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Here is a way of looking at the potential for internet stocks that is being presented to Institutional Investors. I don't think the AXC model fits this, but it shows that the big money is trying to find a way to enter the internet field. Maybe some other investment firm has produced a model for backbone companies? I would like to see some other attempts at this.
PS..I got this off the Cyberian Outpost (COOL) site, dated today.
Still lurking,
CMM
Institutional Valuation Metrics For Internet Stocks
One of the interesting historical aspects of the Internet revolution
will be that the tremendous rise of Internet stocks from 1997 through
1998 was due almost entirely to individual investors.
Although investment bankers brought internet companies public primarily
through institutional investors, but most of those institutions sold the
shares quickly. Institutional investment in many of the best known and
most important internet companies was minimal throughout most of 1997
and 1998. Amazon.com (AMZN), for example, had only 17 mutual funds
invested in it in Q1 of 1998 with a total combined investment of 768,600
shares, not even 1% of the float. This means institutions, by and large,
missed out on the fantastic returns in internet stocks from mid-1997 to
the end of 1998.
But, as Briefing.com has noticed time and again at conferences for
institutional investors, the institutional investors will eventually be
major buyers. Why? Because some of the internet stocks will eventually
become major blue chip companies. America Online (AOL) has already
achieved this status. But what stocks, of the hundreds to choose from,
will institutions eventually settle on? And what parameters will
institutional investors use to make their choices? Certainly traditional
valuation metrics such as Price/Earnings ratios are not appropriate for
the relatively immature internet economy.
New Metrics For Internet Stocks
The first glimpses of the answer to this question came recently at the
NationsBanc Montgomery Securities Technology Week Conference, held in
the first week of February, in San Francisco.
Principal Analyst Steve Horen made a presentation listing new
measurement parameters for internet stocks. The parameters, while
actually rather straightforward calculations, give clues as to what will
be important to institutions as the internet economy matures.
Mr. Horen presented four parameters by which an internet business model
should be judged. These were the following:
MetricPurposeRevenue/ReachHow an audience is monetizedGross
Profit/ReachQuality of revenueRevenue/EmployeeRough estimate of
leverageGross Profit/EmployeeMore precise estimate of leverage
These are all relatively straightforward calculations. The numbers used
are readily available to individuals and institutions alike, with the
exception of "reach." Reach is a standard metric in the advertising
industry and indicates how many potential "viewers" a channel is able to
"reach." It is generally presented as a percentage of the total possible
audience. In Internet terms, "reach" is roughly equivalent to traffic,
as measured by unique users. The most common provider of reach data is
Media Metrix, Inc.
The revenue/reach statistic indicates how a company is able to make
money from its audience. In other words, so what if you have a lot of
traffic, if you can't get a buck from anyone?
This seemingly basic concept has been largely ignored by many investors
in Internet stocks over the past year. High traffic numbers were used by
many as an important statistic for determining an Internet sites overall
business future. But that era appears to be ending.
However, the ability to generate revenue is not a single criteria. Gross
Profit/Reach measures the "quality" of the revenue generated. Gross
profit is the difference between the price charged for an item, and what
the item costs the merchant. It is different than net profit, which
would include all marketing and sales, administration, and capital
costs. .
The crucial element to recognize here is that profit matters. Although
apparently willing to ignore marketing costs, for the time being,
institutions will want to see profits. For now, gross profit is enough.
The assumption is that if gross profit is high enough, eventually the
internet business will become efficient enough to actually show net
profits.
Clearly, higher is better for both of these metrics. If you can get more
dollars from more people, that's good.
The next two metrics, revenue/employee and gross profit/employee are
measures of leverage. Leverage is the relationship between fixed costs
and variable costs. The lower the variable costs of providing additional
revenue, the greater the leverage.
Leverage is one of the great features of the internet. When people talk
about the internet not having "brick-and-mortar" costs, they are
focusing on the leverage. Incremental sales on the internet do not
require additional time by an employee. Territorial expansion does not
require building another building. Achieving growth, without incurring
additional costs of the growth, is a key element of internet business
models.
Institutional investors have always loved to see companies that are able
to increase their gross, and net, margins as they grow their revenues.
The internet, practically by definition, will provide many companies
that are able to do this.
Although there are far more fixed costs than salaries, using the number
of employees in a company as the measure of fixed costs is probably
appropriate. Certainly it is an easy calculation. Other fixed costs,
such as the capital costs to set up the internet site, do not represent
the ongoing fixed costs of business, as the capital costs are
depreciated over time.
The two leverage metrics also are better if they are higher. The ideal
company has few employees, but high revenues and profits. The closer the
ecommerce company comes to a vending machine, the better.
How Internet Companies Measure Up
How do internet companies measure up using these metrics? Here are some
tables analyzing some of the well-known internet companies, as
calculated by NationsBanc Montgomery Securities. (Not all internet
companies were measured by Mr. Horen; his universe was limited to those
covered by NationsBanc Montgomery Securities.) All of the numerical
calculations listed below were determined by Briefing.com, by
approximation from a bar chart. The actual data was not released at Mr.
Horen's presentation. However, for comparative purposes, the numerical
approximations are useful.
Revenue/Reach Measurements
Revenue/reach is measured in millions of dollars divided by millions of
users. Note that the reach number is not the actual number of customers,
it represents unique users who visited the site. Reach is determined by
survey, done by Media Metrix.
TOP FIVEREV/REACHBOTTOM FIVEREV/REACHONSALE (ONSL) $108Yahoo
(YHOO)$5America Online (AOL)$95Lycos (LCOS)$5Amazon.com
(AMZN)$65theglobe.com (TGLO)$2Cyberian Outpost (COOL)$48Xoom.com (XMCM)<
$1Intuit (INTU)$33Geocities (GCTY)< $1
Source: NationsBanc Montgomery Securities
It should be noted, however, that the above measurements were made
before ONSALE made its business model transition to a
"fee-per-transaction" where items are sold at cost, plus a small fee.
This change would likely alter Onsale's prominent position on the chart.
Gross Profit/Reach Measurements
Gross profit measures only the difference between revenue and the cost
of goods sold. It does not include sales and marketing, administrative,
capital investments, etc. Again the numbers are best used for
comparative purposes.
TOP FIVE GP/REACHBOTTOM FIVEGP/REACHAmerica Online (AOL)$34C/Net
(CNET)$2Amazon.com (AMZN)$14Lycos (LCOS)$2ONSALE (ONSL)$11theglobe.com
(TGLO)$1Cyberian Outpost (COOL)$7Xoom.com (XMCM)< $1TicketMaster
(TMCS)$5GeoCities (GCTY)< $1
Source: NationsBanc Montgomery Securities
Revenue/Employee Measurements
Revenue/employee numbers are easily calculated. In judging the leverage
capabilities of an internet company, however, Briefing.com believes you
should make an adjustment or "fudge" factor for the maturity of a
business model. If the company's model is highly leveraged, but the
potential of that model has yet to be reached, the revenue/employee will
be lower than that of a more mature company. Leverage implies that
revenues can rise without adding additional employees. Numbers shown are
approximations and listed in thousands.
TOP FIVE REV/EMPBOTTOM FIVEREV/EMPOnsale (ONSL) $980C/Net (CNET)$90TMP
(TMPW)$370TicketMaster (TMCS)$60Cyberian Outpost (COOL)$300EarthWeb
(EWBX)$30Amazon.com (AMZN)$275theglobe.com (TGLO)$30CDNow
(CDNW)$240Intuit (INTU)< $10
Source: NationsBanc Montgomery Securities
Gross Profit/Employee Measurements
Gross profit/employee numbers are also easily calculated. Again,
Briefing.com believes that a consideration should be made for the
maturity of the company's business.
TOP FIVE PROFIT/EMPBOTTOM FIVEPROFIT/EMPIntuit (INTU)$145Computer
Literacy (CMPL)$35ONSALE (ONSL)$96C/Net (CNET)$25TMP
(TMPW)$92theglobe.com (TGLO)$22Amazon.com (AMZN)$58TicketMaster
(TMCS)$15Xoom.com (XMCM)$50EarthWeb (EWBX)$1
Source: NationsBanc Montgomery Securities
Briefing.com Analysis
Institutional investors widely believe that 80% of all internet stocks
will eventually be worthless. But the remaining 20% will likely be worth
much more than they are today. As the internet promise begins to be
fulfilled over the coming years, institutional money will have to find
internet stocks to buy.
Figuring out how institutions will invest long term in internet stocks
will be just as important as figuring out which business models will
eventually succeed. While Briefing.com believes that all internet
companies will eventually be judged by the more traditional valuation
measurements such as price/earnings and PE/growth ratios, that won't
happen until the industry starts to show signs of maturation.
Until then, creative measurement techniques such as Mr. Horen's metrics
will help investors judge which internet companies will be the long term
survivors. Briefing.com doesn't expect these metrics to become the only
criteria; in fact, it is likely that other analysts will begin
developing additional metrics. But the very fact that institutional
investors are beginning to find ways to value internet stocks is itself
encouraging.
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