Qualiport

Internet Shares
Monday, 16 November 1998

EMAP's interim results

The hunt for the 6 "best" companies in the world continues. On Friday, I had hoped to start covering the remaining growth industries we want to look at, but the Independent Insurance (IIG) announcement threw things off track a little.

Internet shares are all the rage again in the US. Recent offerings such as eBay and EarthWeb have soared to enormous premiums. The latest to hit the heights is theglobe.com. Floated at $9 per share, on Friday it hit as high as $97 in early trading. Some investors wait a lifetime to get a ten bagger, but it seems these days they can happen in a matter of hours.

Some of this enthusiasm is clearly madness. Many companies, although probably relatively successful, will never make profits to justify these early valuations. The fallout may take three to five years, but it will almost certainly happen.

That's not to say there won't be a relative few highly successful companies that will dominate the industry, if they are not already doing that now. Remember, at this stage we are deliberately not looking at valuation, instead we are trying to identify the great companies within a growing industry.

First of all, we need to understand how companies make money off the Internet. At the moment, there are basically three business models: commerce, subscription and advertising. Some companies combine all three, others very much concentrate on one revenue stream. All companies are looking to maximise the traffic through their sites. The more people who regularly use each site, the more opportunity a company has to increase the revenue per customer.

Here are the four companies I believe may end up being winners in the Internet world. They already have strong brand names, but the next challenge is for them to turn this advantage into significant profitability.

Amazon.com (commerce and advertising). This company started off as an online book retailer and has recently branched out into music and videos. Has a huge brand name in the online community. It sells its products at a significant discount to the traditional book or music store and has none of the fixed costs associated with the latter. Has a high degree of repeat purchase customers.

America Online (subscription and advertising). AOL is an Internet service provider (ISP), but it also provides its own content. AOL aims to make it very simple to surf the Internet. Have over 15 million subscribers worldwide, mostly in the US, who pay a monthly connection fee. This gives AOL a steady cash stream. The simple e-mail address is one of the ways AOL locks in customer loyalty. It is like changing your phone number -- you only do it if it is absolutely necessary, and usually because you are moving house. There are far fewer reasons to change your e-mail address than your phone number, so most people never do.

eBay (commerce, advertising, and possibly even subscription). The site is an online action house. You can buy or sell just about everything under the sun. eBay doesn't buy the goods, it just hosts a site that attempts to match buyers with sellers. It therefore carries no stocks and makes its money from the seller of each product. The Loot newspaper makes its money from the cover price and trade sellers. Imagine if they gave the paper away for free, charged the sellers a fee for placing the ad, and charged them again if they successfully sold their goods. That's what eBay does, but without the costs. Has a big brand recognition in the US and, although there are competitors, locks people in because it is the biggest and best of the auction sites.

Yahoo! (advertising). Probably the number one brand name on the Internet world. They are, by some distance, the most popular search engine. As such, they can charge premium rates to advertisers -- and, courtesy of their enormous number of impressions ("hits" to the layman), they have that much more advertising space to sell. They have competitors but also have the brand recognition. Ask someone who knows a little bit about the Internet to name a site they know, and the chances are that Yahoo! will be quite high up their list.

In my mind, they are the big four at the moment. eBay only opened for business 3 years ago, so the chances are that another few great Internet businesses will come along in the next few years.

Before leaving the Internet sector, here's advice investors must have uppermost in their minds when looking for great Internet companies.

Worship brand equity. Look for a strong brand, one that has a stranglehold on its market. Either create a brand, or align your startup with an existing brand that rules its market. Everything rests on the strength of the brand.

EMAP Interim Results

Our media company today released interim results for the 6 months ended September 1998. The good news is that they exceeded market expectations, but the bad news was that the shares lost 30p. The comment depressing the share price was that EMAP (EMA) noted that "revenue growth has begun to slow in our major UK markets." This is hardly the most unexpected piece of news. As we've commented in this space before, because EMAP are a media company and are somewhat dependent on advertising income to fuel profits, any economic downturn will adversely affect them.

Men's magazine FHM consolidated its position as the country's largest selling monthly magazine. At last count, 750,000 were being shifted each month. The magazine has also gone straight to the top of the best seller lists in Australia, where it has recently been launched. EMAP have invested heavily in promoting the brand, and the results are clear to see. This investment and brand recognition will also, hopefully, bode well for the magazine in times of an economic downturn.

EMAP have adopted the new Financial Reporting Standard 10 "Goodwill & Intangible Assets." Without boring you too much at the moment (we'll leave that to a later session), EMAP have capitalised as intangible assets most of the acquired goodwill previously written off against reserves. This asset is then amortised, or written off, over 20 years. The upshot of this is that EMAP's reported earnings have been reduced by over £20m. However, this is just an accounting entry, and most importantly doesn't adversely affect their cash earnings. Stated earnings per share (EPS) were 21.0p, up from a restated 12.2p. On a similar restated basis, fiscal 1998 EPS were 28.3p.

At 1075p, that leaves EMAP trading on a trailing price to earnings ratio (P/E) of 38. That suddenly looks very high, but nothing about the company has changed since we bought it. The reported 1998 EPS was 45.7p, meaning the company traded on a pre FRS10 P/E of 23. These accountants deliberately make things difficult for us. As I said, more about this in the future, and about EMAP's results. As a final point, operating margins again increased significantly, up from 17.0% to 18.5%. With every reporting period, they just keep on getting higher. The company's aim is to increase these to 20% by 2000.

Before we close this Monday Qualiport special, Michael Bright, the Chief Executive of Independent Insurance, today purchased 35,000 shares at 231p. Bright has been a consistent purchaser of shares in the company he runs, usually after results are released. The shares dropped 33p to 228p on Friday after the company said that weather related losses would affect full year results. Bright now owns 5.87% of the company.

See you Wednesday, Fools, where we will continue our search for the best companies in the world by looking at the telecommunications sector. See you on the message boards.

Bruce Jackson (TMF Googly) Qualiport Numbers

                           16/11/98 Close

                    Company    Change    Bid
                       EMA     -0.30    10.75
                       IIG      0.00     2.25 
                       MKS      0.00     4.46
                       PIZ      0.01     8.01 
                       RTO      0.16     3.74
                       ULVR     0.09     6.37 

Qualiport Stocks

Last Rec'd  Total #  Company   In At   Current  Change
 19/12/97      783   RTO        2.55      3.74     46.7%
 04/11/98      245   PIZ        7.93      8.01      1.1%
 17/07/98      298   ULVR       6.72      6.37     (5.2%)
 17/04/98      169   EMA       11.85     10.75     (9.3%)
 27/10/98      755   IIG        2.58      2.25    (12.8%)
 11/05/98      368   MKS        5.54      4.46    (19.4%)


Last Rec'd  Total #  Company   In At     Value    Change
 19/12/97      783   RTO      2046.53   2928.42    881.89
 04/11/98      245   PIZ      1966.34   1962.45     (3.88)
 17/07/98      298   ULVR     2052.54   1898.26   (154.28)
 17/04/98      169   EMA      2052.57   1816.75   (235.82)
 27/10/98      755   IIG      1972.64   1698.75   (273.89)
 11/05/98      368   MKS      2054.11   1641.28   (412.83)


Cash:                          £3,975.57
Current Total :                £15,921.48
Total Invested:                £16,184.62
Profit/(Loss) :               (£ 263.14)

Value Per Share

                    Day      Month      Year       History
Qualiport          0.87%     0.17%     31.61%      34.58% 
FTSE 100           0.87%     1.33%      7.30%       9.77%
FTSE All Share     0.71%     1.26%      5.20%       7.42%

For an explanation of Value Per Share accounting, please click here.