Internet / Electronic Commerce – 9 March 1999
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We consider the Internet a global mega-trend, along the
lines of the printing press, the telephone, the computer,
and electricity. We believe it will affect dozens of
industry sectors in the world economy over the next few
decades. Unlike a mere technology trend, which renders
prevailing technologies obsolete and, in so doing, creates
an opportunity for vendors of new technologies to quickly
build large businesses, the Internet is changing the way
people and companies communicate, research, buy, sell,
and distribute goods and services, and spend leisure time.
As a result, it is not only creating the opportunity for new
businesses to get big fast, but introducing change and
competition into a wide range of mature industries,
including media, retailing, technology,
telecommunications, financial services, transportation,
healthcare, and energy. Despite the enormous hype that
has surrounded the sector over the last few years, we
believe we are still in the early stages of this trend.
We believe that the Internet will continue to cause the
creation and/or redistribution of hundreds of billions of
stock market capitalization. Investment capital--and, with
it, market value--migrates toward growth and away from
stagnation and risk. The Internet is creating both amazing
growth and significant risk—a phenomenon that in our
opinion is evident in the microcosm of one small sub-sector
of the economy: bookselling. Amazon.com, one of
the fastest-growing companies in history 1 , has grown from
nothing to a $1 billion run-rate only four years after
opening its virtual doors; Borders, meanwhile, just missed
its Q4 numbers (did the snowstorms discourage people
from going to stores—or make them see the convenience
of shopping from home?). We believe that the dynamics
of the Internet's impact on the bookselling market may
well be played out in other sectors and sub-sectors of the
economy: a nimble Internet start-up gets shot out a cannon
and grabs the first-mover advantage; certain existing sector
leaders react late but effectively; other players miss the
boat. The end-result of the Internet on the stock market, in
our opinion, will be a significant re-distribution of market
value (compare charts of AMZN, BKS, and BGP). Based
on the speed with which the medium is developing, this
redistribution may happen sooner than people think.
We recommend that investors analyze, industry by
industry, the Internet's likely effect on the economy and
develop a comprehensive investment strategy, whether
direct or indirect, offensive or defensive. The broad-based
Internet stock phenomenon clearly looks like a
bubble, and although we still like the leading stocks, we
can certainly understand the hesitancy on the part of
investors to jump in. The good news is that there are many
different ways to play this trend—and not all of them
include chasing YHOO out of the solar system. As with
most trends, some industries and companies are positioned
to benefit from the revolution, others are positioned to get
hammered by it. We believe the Internet's impact will be
significant enough that a viable long-term investment
1 As measured by internal revenue growth.
strategy may be to hitch capital-wagons to companies that
will benefit from Internet-related growth and move them
out of the way of companies that will be hurt by it.
We recommend that diversified growth investors allocate
a small percentage of total capital to a basket of high-quality,
direct Internet investments (of which, in our
opinion, there are about 10 to 15). Underneath the
Internet sector's dizzying valuations, in our opinion, are
the foundations of what could become the early 21st
Century's leading growth companies—a group that we
think could include one or more of today's “big three”:
AOL, Yahoo!, and Amazon.com. Much of the capital in
our model Internet portfolio is concentrated in these three
stocks, which we consider the best proxies for the growth
of three major Internet revenue streams—access,
advertising, and commerce. The three companies have
shown an ability to manage extraordinary growth and,
importantly, evolve along with the industry, and they have
management teams that appear to be motivated by much
more than money (namely, the chance to make history).
Because the companies have solid fundamentals (or, in
Amazon.com's case, at least astounding growth), we
believe that in the event of a sector correction, their stocks
will be among the least risky investments in the industry.
The “basket” approach allows investors to make a few
disastrous individual investments and still generate a
compelling long-term rate of return. If you take all of the
pure-play Internet companies in the public market and add
them together, you get about $150 billion in market
capitalization—or about a third of a Microsoft. We believe
that over the next 5 to 10 years, the Internet opportunity will
result in the creation of at least one Microsoft-sized
company and maybe more (more on this in future notes).
The good news is that you don't have to pick out the
Microsoft at this stage of the game to make good money—
you just have to make sure it's somewhere in your portfolio.
If, for example, you were to buy $100-worth of AOL,
Yahoo!, and Amazon.com today and two of them were to go
to zero (we don't think they will) while one became
Microsoft, you would still get a good rate of return (if the
collective value of AOL, YHOO, and AMZN increased
from $150 billion to $500 billion in 7 years, the annual rate
of return would be 19%; in 2006 your $300 investment
would be worth $1,013 regardless of who won).
The overall Internet stock phenomenon may well be a
“bubble,” but in at least one respect it is very different
from other bubbles: there are great fundamental reasons
to own these stocks. Say what you will about their
valuations, the leading Internet stocks are not “concepts”—
and they are riding on meteoric fundamentals. The
companies underneath the stocks are 1) growing amazingly
quickly, and 2) threatening the status quo in multiple sectors
of the economy, a one-two punch that many other famous
“bubble” investments lacked. The rise and fall of the South
Sea Company's stock in 1720, for example (from 125 to 850
to 33 in six months), as well as the rabid urge on the part of
South Sea investors to finance thousands of other dubious
business plans (sound familiar?), was based on a fraudulent |
