A BUYING OPPORTUNITY FOR PORTAL STOCKS?
BUSINESS WEEK ONLINE
August 28, 1998
STREET WISE by Sam Jaffe
Amidst the rush of selling that occurred on Aug. 27, what kind of stock would you have liked to own? How about one whose market is growing by nearly 500% a year in an industry that seems insensitive to the turnings of economy? How about the stock of a three-year-old company that's already profitable and is showing steady revenue growth? Judging by those criteria, investors should have been fleeing the overpriced blue chips to buy Internet portal stocks. Yet the portals were some of the hardest hit in Aug. 27's 357-point market sell-off. Excite (XCIT), courtesy of a negative story in the Wall Street Journal, was down nearly 12%. CNET (CNWK) lost 10%, Lycos (LCOS) was down almost 8%, and even industry heavyweight Yahoo! (YHOO) saw its share price decline by 5%.
Of course none of this would come as much of a surprise to anyone who has been studying the valuations of Internet stocks this year. Once again, the market has proven the adage, "The bigger they are the harder they fall." By that we don't mean market capitalization. Microsoft (MSFT), which is the most valuable stock in the world, fell only 3% yesterday.
Big, in this context, means the astronomical valuation ratios of the portal stocks. These companies sport price-to-earnings ratios in the three figures, and that's even if you buy the argument that their earnings are real, not just accounting magic. A more solid figure to measure them would be price to book value, which means the stock price divided by the per share dollar value of all the measurable assets of the company. The average PBV of the Standard & Poor's 500-stock index is now at about seven. The average PBV of the four portal stocks mentioned above is more than 40. "These things aren't just discounted for their future earnings potential, they are discounted for the hereafter," says Bob Rodriguez, manager of the FPA Capital fund, who was never a big fan of Internet stocks to begin with.
So it's not that hard to understand why these stocks would fall so far so fast in the midst of a broad market tumble. But before you go writing them off as the dear departed 90s' bull market version of the 18th century's tulip bulbs or the 80s' limited partnerships, you might consider adding them to your portfolio.
As crazy as that might sound, bear in mind that these companies are hard to measure for value. "If I taught a class, on my final exam I would take an Internet company and ask [my students] 'How much is this company worth?' Anyone who would answer, I would flunk," said Warren Buffet in last May's Berkshire Hathaway annual meeting. Few disagree with him, including the analysts who cover these companies. Most of them make valiant attempts at coming up with some formula that would place a correct valuation on portal stocks, but in the end most plead ignorance, off the record of course.
The most common tool to value these companies is determining -- or really, guessing -- their price-to-revenue ratio. Yahoo, for instance, is expected by the analysts who follow it to generate revenues of $248 million in 1999. As of the Aug. 27 market close, that puts its price to 1999 revenue at 34. That's a much more intriguing ratio than its price to 1997 revenue figure of 69 ('97 is the most recent year available for this figure). BankAmerica Robertson Stephens analyst Keith Benjamin thought that Yahoo was approximately 10% to 15% overvalued before yesterday's correction. Now it's starting to come closer to a buy. "Given volatility, we recommend opportunistic purchases and trading around core positions in franchise companies," he says.
The basic problem with placing a value on these stocks is that the market they will serve hasn't yet been fully defined. If portals go the way of push, few people will want to advertise on them. But if the rosiest predictions come true, then these stocks are underpriced. Benjamin, for instance, expects the Internet audience to climb from a current 35 million or so Webniks to 75 million by 2000 in the U.S. alone. If the portals serve as the funnel for all those surfers, they will command the most valuable advertising space on the Internet. "Audience size is the root of value," he says.
If the audience does grow according to such enthusiastic expectations, and if sites such as Yahoo! and Excite continue to maintain their brand presence, then any portfolio would do well to hold a portal stock. And with the recent correction, these stocks just became a whole lot cheaper. As to which of the stocks to own, Yahoo is currently the most expensive, but it does claim to be making a profit right now. Netscape (NSCP), which is making the transition from a being a browser company to a portal company, is probably the biggest bargain of them all. It has a PBV of about five after it fell to $23.94 in yesterday's correction, losing 10% of its value. It has a strong brand name, a portal site that's already competitive with the others, and it's technically making a profit already.
Of course, who knows how long that'll last. Which is a bromide you could safely apply to the entire portal stock group.
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