Internet Stocks
Are Internet Stocks Fairly Valued?
NO!
Carlos Carvallo, Naji Ghazal, Jody Goodall
Scott Huxtable, Heiko Ziehms
Overview
• Present Market Capitalization's are too high
• Internet Growth  Profitability
• Historical analogy
Present Market Values*
35
25
20
15
10
*Market Capitalization as of 5/3/99
Delta Air
@Home
Sears
Priceline
eBay
Amazon
JP Morgan
0
Kodak
5
Yahoo!
$ Billions
30
What is Value?
• “Value today always equals future cash
flows discounted at the cost of capital”
Brealey / Meyers, Principles of Corporate
Finance, p. 73
• All other valuation techniques are
estimations or shortcuts (Steve Harmon et
al)
What is Fair?
• Today’s market capitalization must be
justified by realistic future cash flows
Example: eBay Valuation
• eBay requires a growth rate of 300% a year
for five consecutive years to justify their
present Market Value of $24 billion
• Analysts average growth rate forecast for
eBay over this period is 54%
• eBay’s gross profit margins have actually
decreased for the past three years
Analysts’ Valuation
Market Pseudo-DCF
Delta
Market Value/
Value
Value
(Pseudo-Market) Pseudo DCF Value
AOL
$139.8
$14.1
$125.7
9.9x
At Home
$144.9
$14.9
$130.0
9.7x
Compaq (Control) $23.6
$24.0
-$0.4
1x
eBay
$176.0
$6.7
$169.3
26.2x
Yahoo
$189.2
$18.5
$170.7
10.3x
*assumes very conservative 17% discount rate
*growth rate forecasts from Yahoo! Finance
*Source: Group A White Paper
New Medium - No New Rules
• Growth of the Internet does not necessarily
imply growth of profit for these companies
• Low barriers to entry
• Increasing competition
• Minimal switching costs
• Decreasing profit margins
Reality Check - Amazon
• If amazon sold every book in US in 10
years time they would still not justify
even half of their valuation.
• 2008 book sales $16 Billion
• Amazon requires income of $63 Billion
(BusinessWeek)
• a lot of cd’s
Even eBay knows the truth
• eBay ”We may not retain profitability”.
(10-K)
• 11/15 Internet companies lose money
– why should this change so much
Growth
Market Cap
last
($B)
profit margin
AOL
133.3
7.8%
Yahoo!
35.0
13.0%
Amazon
27.7
-20.0%
eBay
26.0
5.1%
Priceline
23.1
@Home
17.9
-300.0%
e-trade
13.3
-6.8%
Excite
7.9
-24.0%
Inktomi
5.8
-83.0%
DoubleClick
5.5
-23.0%
Cnet
4.5
4.6%
Lycos
4.3
-136.0%
InfoSeek
3.1
-136.0%
Earthlink
2.2
-34.0%
OnSale
0.5
-7.1%
Historic Bubbles
• Previous experience shows that the market
can’t sustain such hyper growth based on
momentum and irrational euphoria.
• Bio-Tech in the late 80’s and early 90’s
• Railroad and Radio in 19th Century
In Conclusion
• Growth needed to achieve required future
cash flows is practically unobtainable
• Internet Growth  Profitability
• History shows all bubbles burst