Ratios R Us:
Wall Street's Keys To Valuing Internet Stocks
.....what do you think about this??????
By Steve Harmon
Senior Investment Analyst
Internet.com
"Where Wall Street Meets The Web"
The reason why legendary investor Warren Buffett makes no investments in technology is because he admits he doesn't understand it. Despite the fact that he and Bill Gates play cards together Buffett is not an investor in Microsoft. If oldline players on Wall Street don't understand your father's technology stocks (which have been around for decades), how does anyone make sense of Internet stocks, which popped out of a time warp a short three years ago?
Despite the tendency of a few analysts to wholeheartedly make claims and target share prices like Nostradamus calling the Psychic Friends Network, we prefer to examine a few key metrics and place them in the context of the whole before giving a thumbs up or down on a stock or company, or at least letting you play Siskel and Ebert on your own which is far more valuable to you.
Here's a snapshot of a few key elements that we think are important to consider when valuing Internet stocks:
1) Management. A bad captain and great ship make for rough waters no matter how pretty the sail. Often in the Internet it's those that come from it, who pioneer parts of it, that understand how to leverage it better than those who jump on board later and try to force a square peg in a round hole. Here's our short list of a few we think may have done it right so far, created something that is unique in its arena and difficult if not impossible to duplicate: Yahoo (NASDAQ:YHOO - news) , Amazon (NASDAQ:AMZN - news) , E*TRADE (NASDAQ:EGRP - news) , AOL (NYSE:AOL - news) , CheckPoint Software (NASDAQ:CHKPF - news) , Vocaltec (NASDAQ:VOCLF - news) , Mecklermedia (NASDAQ:MECK - news) , producer of this report, Lycos (NASDAQ:LCOS - news) , Excite (NASDAQ:XCIT - news) , Microsoft (NASDAQ:MSFT - news) , Sun Microsystems (NASDAQ:SUNW - news) , @Home (NASDAQ:ATHM - news) , and Netscape (NASDAQ:NSCP - news) . There's a few more but space is limited so let's go on.
2) Barriers to entry. It's often said that duplicating any company's game plan is easy on the Web since two guys or gals in a garage can do it. That sounds good in the 10,000 business plans bombarding Sand Hill Road every day but isn't so on Web Street. We estimate it'd take at least $1 billion to even touch Yahoo's accomplishments globally. In our minds it's brand equity alone may be worth north of $400 million. For 25 million people a month Yahoo IS the Internet.
For comparison, Microsoft spent more than $250 million just to promote Windows 95 when it first came out.
And we believe the biggest barrier is time. Lead time may be worth anywhere from a few million to several hundred million dollars, depending on the market segment. Netscape is one example as its revenue zooms past the $500 million mark just three years after Jim Clark and Marc Andreessen sat down over sundaes at Dennys in Silicon Valley and etched out Mozilla on a napkin (or something similar). Nobody's submitting browser software business plans to venture capitalists anymore.
3) Timing. The perfect product at the wrong time is useless. Remember home banking in the 1980s? Financial institutions touted this as the second coming of bean counters, pay your bills online. The trouble was that nobody was online at telegraph baud rates and the quality of experience was like chewing gum during a root canal. And about as fun.
It took Xerox PARC, Apple, IBM, Microsoft, Intuit, US Robotics, Cisco, Intel, Amiga, the telephone companies, Vint Cerf, Tim Berners-Lee and the University of Champaign, Illinois (and dozens of others firms and people) to create the Internet/Web/PC/multimedia world we enjoy today--and people the ability to AFFORD it all. Marc Andreessen in 1975 with a browser application would be out of sync and unfunded.
4) Access to capital. The record number of Internet initial public offerings, and the record amount of capital pouring into venture capital for the Internet is for one reason: this industry moves at up to 10x faster than any other and the lights and modems must keep whirring somehow.
Just making it into pre-alpha stage may take as much as $10 million to $20 million for a company to get its footing.
Add the sales and marketing force, the talent (see management above), and the folks to take it to the next level gets into the $50 million range easily.
Consider Proctor and Gamble's ad budget and you'll see how difficult it can be to compete with the barrage of messages from established players. All the more that a brand equity that's recognized means something (but likely isn't valued that much on Wall Street even still).
How do ads and value equate? For your brain cells. One Super Bowl ad minute costs more than $1 million. Internet startups must compete against that and more-- the millions of Web sites, radio, cable, newspapers, movies, video games and more-- just to get your attention. If they don't have your attention they will most likely not have your pocket book.
Ratios & Percents. There are numerous ways to value a company. One is to take overall future market segment revenue and apportion a certain amount to a firm. For example, if we estimate that 300 million people may be on the Web in the year 2005 and AOL manages to maintain its position as access leader (we estimate its current position could be about 10% of all people in the world on the Internet use AOL, 10 million people out of a global 100 million on the Web in 1998), than that implies an AOL subscriber base of 30 million in seven years.
We can then apply a discounted revenue and cash flow per subsriber basis to that figure and arrive at a imputed AOL value. Factor in the marketing deals it currently is signing--Tel Save pays AOL $100 million to market its long-distance services, for one, and extend that to how many other marketers would like to reach 30 million people in one shibang.
The more traditional ways of looking at stocks apply to Internet stocks also. Because few early stage Internet companies have earnings, revenue is extremely important, and not a given.
Fully-diluted shares to revenue is another value metric. Take all shares out plus options, warrants, preferred, etc., and divide by sales vs. peer group and rival industries. Of course managment and timing also must be factored. Price-to-earnings provides yet another ratio.
Many try and reign this in under 50x, discounting it ahead to help them sleep at night. Sure, there's more to look at, and experience and instinct play a part, as do technical analysis. Also important: Debt, ROI, ROE, the same ratios that Buffett uses do apply at some point.
In fact, most of what we just outlined is straight out of Buffett's bonanza bag. Because at the end of the day, or beginning of a new one, whether it's Coca Cola or Amazon.com it's still business, and that means somoene making money. |
