The Epicenter – 8 April 1999
6
evolve to take advantage of new opportunities as they develop (Yahoo! started as a
directory; Amazon.com as a bookstore), and 4) strong, deep management teams
that are motivated by more than increasing their net worth—if Bill Gates just
wanted the money, he probably would have stopped about $75 billion ago.
What we worry about. The sector's valuations worry us. As described, however,
we do not believe that valuation alone will knock the stocks down. We believe
that the valuations will begin to conform more with historical norms when 1) the
fundamentals slow down, or 2) the supply of quality investment opportunities
finally exceeds demand (never before have so many investors been seeking so few
shares). As far as the fundamentals are concerned, we are keeping close tabs on
four major growth drivers: 1) new online users, 2) advertising dollars,
3) commerce dollars, and 4) technology and services dollars. Of these, we are
currently most focused on the number of new users, which is the first of the major
metrics that we believe will slow down. With regard to the supply/demand
imbalance, we also acknowledge the possibility that this spring's massive IPO
pipeline, combined with recent billion-dollar financings from Amazon.com,
Inktomi, Network Solutions, and others, will begin to sate investor demand for
internet shares. Our hope and belief, however, is that the ever-growing demand
will continue to outpace supply—especially considering that only a minority of
filed IPOs can be labeled “high-quality.”
To review…we find it helpful to consider the following when assessing the
internet sector's valuation and volatility risk: 1) whether allocating a small
percentage of the portfolio to direct investments in one of the largest economic
trends in history is worth the valuation risk (we think it is); 2) more specifically,
whether the risk of losing 50%-75% in a correction is offset by the risk of missing
further 3X-10X returns (we think it is), and 3) whether the internet's potential to
hurt other, “safer” investments increases the value of owning a small basket of
these stocks (we think it does).
Key concerns.
Three major considerations.
[AOL] MLPF&S was a manager of the most recent public offering of securities of this company within the last three years.
[AMZN, YHOO] The securities of the company are not listed but trade over-the-counter in the United States. In the US, retail sales and/or distribution of this report may be made only in states where these securities are exempt
from registration or have been qualified for sale. MLPF&S or its affiliates usually make a market in the securities of this company.
Opinion Key [X-a-b-c]: Investment Risk Rating(X): A - Low, B - Average, C - Above Average, D - High. Appreciation Potential Rating (a: Int. Term - 0-12 mo.; b: Long Term - >1 yr.): 1 - Buy, 2 - Accumulate, 3 - Neutral, 4 -Reduce,
5 - Sell, 6 - No Rating. Income Rating(c): 7 - Same/Higher, 8 - Same/Lower, 9 - No Cash Dividend.
Copyright 1999 Merrill Lynch, Pierce, Fenner & Smith Incorporated (MLPF&S). This report has been issued and approved for publication in the United Kingdom by Merrill Lynch, Pierce, Fenner & Smith Limited, which is
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