but he can reduce it by 80% over a competitor's lame programmer. If you talk to some programmers, this happens fairly frequently (okay, I admit, I'm one of them!). In this 'new economy', almost everything is powered by software. And, with the rapid pace of evolving software services and technology, software development *is* the growth of your company.
So, YHOO, with the benefit of being a well-known, hot company to work for, attracts the best in the valley, which are the best in the world. And these guys don't just improve things 20% or so. Nope, they make a *BIG* difference-- 100%, 1000%. Who knows? If your P/E is 5000, and your engineers are 200 times more efficient than IBM's engineers (with a P/E of 50). Does that mean it's a bargain?
In large 'old economy' companies, they have what I call the shotgun approach to hiring programmers. Hire 20 programmers, 5 will be competent to do the required job. 2 or 3 of them will do 90% of the work. The remaining 17 will finish the remaining 10%. The product's profits more than offset the cost of the small programming staff. Eventually, the 2 or 3 hotshots get tired of working with losers and want to join a group of like-minded, highly aggressive and highly capable people like themselves.
And, as great as they were in their old companies, they're even better in a startup where they feel motivated, are empowered, and have a huge financial incentive for success. So they work 50% to 100% harder and are more efficient just changing their jobs in the first place, on top of their outstanding efficiency before.
So, my question is this:
Suppose that 10% of the employees of a $100 billion company do 90% of the work which generates 100% of the revenue for that company (a purely software, human-power reliant company). Suddenly, they leave to form a new company. What is the value of the new company? What is the value of the old company? What are their values in 5 years?
What I've seen happen in practice to answer the above questions is this. The smaller, new company, very quickly can grow to capture a very nice share of the larger company's market. They have the advantage that they can easily replace the administrative, clerical, and random other interchangeable human resources which they left behind at the larger company. The larger company, does not shrink as rapidly as the smaller company grows, however. The larger company has the advantage of their reputation and wealth, and can hire many less experienced people and perhaps replace their gems using the shotgun hiring method. Their larger market cap allows them to purchase startups like the one that they spawned.
In a situation like this, valuation based on P/E is meaningless. You'd might do better to ask the IQ and SAT scores of the founders, and keep track of when they leave to form yet another startup. (Not that standardized test scores are indication of a startup's future valuation... Just making the point that P/E is no better an indicator.)
Anyway, hope you enjoyed my rambling,
El Guapo |
