Qualiport

[ November 1, 1999 ]

Wonderfully Internet

By Bruce Jackson (TMFGoogly)

Baker Street, London -- Just how do you value Internet companies? That is the age old -- all of 2 years old -- conundrum facing value investors. I place the word Internet in italics because there's no such thing as an Internet company. It's just that some companies choose the Internet as their preferred way of selling things to customers.

I may be stating the obvious here, but the Internet allows companies to run extremely low-cost operations. A simplistic look at on-line retailer Amazon's (Nasdaq: AMZN) business model gives you an insight into the benefits of operating on the web.

1. They buy their merchandise on credit, and sell those goods for cash. This means the company's end customers are effectively funding the growth of the business.
   
   
2. One shop does all. Unlike traditional bricks and mortar retailers, Amazon has just one shop front. The lower cost of that business model is clear. For example, Marks & Spencer (LSE: MKS) has just under £4.4 billion of tangible fixed assets - things like property, furniture and fittings and various other expensive stuff. This is a huge drain of their cash resources. A company like Amazon can direct that cash into other areas of the business. At the moment it appears they are directing it into their marketing budget as the attempt to build a world-wide and world recognised brand name. I don't know about you, but they appear to me to be doing a reasonably good job at it.
   
   As a side note, how many Internet companies have built a world-wide brand name? I'd argue that only Amazon, AOL (Nasdaq: AOL), e-bay (Nasdaq: Ebay) and Yahoo! (Nasdaq: YHOO) have done so to date. It's not surprising therefore that those four companies are capitalised at a combined value of US$230 billion. As for whether those valuations are realistic in comparison to their respective prospects, that's a different story. The following table is however quite illuminating.

   
         Market Cap. Forecast sales Price-to-sales
             US$m         US$m
   
   Amazon    24,000       1,500          16
   AOL      143,000       6,500          22
   e-bay     17,000         220          77
   Yahoo     46,000         570          81
   

   As a comparison;

   
                Market Cap. Forecast sales Price-to-sales
                     £m           £m
     
   M&S              8,200       8,100           1
   Freeserve        1,400          16          88
   FTSE 100 (median)                            2
   

   What does that tell us? On this measure, could Marks & Spencer (LSE: MKS) be cheap? Or is Freeserve (LSE: FRE) expensive? I think most Qualiport followers know my opinions about M&S, even at these levels. As for Freeserve, a company without a global brand name, one can only cringe at its valuation, especially when you compare it to the other names above. Don't get me wrong; Freeserve have successfully taken the ISP market by storm, and fully deserve recognition for their success. But is that business, in a highly competitive market, currently worth £1.4 billion? It doesn't seem it to me.
   
   Back to Amazon and its business model
   
   

3. Low inventory levels. This one carries on from point 1. Unlike traditional retailers, Amazon don't have to carry oodles of stock, displaying it for all to see, and hopefully buy. Stack up all the pairs of underpants M&S stock in all their stores across the world, and you'll be looking at a pretty big pile. If it ain't on display, no-one is going to buy it. Amazon by contrast can simply display an icon on their web-site, have just enough items in stock to meet demand, and carry all that stock in just a few giant low-cost out-of-town warehouses.
   
   
4. Low transaction costs. The Internet allows a virtual seamless transfer of goods from retailer to consumer, usually without the need to talk to anyone. The first time anyone uses the Internet to purchase something is an amazing experience. Almost everything is automated. This means little in the way of paperwork changes hand -- it's all handled by computers -- there's no need to have thousands of cash registers and therefore no fiddling about for change, and crucially there's no sales assistant. All those things cost money, but in the Internet world, that cost is minimal.
   
   

Now we've established the business model, what about those valuations? Unfortunately, there's no easy answer, and each company is different. Many people try and value companies on a per-subscriber basis, attempting to put a value on each existing and potential customer's contribution to the company's bottom line.

We'll tackle this on Wednesday, by first looking at the mobile phone industry. All feedback and thoughts encouraged to the Qualiport message board. If there are any M&S fans still out there, I'll be covering tomorrow's interim results in the Lunchbox, on site by 12.30pm every market day.

Qualiport Numbers
1/11/1999 Close

Company  Change    Bid
DELL(US)+1.60    40.00
EMA      0.00     7.85
IIG     +0.05     2.73
MSY     +0.15     5.22
PIZ      0.00     8.00
RTO     -0.01     2.00
ULVR    -0.10     5.53
LLOY    +0.02     8.42


Qualiport Stocks

Last Rec'd  Total # Company    Buy  Current Change

 29/09/99   356     Lloyds TSB 7.56  8.42    11.4%
 27/10/98  1133     Indep Ins  2.60  2.73     5.0%
 04/11/98   245     Pizza Exp  7.93  8.00     0.9%
 22/04/99   348     Misys      5.76  5.22    (9.4%)
 27/01/99    74     Dell (US) 44.63 40.00   (10.4%)
 19/12/97   783     Rentokil   2.55  2.00   (21.6%)
 17/04/98   301     Emap      10.20  7.85   (23.1%)
 17/07/98   266     Unilever   7.53  5.53   (26.5%)

Last Rec'd  Total # Company     In At  Value   Change

 29/09/99   356     Lloyds TSB 2723.20 2997.52  274.32 
 27/10/98  1133     Indep Ins  2990.63 3093.09  102.54
 04/11/98   245     Pizza Exp  1966.34 1960.00   (6.34)
 22/04/99   348     Misys      2028.71 1816.56 (212.15) 
 27/01/99    74     Dell (US)  2007.42 1793.94 (213.48)
 19/12/97   783     Rentokil   2046.53 1566.00 (480.53)
 17/07/98   266     Unilever   2052.00 1470.98 (581.02)
 17/04/98   301     Emap       3139.85 2362.85 (777.00)

Cash:                                        £1,046.15
Current Total :                             £18,107.09

Total Invested:                             £20,184.62
Profit/(Loss) :                            (£ 2,077.53) 

Value Per Share

                    Day      Month      Year      
Qualiport          0.85%     0.85%    -14.26%
FTSE 100           0.45%     0.45%      6.82%
FTSE All Share     0.43%     0.43%      9.08%