INTERNET STOCKS
A GOOD INVESTMENT?
BY: DARYL ELBERT, CHERYL HOGENMILLER, DEBBIE PYATT, AND LANCE WILSON
INTRODUCTION
Internet Stocks: The Modern Day Tulip
viewed 03/26/02)
(www.itulip.com\background.htm,
No profits, no assets, no experience-So what’s the big deal?1
By April 2000 market capitalization of Internet companies was $1.1
trillion
Any company with “.com” in its name was awarded a very large
valuation
Valuations based on assessments of the future1
Many Internet companies experience rapid growth and make a lot
of money but still more will not turn the corner
Fall victim to increasing losses
Sell out
Go out of Business
What is the best way to value a single Internet company?
Traditional valuation methods2
Why Do Investors Put Their
Money In Internet Stocks?
“The next Microsoft”
Mentality-winning the
lottery3
New Technologygetting in on the
ground floor4
Rapid growth-high
growth potential5
Low operating
expenses-characterize
most e-businesses6
Consumer & Investor
Interestrecommendations by
investment firms7
Disproportionate market
share-first and second
firm8
Characteristics of Start-up
Internet Companies
High start-up costs and low initial revenue9
Start-up costs relate to software and marketing
Few Internet programmers
Valuation by Investment analysts
Start-up scenario: idea, business plan, programming, open
website, need for additional capital10
Investors place bets on their confidence in the idea, the
entrepreneur or both
Value determined by present value of future cash flows11
History dictates that a majority of companies never meet
much less exceed their initial business plan
Valuation of Established
Internet Companies
Discounted cash flowpresent value of future
cash flows12
Comparable Method12
Revenue trends
(Negative) earnings
trends
Competitive position
relative to other ebusiness firms
Comparison to Big fourMicrosoft, AOL, Yahoo &
Amazon
Initial Public Offering (IPO’s)
Investment in IPO’s-Getting in on the ground floorBuy low sell high attempts13
Primary Market
Secondary Market
Examples13
VA Software Corporation (LNUX)
Amazon.com (AMZN)
Can these types of businesses succeed?
13
Many will experience cash burn on their way to bankruptcy
Similar stories to LNUX & AMZN-predictable effects on
markets
Investors learn their lesson
Internet IPO’s
Internet IPOs per Year
300
275
250
225
200
175
150
125
100
75
50
25
0
IPOs
1990
1992
1993
1994
1995
1996
1997
1998
1999
2000 Jun-01
eBay Profile
Secrets of Success:
Key strategic partnerships
AOL- increased customer
base14
IBM- software, sales, and
marketing alliance15
Microsoft- improved
technology16
Acquisitions
Butterfield & Butterfield14
Alando.de14
Kruse International14
iBazar.com14
Announced intent to purchase
EachNet.com17
Copyright © 1995-2002 eBay Inc. All Rights Reserved. Designated trademarks and brands are the property of their respective owners.
eBay Profile, Contd.
Sustained growth = Strong Buy
Revenue (MM)
Registered Users (MM)
45
$800
40
$700
35
$70
$60
$500
25
$400
20
$50
$40
$30
$300
15
$200
10
$20
$10
$100
5
0
$100
$90
$80
$600
30
$0
1998
1999
2000
2001
Net Income (MM)
1998 1999 2000 2001
(18, 19, 20)
$0
1998 1999
2000 2001
eBay Profile, Contd.
Competitors
Traditional retailers such as Wal-Mart, Target,
Sears, Macy’s 21
Online retailers such as Yahoo! Shopping,
Amazon.com, Buy.com 21
Biggest competitor is customer habit 22
What’s next for eBay?
Continued growth through international
expansion
In 2000, entered four new markets, Japan, Canada,
France & Austria
In 2001, established presence in Belgium, Brazil, Italy, the
Netherlands, Portugal, Spain, and Sweden
Recently Launched eBay Singapore
The next AOL Time Warner?
23
Amazon Profile
• Conceived in 1994 by founder and current CEO Jeff Bezos
• Central Headquarters based out of Seattle, Washington
•Created website that stood out from other competitors
• Amazon’s success came overnight
• Created competitve advantage over Barnes & Noble and Borders
"Amazon.com Inc. -- Chronology", Business & Company Resource Center; pgs1-4; Aug. 2000; Gale
Group,<http://galePagenet.galegroup.com/servlet/BC…tle&n=25&l=dh&locID=morenetumsl&CO=AMZN>
Why Amazon is still alive?
• Owns majority of U.S. and International on-line market share
• Huge cash revenue generator
• Amazon Offers wide array of products “Everything from A-Z”
• Venturing into new businesses63
• auction sites to compete with Ebay
• Zshops – commissions 15% of all sales
• service provider for bricks and mortar companies
Current Situation
• Recorded first profit for Fourth Quarter Fiscal Year 2001
• Slashed 1,300 jobs65
• Closed distribution centers
• Changed network to more economical Linux system67
• Rapid Global expansion 29% of revenues64
• Copyrights on “one-click shopping™” webpage66
Priceline Profile
Initiated its own Internet pricing system-demand collection
system30
Priceline Slogan-”Name Your Own Price”
Products-hotel rooms, rental cars, long distance calling minutes, airline
tickets
Initially tremendous growth from IPO in 1999 to 3Q 200032
Serious decline32
Major licensee closes
Negative publicity regarding customer service issues
September 11, 2001 subsequent travel industry lull33
February 2002, Delta Airlines sold 1.7M shares33
Turnaround Strategy34
Focus on core products
Taken steps to improve functionality of delivery
Partnership with eBay
Financial Profiles
52-Week Low
52-Week High
52-Week Change
Market Cap
Shares O/S
Book Val (mrq)
Sales (ttm)
Cash (mrq)
eBay
Amazon
Priceline
$29.25
$5.51
$1.80
$72.74
$18.16
$10.35
59.20%
52.40%
135.20%
$16.3 B
$5.8 B
$1.22 B
275.1 M
373.3 M
224.7 M
$5.20
-$3.86
$0.66
$2.65
$8.50
$5.53
$2.63
$2.67
$.067
Data provided by Yahoo financial, http://finance.yahoo.com as of December 31, 2001
Financial Profiles, cont.
eBay
Amazon
Priceline
Price/Book
11.38
N/A
8.27
Price/Earnings
183.88
N/A
N/A
Price/Sales
22.30
1.83
0.98
ROA
5.81%
-33.17%
-3.02%
ROE
7.50%
N/A
-36.70
Current Ratio
4.91
1.31
2.12
Debt/Equity
.02
N/A
0.00
Total Cash
$723.4 M
$996.6 M
$149.2 M
Shares Short
15.4 M
58.2 M
4.94 M
% of Float
10.30%
40.00%
5.80%
Shares short (prior)
18 M
64 M
4.70M
eBay Graphical Comparison
Amazon Graphical Comparison
Priceline Graphical Comparison
Mutual Funds
Are mutual funds the answer to investing in
Internet stocks?37
Diversification is accomplished cheaply and easily
Purchase a claim against large portfolio of stocks, bonds
and/or other investments
Managed by professional money managers-better
equipped to follow & react to market changes
Internet mutual funds offer little diversification38
Volatile to market news, earnings & movements
Most cost efficient way of investing in Internet stocks38
Standard & Poor’s reports Internet stocks coming
off their lows in the aftermath of September 11th38
Uncertainty still clouds Internet stocks39
Many funds still suffer from loss of assets, plan to
liquidate or changing investment approach39
Index Funds
Index providers &
publishers have created
Internet indexes40
Most have added confusion
rather than clarity
Two most popular Internet
Indexes
The DowJones Internet
Index (DJII)
The Internet Stock Index
(ISDEX)
The Dow Jones Internet Index
Includes only companies whose primary focus is
Internet-related41
Must generate 50% of revenues from Internet
commerce or services
Must be currently included in Dow Jones U.S. Index
DJII broken into two areas42
Internet Commerce-majority of revenues derived from
providing goods and services through an open market
Internet Services-majority of revenues derived from
providing access to the Internet or providing services to
those who use it
The Dow Jones Internet Index
DJII includes 15 Commerce stocks and 25
Service stocks-Not fixed42
Eligibility requirements43
IPO’s must have a minimum of 3 months’ trading
history
Spin-off’s require this history only if parent stock
has not been trading for 3 months
3 month avg. market capitalization of at least
$100 M
3 month avg. closing price above $10
Sufficient trading activity to pass liquidity tests
The Dow Jones Internet Index
Index components selected using an equally-weighted
combination of market capitalization and trading volume43
Ranked by float-adjusted market capitalization then by share
volume
Ranks summed in order to determine score
Sorted in descending order
Composite
Internet
Index
Close
1 Day
3 Month
6 Month
1 Year
3 Year
CII
48.49
-2.11
-16.96
-11.46
-49.11
-36.03
Internet
Commerce
47.46
-.04
2.44
.57
-15.69
-41.05
Internet
Service
42.50
-4.26
23.20
-17.50
-64.91
-37.28
Data provided by Dow Jones. 3-year return is annualized. Data as of 2-28-2002
The Internet Stock Index
ISDEX represents Internet investment barometer-first pure
Internet Index44
Relies on the 51% revenue to determine listing
No minimum market capitalization, trading volume, or shares
outstanding qualifications
Represents 95% of the capitalization of the Internet stock universe
Defines seven subsectors of the Internet industry44
Etailers and ecommerce
Software
Enablers
Security
Content and portals
High speed and infrastructure
ISP’s and access
ISDEX reviewed quarterly45
ISDEX Sample Listing
Company
Last
Change
% Change
Amazon.com Inc
$14.03
-.45
-3.10%
Ameritrade Holding
$6.26
.05
.80%
AOL Time Warner
$26.33
.59
2.30%
Ariba, Inc
$4.65
-.29
-5.9%
Art Technology Gr
$2.52
-.12
-4.50%
Asia Global Crossing
$.36
NC
NC
BEA Systems
$15.29
.35
2.30%
Broadcom Corp
$38.85
-.39
-1.00%
Broadvision Inc
$1.94
-.06
-3.00%
Check Pt Software
$32.17
-1.11
-3.30%
Data provided by Internet.com as of 03/15/02
Internet Stock Questionnaire
We asked various members of the financial community to answer the following
questionnaire.
Please answer questions 1-5 on a scale of 1 to 10. 1 being bad and 10 being good.
1.
2.
3.
4.
5.
6.
Where do you see the future of investing in Internet stocks?
What are your feelings about investing in Internet stocks?
Would you recommend investing in Internet stocks?
Do you feel Internet stocks are good short-term buys?
Do you feel Internet stocks are good long-term buys?
Do you have any Internet stocks in your portfolio? Yes or No
What do you see as the major growth inhibitors?
What are the potential growth opportunities?
What have been the major mistakes Internet companies have made?
Internet Stock Questionnaire
The following is the average of responses that we received from the
financial community.46
Please answer questions 1-5 on a scale of 1 to 10. 1 being bad and 10 being good.
1.
Where do you see the future of investing in Internet stocks? 5.4
2.
What are your feelings about investing in Internet stocks? 4.8
3.
Would you recommend investing in Internet stocks? 4.2
4.
Do you feel Internet stocks are good short-term buys? 4.0
5.
Do you feel Internet stocks are good long-term buys? 5.6
6.
Do you have any Internet stocks in your portfolio? 4 out of 5 Yes
Internet Stock Questionnaire
What do you see as the major growth inhibitors?46
Cash Burn
Generating Revenues
Consumer confidence
Sensitivity to industry news and market conditions
Day Trading
Raising additional financing
Little or no barriers of entry
What are the potential growth opportunities?
Technological opportunities spike short-term valuation
Growth opportunities are unlimited
One of the best business is software, services
Providing services that people need or that make the Internet an easier place for the average
person
What have been the major mistakes Internet companies have made?
It is not necessarily the companies but rather the investors’ belief in their earnings potential
and investing in companies with little or no sales or profits
Forecasting that trends will continue
Not combining the use of “brick and mortar” in their business
Believing that advertising revenue will pay for a majority of the Internet services
Underestimating the start-up rate for new services
Not being conservative with capital because of the belief that it will always be available
Questionnaire Response
Richard Todaro, Vice President of Kennedy Capital responses46:
1.
2.
3.
4.
5.
6.
Where do you see the future of investing in Internet stocks? 4
What are your feelings about investing in Internet stocks? 2
Would you recommend investing in Internet stocks? 2
Do you feel Internet stocks are good short-term buys? 2
Do you feel Internet stocks are good long-term buys? 2
Do you have any Internet stocks in your portfolio? Yes or No
What do you see as the major growth inhibitors?
1. Raising additional financing
2. Very little to no barriers to entry-best business models are those who have their
own product and use it as another distribution channel, ie. Microsoft
What are the potential growth opportunities?
1. Growth opportunities are unlimited, the question is profit margin
2. The best businesses are software & services (Games, Accounting, Tax on-line)
Questionnaire Response, cont
What have been the major mistakes Internet companies have made?
“Honestly the companies should be given some credit if suckers where willing to pay
billions of dollars for a company that has little to no sales or profits then those
companies should and did sell as much ownership in their companies as possible.”
Example-Garden.com (GDENZ)-used to be GDEN but is no longer listed on NASDAQ
1999 company sales $5.4 million and losses of $375 million
2000 company sales $15.5 millions and losses of $49 million
How much would you have paid for the company? Investors paid $440 million
Who did something wrong the company or the investors? The company now trades at
.01 a share or $177,000-which at .01 could still be argued as over-valued
Recent News
February 5, 200247
Priceline drags down Index
Amazon gave up$1.03
March 4, 200248
Of the only 10 IPO’s to be
priced none finish above
initial offering price
March 7, 200249
Cable Internet subscribers
grew by 58%
Recent News
March 15, 200250
Toys “R” Us wants to
lighten payments to
Amazon-a critical source
of profits
March 19, 2002
For 2nd time in a week
eBay has moved to
solidify foothold in Asia51
Nasdaq up almost 10%
but no cause for
celebration52
Recent News
March 20, 2002
Amazon’s German and British web sites
started selling used and collectible items53
eBay posts new privacy policy54
March 21, 2002
Some Internet stocks become so attractive
that people want ALL of it55
Conclusion
Valuation of the “New Economy” firms56
Important area of accounting research
Concerns whether the traditional
accounting model can be used to value
firms consisting only of growth
opportunities
Residual valuation model created by Brett
Trueman, M.H. Franco Wong, and Xiao-Jun
Zhang (TWZ)
Conclusion
Residual Income Valuation Model56
Incorporates two “eyeball” measures56
Unique visitors
Pageviews
Accounting measures tested-gross profits56
Indicators of web traffic are positively and
significantly associated with firm value56
Process57
Select simple proxies for investors
Combine accounting measure with eyeball data
Book equity insight
Conclusion
What is the best opinion if you do not want to risk
investing in Internet stocks?
Back-door Internet play60
Companies that are not strictly Internet companies but stand to gain
by Internet growth
Infrastructure stocks
Investment in shipping companies61
So what should the average investor do if they still want
to invest in Internet Stocks?
Mutual Funds-hedge risk at a minimal cost
Remember no investment is 100% safe
Perform due diligence on your broker and potential investments
Keep a close eye on company news
Review your investments at least monthly
Citations
1.
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47. Questionnaire answered by: Alikhan, Omar (stock broker, Scottrade Inc.); Elbert, Daryl (investor); Kosar, Robert
(options broker, Helios Inc., Chicago Board Options Exchange); Todaro, Richard (V.P. of Kennedy Capital);
Toedebusch, Cory (investment banker, Vine St. Inc. );
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