03/24/99
Sydney Morning Herald
Page 1
First it was tulips, then it was treasures
from the South Seas, now it's technology stocks. Will this bubble burst, too?
THEY have plenty of P, but
no E, and they'll make you either a billionaire or a pauper by next Tuesday. It's revenue, stupid, not earnings that count in the new e-lated world order of Internet stocks. But party poopers are starting to ask when will the bubble burst.
The mania for Internet stock is being
driven by the United States, the world leader in the field, where Internet
companies have achieved blue-chip status with hardly a profit in sight.
This frenzy for e-stocks calls for a
closer look at other speculative manias through history, such as Holland's 17th-
century tulip frenzy and England's South Sea bubble; both examples where people gambled away their assets in the belief that they could make a quick fortune. Could the craze for Internet stocks go the same way?
Recent speculative buying during the silly season in the US prompted the British
magazine The Economist to ask whether the virtual world has displaced the physical world for punters.
And no wonder.
Internet pioneers like Amazon .com, Yahoo! and America Online (AOL) are now worth more than some of America's corporate giants. AOL has a market value greater than General Motors, Yahoo! has overtaken Boeing and Eastman Kodak, and Amazon .com is worth more than all US bookstores put together, and for a time surged past $US30 billion ($47.7 billion), overtaking oil company Texaco.
The enthusiasm has spread to Australia as mining companies transmute into Internet businesses with odd names and questionable prospects on the basis that anything with a "net", ".com" or "e" in its name will head into the stratosphere.
Says Dominic McCormick, a research manager at Bridges Personal Investment Services: "The market here is a smaller
version of what is happening in the US. People are treating Internet stocks as an option on the future.
"You have to understand that the risk is very high; it's in the speculative mining stock
category, which made some people very rich and some
people very poor. The thing about any new technology is that capital just flies to it."
Pity the poor investor, then, who wants some exposure to this important growth area but doesn't want to get burnt when the bubble bursts, as everyone says it must.
The key determinant for valuing Internet stock is revenue, as opposed to earnings, as an acknowledgment that sustainable profits are unlikely until the winners are finally
established. Or that's the theory.
The how and when remain elusive. Shane Oliver, the chief economist at AMP Asset Management, says: "The Internet is a very open forum to trade. It's very competitive and margins are under pressure. It's hard to see profits going up. The key beneficiary is the consumer, who has reaped enormous benefits, not necessarily the shareholder."
Even the more risky, smaller companies, he says, have surged in price. "The trouble
is Internet stocks are trading at excessive
valuations. It's carried along by euphoria for anything surrounded by 'dotcom'."
The mania is not quite as pronounced in Australia, where the pickings are limited.
Investors can invest in media or telecommunications companies that have Internet
operations or a mishmash of smaller, high-tech businesses. Other than Liberty.One (which has the rights to operate the US search engine Excite in the Asia Pacific), there are no pure players.
However, a whole raft of small cyber
companies are preparing to seek cash injections through sharemarket listings, ranging from greengrocers and finance brokers to travel agents and research houses.
Andrew Swan, an Internet analyst at Ord Minnett, says opportunities for investors will increase over the next two years as more companies list. "The Australian sharemarket is 18 to 24 months behind the US market in its stage of development. In addition to competing with domestic players, Australian companies will have to compete with local versions of successful US brands like Yahoo!, Excite, eBay, AOL."
There are about 58 million regular Internet users in America, he says, compared with
4 million in Australia, which puts Internet penetration of the Australian market at 20 per cent compared with 28 per cent for the US.
Tim Phillips, the head of equities at Tyndall Funds Management, says it bought Liberty.One for one of its small cap funds; apart from that "Internet stock never get on our radar screen".
"It's really an interesting area and cutting-edge stuff," he says. "I think for every success there will be quite a few disasters. The early people in the game are the ones that will
probably succeed. There are a whole raft of late entrants jumping on the bandwagon. I'd be very nervous punting on those."
But sooner or later the bubble will burst. He warns: "The risks of that happening are enormous. It will get pretty bloody here, too.
"People are buying them because they're going up, not because they represents any value. Greed has taken over and very quickly will be replaced by fear on the way down," he says.
Earlier this year the likes of Publishing and Broadcasting, John Fairfax, Telstra, Cable & Wireless Optus and AAPT saw their share prices boosted by investor demand for Internet stocks.
They all have Internet operations and have become "a proxy" for Internet stock.
Michael Heffernan, an investment analyst at Holst Sharebrokers, says: "Telstra has Big Pond, so why go past Telstra? It is an Internet service provider and more than that it owns the cable."
If you go into the smaller Internet companies, he warns, they may go up by 400 per cent from a small base, but you'll never know whether they will be around in a few years.
Big players such as PBL (which has hinted at floating its online operation) are positioned to do well, he says. "It has a lot of money behind it. It has the resources to put products out, it can withstand competition and bad times, and it's an integrated, multi-faceted company.
"They have TV, magazines, telephone
networks [One.Tel], an Internet business and Crown Casino. It's a major player in all the growth industries of the future. If you invest in a company like that, that has Internet operations, you can do well. PBL online is not likely to go to the wall; if you choose smaller ones you run a risk."
Gordon Fell, the head of Corporate Finance at Ord Minnett, sees things
differently. "What we have observed is the first movers tend to get a really decent advantage, like Amazon .com.
"The companies that will win at the end of the day will be the pure Internet players because they are more nimble and able to adapt to changing situations.
"Traditional companies have an eye over one shoulder to see how the new business is devouring the old business, while the small, pure players don't have to worry about it, they just go for it."
One company that is about to float is InvestorWeb, which does research into
managed funds and shares and caters for the growing armies of online investors. Corporate clients include PBL's Ninemsn, Yahoo!, Merrill Lynch, Greenline Investors Service and more than 20 leading investment managers.
InvestorWeb's director, Otto Buttula, says online trading is growing exponentially. In the American December quarter it was up 35 per cent.
But investors need to assess Internet companies in the same way that they would research any other business. "The Internet word is used very loosely to get
people excited," Buttula says. "It's no more than a medium of delivery - you have to have a business behind it; you have to have a
product to deliver to the market."
Many Internet companies maintain that profits will be derived from advertising on their Web sites, saying it's no different from free-to-air TV.
But McCormick says the argument is flawed. As the number of sites spread, he
suggests, advertising rates will inevitably come under pressure.
The other argument he questions is that those that get in early and establish a brand name will automatically win. The Internet hands power to consumers to play the field, to chase the cheapest service or product one mouse-click away.
"Basically we take the view that Internet stocks are almost impossible to value. They're a punt on the future. All investments are but the variables are much more known, whereas with the Internet the variables are unknown; it's unclear what works."
He recommends long-term investors go for the telcos which provide infrastructure, like Telstra and Cable and Wireless Optus, and which are in a good position to benefit no
matter which way things pan out.
More aggressive investors who want to take a punt on the more speculative
companies should be aware that if the stocks don't live up to expectations they may fall, not by 20 per cent, but by 80 and 90 per cent, and some will go broke. "It's always been the way with biotech and resources stock," says McCormick.
D & D Tolhurst's Russell McKimm agrees. "My general view to people is to really be very careful about investing in these small Internet stocks. As soon as you mention Internet, prices double.
"Go for the big people - they are going to make money. Go via Telstra, that's what we've urged our clients to do. One.Tel is
very successful, Kerry Packer and Murdoch became involved and that's boosted its
credibility."
There's a tendency at this point of the advanced state of the market
for investors to hold some speculative stock, says Frank Villante, a portfolio manager at BT Funds Management.
Previously it was biotech stock; now it's Internet stocks. BT has Liberty.One in a small fund.
"The direct way may not be the most opportune low-risk way of
playing it. My thoughts are, admit this
technology will change the way people
interact and sell products. Find a company that will benefit from this."
This could include investing in retailers which may be beneficiaries of strong growth, such as Harvey Norman and Strathfield Car Radio, he advises.
Cochlear is another, because it has used the Internet to successfully target its market in a more personalised way and benefit from its lower cost delivery channel.
Lucinda Chan, an associate director of Macquarie Equities, shares his view that investors are interested in taking a punt on more speculative stock right now.
They've done well in the market as
a whole and are expressing interest in
technology stocks, Chan says.
"They are buying purely speculatively in the hope these companies will get taken over. With Liberty.One it could happen," she says.
"If you take a flutter you've got to be
prepared to cut your losses immediately or take a profit quickly. What these investors are doing is not based on fundamentals, but on market sentiment, a lot of it led by the US."
.com: Part of the Internet domain name signifying that it is a business or company.
SPECULATIVE STOCKS: Shares with a higher than usual level of risk.
The crash and burn of speculating through the ages
THE best recorded episode of speculative mania erupted over a tulip bulb. It swept 17th-century Holland, making thousands of speculators fabulously wealthy, but destroyed many more in its wake and resulted in economic chaos.
The bulb was introduced into Europe from Turkey in 1554. Its exotic appearance enchanted European nobility, which developed a passion for the bloom and paid exorbitant prices for it.
Holland, which was successful at cultivating rare and beautiful tulips, established itself as Europe's main supplier. As prices were bid up by demand, farmers, tradesmen, rich and poor alike, climbed on the bandwagon to speculate on the country's tulip exchanges.
People liquidated other assets to participate and used a form of futures trading, selling and reselling the same bulbs for future delivery in anticipation of higher prices. When racketeers flooded the market with poor quality bulbs, panic set in, prices collapsed and thousands of people went from riches to rags in no time.
The South Sea bubble was even more bizarre. The South Sea Company held the monopoly on British trade in South America and was funded by public debt.
The company's shares shot up eightfold in five months in anticipation of all the gold and silver that would be brought back from the south seas. Cashing in on easy credit and speculative fever, other "bubble companies" popped up.
In an effort to protect the South Sea Company, Parliament passed the Bubble Act making all other companies illegal. At first this worked in its favour and its share price shot up. But investors had exposure to the clones as well and held most shares on margin. When the act was enforced everyone suffered in the scramble for liquidity and the companies collapsed.
What makes this mass display of madness even more astonishing is that the South Sea Company never had a right to ship the gold and silver back to England.
The gold and silver of South America belonged to the King of Spain.
Australia's nickle boom of 1969-70 was our own version of speculative mania. It centred on a small mining company called Poseidon. In December 1967 its share price was 10c. Following reports of a significant nickel discovery, its share price rose to $7.
Speculation took over and by February 1970 the share price was $280. At this point analysts realised it was overvalued and its price started to drift down. The nickel discovery proved less than expected and the company was eventually delisted.
AMP's Shane Oliver, who wrote his PhD thesis on speculative manias, says the frenzy for Internet stock has a lot in common with the boom that preceded the 1929 stockmarket crash.
The boom was driven by new technologies that were revolutionary and provided the platform for the consumer society and postwar prosperity, he says.
"It was an era of great technological development. From 1900 you had electricity, mass production, economies of scale, the invention of the automobile, radio etc.
"They all led to huge industries and had a major impact on the rest of the century. The euphoria that led to the sharemarket bubble had some foundation to it.
"The new technologies generated economic growth and supported rising share prices then speculation took over. Although the fundamentals were sound, prices rose too far."
Oliver says there are similarities with the technology of today and valuations have gone too far. But even if there is a correction the bigger, better-managed Internet companies are likely to survive.
"If you want to take a 10- to 15-year approach and close your eyes in the meantime I'd say there will be huge benefits."
Ord Minnett's Gordon Fell dismisses "misguided" comparisons with the frenzy and enthusiasm attached to the nickel boom. "It misses the point. Nickel was nickel before and after the boom. The Internet has changed the way people are doing things. That fact is being realised by the Australian investor." |
