eBay has a market value US$1.7 billion more than
Newbridge Networks. Newbridge sold US$1.1 billion worth
of networking gear and is making a profit, despite
recent market woes. Ebay will sell about US$30 million
worth of stuff through its auction web site and may eek
out a small profit. Any investor realizes that a company
like Newbridge (even with average 36% annual growth of
profit over the past 5 years) is not worth 196 times its
revenue. It can't possibly grow fast enough to meet that
value put on it by the market. That's just silly. But
silly is now in season.
The most extreme example of silly is K-Tel. Ahhh yes.
Super Sounds of the 70's and Patty Stackers. They
announced that they were becoming strictly an Internet
business to sell their wares and faster than you can
say, "Who buys this stuff?", K-Tel increases
its value 10 times. Their recent stock chart resembles a
seismograph. It went up fast, vibrated a while and came
down fast. Now the SEC wants them to de-list for
violations, but that is another story.
From the traditional investment community, there are
a few theories for what is happening out there:
1. Momentum or Day traders are growing in number and
grossly over valuing the stocks
2. Uninformed and unsophisticated investors are trading
(ironically through the Net at E-trade, etc.) in larger
numbers (this is the favourite reason of my broker...
and any other person that gets commission for a living)
3. This kind of craziness and mob hysteria always
happens at the top of a market about to do a big time
nosedive.
4. Pent-up demand for IPO's based on the dearth of these
offerings in the past 6 months.
5. That there is a smarter (greedier) group of people
close to the deals that know theories 1 to 4 to be true
and are feeding the fire. How? The underwriters of the
IPOs see that the deal is hot. They also know that the
float (number of shares to be sold for the public
offering) is small. Therefore, the demand is high
(called "oversubscribed") and the price should
go up on the first day of trading. They talk to their
institutional friends (mutual or hedge funds) and make a
deal. Buy some of the offer at the inflated initial
trading price and get most at the list price. In the
case of theglobe.com, that meant that you could flip
shares you paid $11 for at $90. Nice deal. Only the guys
in the know get it. The rest of us suckers are the ones
holding shares that we paid $90 for and are worth $28
today.
But wait just a minute. Is there any real value in
Internet companies today? Why haven't Yahoo and
Amazon.com come back to earth like theglobe.com and
K-Tel. Maybe there are new dynamics happening here.
Perhaps the new business models of the Internet economy
make all of the old rules go away. Here's how Andy
Grove, recently retired CEO of Intel puts it:
"What's my ROI (return on investment) on
e-commerce? Are you crazy? This is Columbus in the New
World. What was his ROI?" Good point. As a
professional investor, albeit in early stages, I have to
be very concerned with ROI. But what do I need to be
concerned about when it comes to Internet companies.
Business 2.0
just did a cover story on this very point. Mark
Anderson talked about real value on the Net in his
technology strategy newsletter. Here is a summary of
what they said:
As I pointed out already, you cannot measure Internet
companies against other industries, even within
technology. You can measure them against each other and
see which is the best. In order to do that you have to
use the appropriate metric. Mark Anderson breaks down
the Internet companies into Doors, Store and S'Mores.
While stretching the rhyme a bit, what he was referring
to was portal/search engines (doors), e-commerce vendors
(stores) and community sites (s'mores after the tasty
treat that signifies a comfortable feeling of being
welcome... yeah, it was a big stretch).
When comparing doors, you should focus I on what
makes these companies revenue: eyeballs. The important
metrics are market cap divided by number of page views
and revenue dollar per visitor. Once you have these you
can compare to other doors and see how you stack up. If
you want to be in the "door" business, you
better be able to effectively control the cost of
acquiring a customer and be more efficient at it than
your competitors. I have a bit of difficulty with the
portal/search engine company that wants to get started
today. The world does not need another search engine.
So-called "portals" are getting less and less
attractive, because all of the key locations and
categories are being taken. There can only be one entry
point for the AOL or the Web TV subscribers.
Let's look at the "doors" business model.
In order to get eyeballs, the company needs to provide
universal information or information on a specific
subject that a lot of people are interested in. Please
do not send me the business plan for the "Essential
On-Line Guide to Spotted Owls". Another problem
with the doors model is that the top sites dominate ad
revenue and will continue to do so for a long time. As
banner ads become less relevant and interstitial
advertising (yes, commercials are coming to a Net near
you) grows, the big money stays at the top sites leaving
crumbs for the rest. On the positive side, doors have
great margins. It costs very little to peddle
information on-line. Also, doors have lower customer
acquisition costs than stores. But differentiation is
difficult. Have you noticed that Yahoo, Netcenter and
others are starting to look very familiar?
What about the stores? How do they make money? Yeah,
they sell stuff. Duh. But, what makes this model really
attractive is that the cost of their sales is markedly
less than real stores. When evaluating a store, the key
metrics to look at are market cap divided by customer
and revenue per customer. In order to compare how one
store stacks up to another these are easy things to
measure. Customer is anyone that has made a purchase at
the site, not page views. The on-line trading companies
have remarkable revenue per customer. That indicates
repeat buying and/or large value purchases. As for a
company looking to be a successful store, cost per
customer acquisition is important. But much more
important is the cost of customer service. This is
measured by customer retention.
With essentially no difference between Amazon.com and
baresandnoble.com in price or catalog size, why are more
people buying from Amazon.com? Better brand name is one
reason. But customer service is another. And that has
become the benchmark. A quick example: Chapters just
launched their site in Canada. Hooray, now I can pay in
Canadian dollars and get lower shipping costs. But their
catalog is limited and their service is not up to par
with Amazon.com. Amazon.com allows me to send to
multiple addresses on one bill by simply picking from my
address list. Chapters makes me re-do all the steps to
send a book somewhere else. Amazon.com has order
tracking status. Chapters only sends an e-mail
confirming your order. No notification of when it is
shipped. Until they fix these things, I am going to
Amazon.com.
Overall, the stores model is very attractive. By
providing superior customer service and enjoying much
lower costs than traditional stores, on-line stores can
retain shoppers for a long time and grow enormously.
Amazon.com will sell $1B worth of stuff next year.
Watch. Start-ups need to find a lucrative niche and
build the brand. From day one they need to give great
customer service or they are dead. Recent examples of
VC-backed store start-ups: Drugstore.com, Homeshark,
eToys among others. It will require a minimum of $20
million over 2 -3 years to build a business here as
customer acquisition costs are high initially. This is
not for the faint of heart.
And then there are the s'mores or communities. The
grandaddy of them all is AOL. While stores need to
fundamentally understand consumers and their shopping
habits, communities need to understand consumer
behaviour. They have to offer a place to hang out and
socialize. Why? As Mark Anderson says, "the people
of the world want to talk to each other."
How do communities make money? Once again, the
margins are incredibly high. Truly organic sites like
Geocities and Parent Soup have 80 - 95% of the content
supplied by the users. For free! It's like running a
flea market and taking all of the revenue. Good deal, if
you can get it. And customer acquisition cost is low,
once the brand is known. To some extent, this is like
the doors business model in that eyeballs are required
to generate ad revenue. So, the metrics to measure
communities are the same as the doors, market cap over
page views and revenue per visitor. But here is the big
difference. Communities encourage people to stay for a
long time. On Yahoo, you click, click, click and leave.
On Parent Soup you linger and chat. AOL is what it is
today because Steve Case and Bob Pittman (started MTV)
knew that pimply faced, hormone raging teenagers want to
ineract. Replace the 4 hour phone conversations of a
teenage girl with a 4 hour chat. Blitz them with
advertising and voila, the biggest of the Internet
companies. Make no mistake, AOL may suck, but they know
what the customer wants and they are delivering.
So, let's wrap it up in a neat package. Do I believe
in Internet companies and the new economy? Yes. Do I
believe that the current prices of these stocks are
justified? In most cases, No. There is too much hysteria
still and there will be a correction. What about
investing in Internet start-ups today? There aren't many
doors, stores or s'mores in Canada these days. We
investors have been very gun shy. We prefer the comfort
of intellectual property in Internet and Intranet tools
or applications for e-commerce. But you can't ignore the
successes. You also can't ignore the fact that other
successes will emerge. And, as a lover of IPOs that do
very well, I can't ignore the riches.
Random Thoughts
Due to late deadlines, there will be no extra bits
this time. I'll save them up for next time. Also, the
responses from last week were mostly in response to the
articles I mentioned in the Random Thoughts. Again,
ineffective time management keeps me from posting them.
Maybe next time.
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