Overvalued Internet Stocks
August 24, 1998
Ed McCarthy: Welcome. Our guest tonight is Dave
Jones, an analyst with the California Technology Stock
Letter and the Overpriced Stocks Service. Tonight we
are talking about the Internet stocks and some of the
amazing valuations they've reached. Dave, could you
tell us a bit about your background?
Dave Jones: I've worked with Michael Murphy and the California
Technology Stock Letter for 2 1/2 years, evaluating technology
stocks and helping out with our short-selling picks. Prior to that, I
was CFO of a sporting goods company on the East Coast, and
before that spent 7 years with Apple Computer. I've been investing
in tech stocks for almost 20 years.
Ed McCarthy: Before we get into specific issues, what do you think
in general of Inet stock prices?
Dave Jones: Well, the most common "valuation" method seems to
be free-basing Viagra! Seriously, though, the Internet is a
wonderful new medium and sales channel and some serious money
will be made by both companies and investors. However, we're
"value" investors (albeit in a growth universe - technology), so we
look for financial fundamentals to support valuations. We just don't
see them yet in most of the Internet stocks.
Audience: Are all Internet stocks considered overpriced? If so,
when is it a better time to buy?
Dave Jones: I'm sure we could find some relative values, but with
the general market being so frothy we think you'll get a better shot
at almost any stock within the next few months. We're looking for a
correction of as much as 1000 Dow points. That should drag even
the Internet leaders down a bit.
Audience: What about Verio? They are on a buyout spree.
Dave Jones: At about 6x revenues, VRIO is probably one of the
more reasonable valuations today. We'd like to see the business
model stabilize, which probably will mean partnering with the
RBOCs and cable companies for improved distribution.
Ed McCarthy: When you value Inet stocks, do you use traditional
methods or take a new approach?
Dave Jones: We generally use the traditional approaches. We'd
like to see a reasonable value based on P/E, as well as some
stability in the earnings stream. Granted, we missed out on stocks
like Cisco because we were too conservative to pay the multiple,
but I don't think we'll make the same mistake with the 'Net leaders.
Having said that, we're being asked to buy 'Net stocks based on
2nd or 3rd order indicators, like traffic which MIGHT lead to ad
revenues and/or transaction fees which MIGHT lead to earnings.
Someday. Moreover, the multiples are often based on a near term
growth rate assumed to last forever, and at a premium to that rate.
It's all a bit too speculative for our blood.
Audience: Is this a good time to buy Yahoo or Dell Computer
stocks? If not, when is a good time to buy?
Dave Jones: YHOO is probably going to be a leader, one of the
new emerging media companies. I'd like to own the stock, and
personally will start to average in if we get a "correction." Dell is a
bit more problematic, since their internal systems are relatively
weak and they could potentially have problems managing their
growth. But both stocks will continue to be perceived as leaders, so
barring an operational disaster or what "feels" like a major bear
market, I'd buy both on a correction. Mind you, I'd average in, not
take a full position right away.
Audience: What do you think will prompt the 1000 point drop you
predict? The Asian crisis?
Dave Jones: Not directly. Most of the bad perceptions about Asia
are probably already in the market. We think the most likely
catalyst will be general awareness of how weak S&P earnings
growth will be. Analysts are constantly cranking their estimates
down. Right now the latest consensus is for about 7% growth for
1999, and we think that's too high. So Asia will have an effect,
factors will bring earnings down. Then once the consumer gets
antsy and weakens their spending patterns, AND/OR slows the flow
of money into equity mutual funds, watch out!
Ed McCarthy: If you had to rank the Inet/tech stocks you follow in
terms of most overvalued, which would be the worst case?
Dave Jones: Probably Broadcast.com (BCST). It's a neat idea, but
we don't think they'll be able to hold on to their claimed monopoly
in content. Moreover, the technology they offer is great, but we
don't see anything that Microsoft couldn't do. Right now the value is
80x the annualized last quarter's earnings. This is an option, not a
stock!
Audience: Can you comment on the future of e-commerce and
any developing companies in this area?
Dave Jones: First of all, let's distinguish between retail
e-commerce (Robby Stephens calls it "E-tail, which I like), and
business-to-business ecomm. Amazon looks like the clear leader in
E-tailing, and I have no doubt they'll continue to maintain a lead. I
think it will be tough for new names to get the premium stock
valuations that AMZN has - look how quickly CDNW, NTKI and
others have collapsed. No doubt many e-tailers will have good,
viable businesses, but the thin margins won't command premium
values from Wall Street. On the b2b side (business to business),
I've always thought Broadvision (BVSN) had a great idea. They
were the first company I ran into who recognized one of the unique
aspects of the 'Net -one to one marketing - and have focused on
augmenting that capability. But they, and even more so
"feature-ware" companies like Verisign and Checkpoint are subject
to erosion by Microsoft and IBM. So the little guys will have to run
to stay in place, and keep products ahead of the big guys. One
other name I'll mention is Pilot Network Services, a recent IPO
trading almost 35% below the deal price. PILT is an Internet
security outsourcer, providing highly secure services. If you
believe, as I do, that the 'Net will allow companies to focus on core
competencies and outsource the rest, PILT makes sense. The
symbol is PILT.
Audience: What do you think of Netscape?
Dave Jones: Netscape seems to be a company perpetually in
transition. The latest venture - essentially mid-wifing e-commerce
between small businesses - seems like a necessary service. But the
jury is still out on whether they'll stay the course and pull it off, and
whether there will be that much margin at the end of the day. I'd
give NSCP at least 2-4 quarters to let the dust settle.
Audience: What do you think of egghead.com?
Dave Jones: I like what EGGS has done in repositioning the
company. Right now the value is pretty compelling, at about 2x
trailing revenues. Of course they have the same execution issues
as everyone else, but it's looks like a reasonable bet. Be sure you
check out another recent IPO, Software.net (SWNT), to compare
business models and results. The CEO of SWNT was VP-Marketing
at AMZN, so he's got the right experience to make SWNT fly. But
there should be room for more than one. By the way, SWNT just
changed name to Beyond.com, but I don't think the ticker has
changed.
Audience: Is Yahoo the premier Inet stock? Will it be the Coke of
the Internet?
Dave Jones: If you had to pick a "Coke," I'd probably pick YHOO
or AOL. Both seem to have premier name recognition and are
aggressive and thoughtful about the ventures they get into. I'd hate
to pick between them. And, of course, while both have great
management, they still don't have a Coke-like secret formula
locked in a safe. You're betting that management can continue to
execute.
Audience: How does the pending Barnes & Noble IPO affect
Amazon, and which stock do you prefer: Amazon or B/N and why?
Dave Jones: B&N's IPO is priced about 35% less than AMZN on a
price/estimated sales ratio. That's probably about right, since
'Net-centric companies should be able to execute more crisply than
ones with bricks & mortar legacies. Having said that, our OSS has a
short recommendation on AMZN, with target price of $31.
Ed McCarthy: Your newsletters cover other tech sectors besides
the Internet. What areas do you like at current prices?
Dave Jones: We think PC sales will surprise to the upside this
Christmas, so some of the related stocks should get a boost. We're
recommending selected semiconductor equipment manufacturers,
since we think the supply/demand equation will reverse quickly in
1999 (especially at the smaller geometries) and boost these stocks.
We also follow a lot of biotechnology names, and see good
prospects for many of those companies as the FDA accelerates the
pace of drug approvals.
Audience: Is what happened to Real Networks(RNWK) proof that
net stocks are highly overvalued and subject to shaky public
opinions?
Dave Jones: I haven't followed this stock closely, but 150% over
IPO isn't exactly a breakdown. Having said that, I think RNWK is in
part a demonstration of what can happen when MSFT sets its sights
on a particular functionality.
Ed McCarthy: What sectors (apart from the Inet) appear to be the
most overvalued right now?
Dave Jones: In general, the big names have the greatest
overvaluation. As for particular segments, some of the ERP
companies haven't corrected, although some (like ITWO and MANU)
have been clipped. It's tough to generalize about which groups are
richly priced.
Audience: What do you think of GeoCities?
Dave Jones: GCTY seems like a neat company. The portal
"meta-strategy" seems to be to offer more and more services and
personalization, hence GCTY should be able to sell out to a portal,
or partner with (say) RBOCs or cable companies looking to add
services. But as a stand-alone venture, they're probably vulnerable
to Microsoft or someone else.
Ed McCarthy: Dave, how can the audience get more information
on the California Technology Stocks Letter and the Overpriced
Stocks Service?
Dave Jones: Visit our web site at www.ctsl.com for a sample of the
California Technology Stock Letter. We don't have OSS on the site,
so call us at 800 998 2875 or send email to OSS@ctsl.com to
request a sample.
Ed McCarthy: Thanks for chatting with us today, Dave--very
informative! |
