So the lesson for investors would seem to be that, though purely
virtual intermediaries tend to be the most sexy stories with the
greatest asset utilization and capital efficiency (Amazon.com),
certain industry value chains, if they are to be changed
(disintermediated) by the Internet, cannot support middlemen that
exist on the Web only; they must have certain physical assets (stores,
personnel, etc.) if they are to become more efficient. So don't scoff
when an E-Loan or ABT starts to look more like their real-world
counterparts, since these may be entirely necessary steps in re-
shaping their industries.
Valuation Watch
Two Factor Valuations
The last two weeks have provided all the proof necessary that Internet
Investing requires courage, patience, and attention. One of the
beliefs we hold dear to our hearts is that these Internet stocks
represent the most difficult investing sector in the stock market. As
a corollary to that, we add that, these Internet stocks will hurt to
own, as anyone who has held on to AOL over the last three years can
attest. Though not having exposure to AOL in one's portfolio has made
it exceedingly difficult to match technology (and certainly Internet)
indices, the pain of watching the stock go from $35 to $12 back in
1996 and being long caused scars not soon forgotten. There can be no
doubt that this will remain true for certain of these Internet stocks;
indeed, we've already been through a few sessions of fear and doubt,
most notably the late August and late September sell-offs that took
away anywhere from 30-50% of these companies' value.
Despite this, these stocks are back at or very near their all-time
highs, approaching valuation levels that leave little room for errors
of strategy or execution (which is why we concentrate on the quality
of management teams so much), having approached this mesosphere
quickly after the late September Internet deflation. So what does all
of this price action tell us about Internet valuations and the
market's appetite for risk? Plenty.
In reality, there are really two factors driving these stocks, macro-
market factors (liquidity levels and risk appetites) and Internet-
specific factors (earnings and industry catalysts). As industry-
specific fundamental analysts, we'd be intellectually dishonest to
suggest that we know precisely how Alan Greenspan's comments,
employment growth, and the CPI impact Internet valuations (though they
most certainly do). We leave that to strategists and market
technicians. For Internet-specific factors like earnings, we couldn't
be more optimistic, since these companies have tended to outperform
(see The Week above for Q3 earnings results) operating expectations
consistently.
What we do know is that, someday, this sector will mature to the point
where the Street has enough data points and company-specific metrics
to gain comfort (or not) with buying (or selling) these stocks in
markets where that might be considered risky today. In the meantime,
as we wait for more information with which to discount these
companies' ability to grow shareholder value, our rule of thumb is
that the leaders of the space should be bought aggressively. As market
conditions create the opportunity to build good, sizable positions at
levels that make sense (notice we didn't say "at levels that you feel
are cheap" since these stocks probably won't ever look cheap enough),
we'd be all over AOL, AMZN, and YHOO, and selectively looking at the
rest of the Internet universe.
Looking through the first investment book we ever bought a few days
back (The Intelligent Investor by Ben Graham), we were heartened to
see in the introduction, if not the letter of our Internet investment
philosophy, then certainly the spirit; we believe investors can
achieve superior returns based on a patient, disciplined, and long
term strategy toward investing in this sector, eschewing a trading
approach (unless you have the guts and genius to do so) and operating
on the principle that leading, well managed Internet concerns will
continue to outperform their peers.
The Calendar: Week of 11/09 & 11/16
Sterling Commerce Q4 earnings report: 11/19
Movies
"Practical Magic" with Nicole Kidman and Sandra Bullock. Yet another
movie that proves that Sandra Bullock is the Keanu Reeves of the
female acting guild. Don't worry, you won't be left out of weekend
cocktail chatter having missed it.
Have A Great Weekend
For reference:
The Internet Capitalist Manifesto
Why "Capitalist"? The Internet is interesting and hip. It's also
popular and cool. Unfortunately, recognition of these facts wouldn't
have necessarily made you much money over the last few years. Indeed,
an investment strategy based on these gleanings would have left you
with a portfolio of Java, VRML, and "push" technology vendors. And
though each of these might have created shareholder value on the
margins, none would have compensated you for the risk inherent in
Internet investing or for the opportunity cost of not being more fully
invested in more profitable Internet themes. Our goal, then, with "The
Internet Capitalist" is to identify and profit from the dislocations
that the Internet has created for businesses and consumers alike. We
start by asking three basic questions: Which companies have identified
the revenue opportunities created by the Internet's growth as a
consumer and business medium? Which have the skill sets and management
breadth to execute against these opportunities? and Which have
business models that will create substantial shareholder value over
time? Our answers to these questions should help you capture the arc
of our thinking in this industry as it evolves from a network for
academics into a medium for the masses.
Why "Companion"? We hope this piece asks as many questions as it
answers, and generates as much debate as it satisfies (which we plan
to include). Coupled with a user friendly layout, we want "The
Internet Capitalist" to stimulate and ease the investment decision.
The mental framework with which we parse Internet investments is
defined broadly and driven by a few relatively simple themes. Within
this framework, however, there are multiple paths to generating
superior, above-market returns. "The Internet Capitalist" is our
attempt to illustrate those paths on an ongoing basis, determine the
commonality among them, and suggest how shareholder value will be
impacted and where it will flow. And though you'll find us to be
bullish on the Internet sector generally, our expectations for these
stocks are tempered by three realities. First, that the market remains
relatively inefficient for these securities, which makes taking a
substantial ownership position both difficult and costly. Second,
valuation levels leave little to no room for errors of execution or
strategy. Third, profits (or cash flow) matter; progress toward
meaningful profitability is a necessary condition for an increase in
shareholder value. With those caveats, we still believe investors can
achieve superior returns based on a patient, disciplined, long term
strategy toward investing in this sector. We hope "The Internet
Capitalist" becomes an indispensable tool toward that end. |
