QUARTER COULD CURE INTERNET INSANITY
Eric Reguly
Globe and Mail Report on Business - January 5, 1999
The New Year has passed and Internet insanity, the stock story of 1998, shows no signs of abating. Here's a bold prediction: The out-of-control buying will last until April, when first-quarter results will confirm suspicions that electronic commerce is expanding at merely triple instead of quadruple-digit rates. The revelation will be enough to shatter the faith of Internet investors, who will abandon the sector as fast as they can zap sell orders through their on-line brokerage accounts.
The Internet sector is becoming a maze of contradictions. It is hard, for example, to find an analyst or institutional investor who does not believe that the Internet is true revolution in the making, as significant as the introduction of the telegraph, telephone and television. In other words, fortunes will be made - some day. At the same time, it is hard to find anyone associated with the industry who does not believe that the vast majority of Internet plays are stupidly overvalued. Last month, Jonathan Cohen of Merrill Lynch called Amazon.com. the Internet bookstore, "probably the single most expensive publicly traded company in the history of U.S. equity markets." Yet investors keep buying and buying. Forget value. Other than blind hope that one of the hundreds of Internet stocks will emerge as the next Microsoft, there is not a single reason, certainly no textbook valuation, to justify their prices. Amazon, whose losses tend to increase in proportion to its revenue growth, is trading at an absurd 115 times sales. The company's market value is more than $17 billion U.S. or bigger than Royal Bank of Canada. Yahoo, the Internet "portal" that no one ever heard of a couple of years ago, has a market value of more than $24 billion, giving it one-third the worth of General Motors. America Online is worth as much as GM and makes household names such as RJR Nabisco and B.F. Goodrich look like junior stock companies.
When the Internet craze wen into overdrive last spring, some "experts" predicted a train wreck by the autumn. The reverse happened as investors seized onto the Next Big Thing. Internet commerce in particular was set to take over the world. Even some conservative institutions bought into the story. For most of the year, they sat on the sidelines as the valuations for companies with no earnings and piddling revenues went from the lofty to the ludicrous. But witht most other industrial sectors losing momentum, Internet companies proved irresistible. Canada's Altamira was one convert. In November, it launched the Altamira E-Business Fund, which is devoted to Internet commerce stocks. When a troubled Canadian mutual fund company starts an Internet fund and buys at nutty prices, you know the end is nigh.
Although the Internet industry has attracted some institutional money, it is still largely the domain of the quick-buck artist, a powerful indication that the stocks are more fragile than they appear. As the Wall Street Journal reported yesterday, the holding period for some of these stocks is becoming shorter and shorter. It takes only 13 days of trading volume in Amazon, for instance, to equal all of its outstanding shares, compared with 58 days in mid-1997. What this means is that short-term traders, notably daytraders, who rarely hold a stock for more than a couple of hours, are driving prices. Day traders, whose knowledge of a company is often limited to its stock symbol, create momentum by buying on momentum, propelling prices ever forward. They are attracted by the stock's liquidity, not its fundamentals. Discounted cash flows, earnings per share and market penetration are irrelevant to them. When they lose interest in a stock watch out below because the crater could get a starring role in Deep Impact, the Sequel.
First quarter results could make or break the Internet stocks, especially the Internet retailers. Almost everyone knows someone who bought something - a book, a toy, an airline ticket, a CD - on the Internet over Christmas. This naturally gives the impression that Internet commerce is destined to put traditional retailers out of business. No more lineups, no more parking hassles or nasty salespeople! But those dazzled by the possibilities forget that the Internet will never dominate some retail sectors - food and clothing are two examples. Sure, first-quarter results will show that Internet commerce is taking off, but the increase may be say 100% instead of 500 or 1,000%. Then the stock will be in trouble.
The aficionados also forget that the Internet has no barriers to entry. Cyberspace presents an unlimited amount of real estate to an unlimited amount of new competitors, which is why Chapters has quickly emerged as a viable competitor to Amazon in the Canadian on-line boom market. The adage, buy land because they ain't making any more, certainly does not apply to the Internet.
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