Jubak on ATHM (also AOL)
by: GospElvis (46/F/TN)
****This may be a simplistic way to look at it, but if sentiment is the primary reason that AOL is off it's high, consider this:
ATHM with so much positive news is about 25% off it's high and AOL is about 28% off it's high for the year. Pretty close.
Both are good companies, as is ATT.
Jubak's Journal
Is At Home the next America Online?
The fundamentals are intriguing but I think too many investors
have already jumped on board for this to be the next big winner.
By Jim Jubak
Is At Home the next America Online?
I've heard the question asked more than once in the days since
AT&T's (T) successful bid for MediaOne Group (UMG). And I
certainly understand the breathless hope in the query. Could the
company offering the next generation of Internet access turn out
to be as profitable an investment as the company that dominates
the current generation? America Online's (AOL) stock has
appreciated a mind-boggling 55,575% since the company went
public in 1992.
Most attempts to find the next America Online or the next Dell
Computer (DELL) or the next Cisco Systems (CSCO) concentrate
on fundamentals. Find a company with revenue growth, profit
margins, earnings growth -- whatever -- that matches America
Online or Dell in its early years and, bingo, you've found the next
big winner.
But after conducting a number of these fishing expeditions myself
over the years, I've concluded that searching based on
fundamentals alone doesn't work very well. I think that's because
such efforts ignore the importance of a stock's market role. These
big winners have carved out unique positions in the stock market
and in the psychology of individual investors. They are all
"gotta-own-it" stocks.
Sure, it's important that America Online has grown revenues to
$3.9 billion over the last 12 months from just $104 million in the
fiscal year that ended in June 1994. But I can find plenty of other
stocks with higher growth rates that don't have anything near
America Online's $140 billion market capitalization. That huge
market cap is a result of so many investors believing that if they
want to invest in technology in general, and the Internet
specifically, America Online must be in their portfolios.
To find the next America Online -- or the next anything -- an
investor should search for a stock that combines extraordinary
fundamentals and the aura of a "gotta-own-it" stock.
Let's look at how At Home (ATHM) measures up on these two
scales.
At Home's value on the fundamentals
Can't beat the top-line projections for this company. At Home, the
largest of the cable-modem access companies, had 460,000
customers nationwide at the end of the first quarter of 1999. (The
total number nationally is about 750,000, according to Forrester
Research. The bulk of the rest, 250,000, belongs to Time Warner's
(TWX) Road Runner joint venture with MediaOne Group.)
Prudential Securities projects that At Home will have 1 million
subscribers by the end of 1999 and 2.5 million at the end of 2000.
By 2002, the number of cable Internet subscribers will have grown
to 13.6 million, according to Forrester Research. If At Home corrals
60% of those (about equal to the company's market share today),
the company's subscriber base would be about 8 million in 2002.
Projecting from the $187 in annual revenue that the company
seems likely to be pulling in per year-end subscriber in 1999 and
2000, I get revenue of $1.5 billion in 2002. All these numbers are
exclusive of the pending At Home acquisition of Excite (XCIT), by
the way.
I'm not sure I trust this revenue number very much. Not only is it
riddled with my assumptions, but At Home's revenue accounting
leaves a lot to be desired. I understand that this company has a
complicated structure. At Home has built the backbone to connect
cable systems to the Internet and has developed the proprietary
content (which should improve, thanks to the acquisition of Excite)
on the At Home service. But the cable companies that own most of
the service get the money from selling and installing the cable
modems and also get the bulk of the $35 to $55 a month that
subscribers pay for high-speed Internet access through At Home.
At Home, in fact, keeps just 35% of that revenue.
But even with that structure in mind, I don't understand why the
company calculates (and Wall Street analysts repeat) its bottom
line before accounting for At Home's rather substantial payments
to the cable companies for distribution. The 7-cents-a-share loss
that At Home reported for its first fiscal 1999 quarter, for example,
did not include a $22 million item called "cost of distribution
agreements and merger and acquisition related costs." Including
those costs more than doubles the loss for the quarter to 15 cents
a share.
Cont. ---> Now, America Online used some pretty questionable accounting
during its growth, too. Some of the games the company played
with its marketing costs were over the line, in my opinion. (The
company took a huge charge to earnings to correct this
accounting problem in 1997.) And even those well-understood
income sheet problems never slowed the stock down. So maybe
they won't bother At Home's stock price, either.
Be that as it may, the way that revenue flows into the company is
still important. The fact that At Home only collects 35% of the $35
to $55 a month a customer pays for the service means that
despite appearances, At Home isn't collecting any more per
subscriber than America Online, which charges $22 a month. The
company's stock, therefore, doesn't deserve any special premium
to America Online because of the price of its service. So I think it's
fair to value At Home against America Online at roughly comparable
stages in their revenue growth.
That comparison is pretty dismaying. At the end of the 1995 fiscal
year, America Online showed revenues of $393 million. The
company's market cap at that point came to about $2 billion. At
Home, which won't see $467 million in revenue until the end of
2000, already has a market cap of $19 billion.
On the fundamentals, there's no way At Home is worth 10 times
more than America Online at this stage in its growth.
At Home's value as a 'gotta-own-it' stock
When I see a discrepancy in valuation like this, I try to understand
it rather than dismiss it out of hand. It's possible to make a rather
tidy profit even when a stock's price is clearly way ahead of its
fundamentals. (After all, I own America Online in Jubak's Picks.)
So why might At Home be worth $19 billion rather than $2 billion?
Chalk part of it up to the general enthusiasm for all things Internet. Is America Online worth $140 billion? It's likely that At Home's market cap is similarly inflated.
But I think that's not the only -- or even the main -- reason. I
think At Home is getting the benefit of a unique position in the
stock market. I can't think of a single stock that's a simpler or
more easily understood way to invest in the trend toward the
delivery of high-speed Internet access to the home. Think about
it: If you believe that trend is coming -- and I think it is -- you
want to be on board. How? Well, you could buy Time Warner or
Cox Communications (COX), but that gets you a company with lots
of businesses besides the one you want. Or you could try to learn
all you can about chip technologies and box makers and operating
systems so you can invest in Broadcom (BRCM) or
Scientific-Atlanta (SFA) or Oracle (ORCL). But isn't At Home much,
much easier to understand? It's just like America Online, only
faster. And everyone knows what happened to America Online's
stock, right?
I don't know if a stock can grow up to be the next big winner if it
gets off to a start like this. Dell, America Online and even Cisco
have climbed walls of skepticism. Dell was just an assembler of
PCs. How could a company like that hold onto its competitive edge
for a decade, skeptics -- myself included -- asked. Cisco couldn't
keep delivering 30% earnings growth and 40% revenue growth
once it dominated its market. Big companies just can't do that.
And America Online, with its reputation for shoddy service and
simple technology would finally get its comeuppance from a real
technology company.
It's important, I think, that America Online rose 172% in 1997 and
585% in 1998 -- the two biggest annual gains in the stock's public
history -- relatively late in its life. It didn't start out as a
"gotta-own-it" stock. It became one.
Are the trains leaving faster?
Maybe the rise of Internet investing has changed the rules. Maybe
the next America Online or Dell will be recognized right out of the
gate, thanks to all the information and tools now available to
individual investors. There's no doubt that, thanks to the Internet,
it's easier to find and research At Home today than it was to
discover and study America Online five years ago. Maybe the next
big winner won't grow slowly in valuation while it overcomes a flock
of naysayers like America Online did. Maybe the trains leave the
station much faster these days. I don't know.
But I do know that At Home is trading at a price that's only
justifiable if the stock is a unique play on a big trend. Investors are
betting that the company, thanks to its relationship with AT&T and
Time Warner, will be part of a near-monopoly over high-speed
Internet access. Over the next year, I think it's reasonable to buy
the stock on that basis -- the company will put up the big revenue
numbers that everyone is expecting and the quarterly reports will
be convincing evidence that this stock is indeed special.
Looking a little further out, however, I can see one technology
that could make investors question that premise. In my next
column, I'm going to take a look at the prospects for high-speed
delivery of Internet access without coaxial cable or copper phone
lines. What will wireless delivery mean for At Home, America Online,
AT&T and the other companies that now rule the wired world?
Updates
New Developments on Past Columns
The real winner of the AT&T deal
At the recently concluded NetWorld trade show, Broadcom (BRCM)
demonstrated the world's first Gigabit Ethernet transceiver chip for
existing copper cabling. The BCM5400 chip will enable network
equipment makers to develop systems that can deliver data at
gigabit speeds over unshielded twisted-pair copper wiring. That will boost performance in networks of this kind by 10 times and without requiring an expensive re-wiring of an existing network. About 80% f current networks run on twisted-pair copper wires.
Taken from the Yahoo message board |
