Heard in Texas: Internet America Is Overvalued
Even Using Web Math, Some Say
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By Jonathan Weil
The Wall Street Journal
By now it's a given that Internet stocks are overvalued. But Internet America looks lofty even by Internet standards.
It's been three months since the Dallas-based Internet-service provider's initial public offering -- a wild three months. After initially dipping below its $13 offering price, the stock soared to an intraday high of $61, for little apparent reason other than it had captured the interest of frenzied day-trading speculators.
The stock has since settled down and now trades around $28.188, but some analysts say it's still way out of line. They start by looking at Internet America's market value per subscriber, an industry yardstick used to evaluate Internet-service providers, many of which haven't turned a profit. At latest count -- released last month -- Internet America had about 53,500 subscribers. Each pays about $20 a month, and the subscriber fees account for nearly all of the company's revenue.
After acquisitions of two smaller Internet-service providers in Dallas, Internet America officials forecast the company will have about 78,400 subscribers by the end of its 1999 fiscal year on June 30. Assuming that target is met, at the company's current market capitalization of $192 million, investors are paying about $2,450 for each subscriber. That's a hefty sum; it would take a single Internet America customer nearly nine years to pay that much in subscriber fees.
That figure is also high when compared with the recent sale prices of closely held Internet-service providers, which typically sell for, at most, just over $600 a subscriber. Last month, Netcom On-Line Communications, which has about 400,000 subscribers, was bought by MindSpring Enterprises for $245 million in cash and stock, a sale price that translates to about $612.50 for each account. Providers with smaller customer bases command much less -- as little as $100 a subscriber for companies with 5,000 subscribers, according to analysts at International Data Corp., a Framingham, Mass., research firm.
Given the per-subscriber valuation of these closely held Internet-service providers, some feel Internet America's stock price is too rich. "The public is paying a multiple for this that's out of whack," says Jay Reynolds, a Dallas-based independent research analyst who has been tracking the stock. "I can't buy into that price discrepancy."
The disparity also has been evident in what Internet America has been paying for customers. Its latest acquisition was a Dallas provider called CyberRamp for 365,725 shares of Internet America stock valued at $10.5 million. Neither company has officially announced CyberRamp's subscriber base, but a person familiar with the transaction says it's between 15,000 and 20,000; about $525 to $700 a subscriber. "There are two views," Mr. Reynolds says. The fact that Internet America can buy customers at such a low price "could be an extreme positive, because they got it cheap. But more likely, the underlying value of the company is absurd."
Internet America officials dispute Mr. Reynolds's analysis, saying the stock's valuation is justified when considering the advantages a growing, publicly traded company has over small, closely held ones. "The disparity in multiples really plays to our advantage," says Michael Maples, Internet America's chief executive officer. "The larger public companies," like Internet America, "are viable, growing businesses that have access to capital to keep those businesses going, while the ones being acquired don't."
Still, Mr. Reynolds and other bears give other reasons to back up their position. Internet America doesn't offer any services that are particularly unique for its highly competitive industry, where the 10 largest companies -- Internet America isn't one of them -- service about 80% of all domestic Internet users. The barriers to entry in the business are minimal. Anyone who buys some basic equipment and advertises can start a Net-service provider. And there are hundreds of U.S. providers with as many subscribers as Internet America, though only a handful are publicly owned.
Of course, some large publicly traded providers, such as MindSpring, EarthLink Network and Rocky Mountain Internet, also trade at extremely high valuations; Atlanta-based MindSpring trades for as much as $2,490 a subscriber. But MindSpring has a subscriber base of one million, more than 18 times that of Internet America.
At Briefing.com, a Web-based research firm, analyst Damon Southward of Burlingame, Calif., sees other bearish indicators. About 26% of the 2.3 million shares offered at the IPO were sold by three existing shareholders, including Chairman William Hunt, who sold 200,000 of his 1.4 million shares. "When you have insiders selling shares at the IPO, a red flag usually goes up because it suggests these guys don't have any long-term faith in the company," Mr. Southward says.
Mr. Southward also notes that one of Internet America's major selling points during its IPO was that it showed a profit of 28 cents a share on $10.6 million in revenue during its 1998 fiscal year. But the profits were possible largely because the company had slashed operating expenses -- mostly marketing costs for its 1-800-Be-A-Geek billboard- and television-advertising campaign -- by 29% from a year earlier. Had those operating costs not been curbed, the company would have reported a loss of 50 cents a share.
"It's obvious the company was attempting to beautify the numbers so they could say, 'We're a profitable Internet company,' because the companies that have been able to say that have seen their stocks rise dramatically," Mr. Southward says. He also notes that reducing the operating expenses kept the company from increasing its subscriber base, since it was cutting down on advertising.
Internet America's Mr. Maples denies the company cut expenses in an effort to pump up earnings for the IPO. Instead, he says, the company simply didn't have enough cash to maintain its advertising levels at the time. The reduction "was more out of cash-flow necessity," Mr. Maples says.
As for the amount of stock sold by insiders, Mr. Hunt says the only reason he and other insiders sold was so that there would be enough shares in the offering for it to be worth at least $20 million, thus making it more attractive to investors and the company's lead underwriter, Hoak Breedlove Wesneski in Dallas. Mr. Hunt says he isn't looking to dump his shares, and expects when he and other insiders become eligible to again sell shares in June that "I'm not going to be a heavy seller," though he says he might unload some shares for estate-planning purposes. "I'm not waiting at the gate to go sell stock," he says.
Company officials also acknowledge having a tough time pitching their deal. Southwest Securities, a Dallas-based underwriter, rejected the company's IPO plans; Larrie Weil, corporate-finance director, says officials concluded Internet America was coming to the market too soon. And Internet America turned down another Dallas-based underwriter, First London Securities, because corporate-finance executives there didn't think the company was worth more than $20 million, says Jesse Shelmire, First London's director of investment banking.
Looking ahead, the two analysts who formally cover Internet America -- both of whom work for the company's underwriters -- expect it to report a loss of 17 cents a share for fiscal 1999, according to a survey by First Call. But they project a profit of 16 cents a share in fiscal 2000. Mr. Maples confirms the company expects to post a loss for this year.
John Bain of Hoak Breedlove maintains a "buy" rating on Internet America with a 12-month price target of $50, but not without some caution. Considering the disparity between the private-market and public-market values for Internet-service providers, he says his recommendation isn't based so much on what the company is worth as on how the stock price compares with those of other publicly traded Net-service providers.
"It's become a mania second only to Beanie Babies," Mr. Bain says of Internet investing. "The only thing you can say that seems to make sense is to look at the Internet stocks as a group, accept where they're trading and then try to pick the best stocks."
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