Qualiport

[ November 29, 1999 ]

Sure-fire Internet Losers

By Bruce Jackson (TMF Googly)

Kilburn, London -- Like many investors who are not participating in the 'tech stock boom', I'm feeling a little envious. Share price rises of hundreds of percentage points in just a few weeks are almost commonplace in this market. For example, our own Christopher Spink (TMF Eagle) wrote about a small AIM-listed company called Affinity Internet (LSE: AIH) in a Breakfast Fool dated November 3rd. In a matter of just over 4 weeks, the shares have flown from 472p to 1795p, or 280%. These sorts of gains in this space of time are positively super-normal. To put that into some sort of perspective, it's the equivalent of a company's market value increasing by 15% per annum for nearly ten years.

The Qualiport's long-term growth target is 15% per annum. In this market, some may be tempted into:

1. Thinking 25% per annum, or even higher, returns are achievable and sustainable, in the long-term. Only the very very best investors get anything close to that return. I'd guess that only about 100 investors have achieved returns of over 25% per annum over a minimum of 10 years. That's 100 people out of the millions and millions of stock market investors.
   
   The vast majority of people will therefore not emulate the returns of those super-investors. However, that's not to say you can't learn from their investment styles and philosophies. But, the chances are that you won't average returns of 25% and above over the long term.
   
   
2. Playing the momentum game. If you jump aboard now, buying any one of these tech/concept/whatever you want to call them stocks, how do you know you're not buying at the absolute top? Because most of these companies won't ever have the earnings to back up their lofty (to say the least) current valuations, there's no fallback safety zone. Ever heard of pyramid selling scams?
   
   
3. Thinking this tech stock frenzy has never happened before. Reading back through some of the investment classics, you realise we have been here before. Sure, the Internet is a totally new phenomenon, opening up all sorts of growth prospects for many different and new companies, and some companies will be long-term beneficiaries of this new way of doing business.
   
   
4. Thinking all Internet shares are sure-fire winners.
   

This is the commonest of all the Internet fallacies. Allow me to elaborate.

Above, I place Internet in italics because there's really no such thing as an Internet share. All companies do, or will do, business over the Internet. Pubs and restaurants take bookings over the Internet. Does that make them Internet shares? I don't think so. Amazon (Nasdaq: AMZN) is a retailer which just happens to use the Internet exclusively to sell its merchandise. Yahoo! (Nasdaq: YHOO) is a broad-based media company. The Motley Fool is a media company, with book, newspaper and radio interests, all complementing our web-based content.

Not until five years down the track will we find out who are going to be the real winners of the Internet world. There will be some big surprises. There's no prizes for guessing that already dominant companies like Amazon, AOL (Nasdaq: AOL), eBay (Nasdaq: EBAY) and Yahoo! will still be around. Their brand names will be recognised the world over, if they are not already. The pure amount of money these and many publicly quoted 'Internet' companies are spending on marketing will see to that. A household name like Coca-Cola (NYSE: KO) has spent billions of dollars on building its brand name, having done so over many many decades. Amazon and the like are on track to spend that sort of money in a mere fraction of the time. The aim is to build a global brand name, and quickly. Do you think they've done so already? I think they're not too far away, certainly as far as most of the developed world is concerned.

Some of the bigger Internet winners don't even exist today. I know speed is important in today's Internet world, and that's why many 'Internet' companies are spending big on marketing. (Note: All the marketing spend in the world doesn't build you a sustainable business model.) But, the annals of time show that new companies can and will prosper, and this will happen in the Internet world.

A company like Tesco (LSE: TSCO) could be an Internet winner. With a huge off-line customer database, courtesy of their hugely successful loyalty card, they will be able to leverage that information in the on-line world. The Tesco.net ISP and portal is already quite successful, albeit in a crowded marketplace. The Tesco.co.uk shopping site is one of the better and more popular e-retailing sites out there. In fact, as measured by sales, Tesco is already the biggest 'Internet' company in the UK.

So, what's the advantage to Tesco in having an Internet shop and a bricks and mortar shop? Surely Tesco doesn't gain too much if existing customers are simply shopping from home or the office instead of on the High Street. Well, actually they do. The beauty of the Internet medium is all in the business model.

If Tesco could keep all their existing customers, but encourage them all to switch to Internet shopping, the company would be infinitely more profitable. They could close all those expensive stores, with their expensive shop assistants. Stock wastage would be virtually zero -- no longer will last week's sandwiches be discarded as they pass their use-by date. Tesco could also move to a just-in-time ordering system, whereby they buy their cans of baked beans from Heinz only after the customer has placed their order. Suddenly, all that cash Tesco has tied up in inventory (or stocks) is free to grow the business and enhance shareholder value.

As per the recently released Motley Fool UK Investment Workbook, one of the 5 things to look for in an ideal balance sheet is low stock levels. The Internet business model clearly is a big advantage to companies who can successfully trade through this medium. One of the other ideal balance sheet items is low debtors, or accounts receivable. With Tesco receiving payment from its Internet customers before they actually receive the goods, debtor levels should be very low.

The days sales outstanding ratio (DSO) gives you a good measure of a company's efficiency in this respect. It is calculated as

Debtors
----------------
(Turnover / 365)

The denominator is effectively average sales per day. Most companies give and accept 30 day credit terms from their suppliers and customers. For a supermarket, you would expect the days sales outstanding ratio to be less than 30 days, because most customers pay for their goods when they purchase them.

For the year ended February 1999, Tesco's DSO was;

£151m
---------------     = 2.97
(£18,546m / 365)

That is outstanding, but could get even lower in a pure Internet business model.

Of course, Tesco will always have its bricks and mortar shops. A totally Internet scenario won't ever happen. It couldn't! There's not enough space on the country's already over-crowded roads for all those Tesco home-delivery vans. But, there could conceivably come a time where Tesco converts its stores to warehouse-type outlets. The customer places and pays for his order on-line, then simply pops into his nearest Tesco warehouse to collect his pre-packed goods. No-more queuing, no-more trolley rage, and no more getting stuck behind the person who wants pay by cheque (don't you hate that?).

So, will Tesco be an Internet winner? I think so. Does that mean they should be suddenly valued at a huge multiple of sales, instead of just 0.70? Clearly not. Tesco for the Qualiport? Not yet, although I'm impressed by the company's management and vision.

This article has sort of turned into a Tesco affair. It wasn't planned that way, but heck, this is the Internet, the medium where rules are made to be broken. The main thrust however is:

If as investors you are benefiting financially from some of the more speculative returns being made in this stock market climate, good luck to you. Know also that it won't last, at least for the vast majority of companies.

For more on Tesco, later this week we'll be having our first ever Duelling Fools feature on that very company. Stuart Watson (TMF Tiger) is in the Bull's pen, whilst Rob Davies (TMF Essex) is in the Bear's Corner. Be sure to tune in for this no-holds-barred heavyweight contest.

See you on the Qualiport message board, where all feedback, thoughts and comments are encouraged.

Qualiport Numbers
29/11/1999 Close

Company  Change    Bid
DELL(US)-0.40    42.80
EMA     -0.11    11.14
IIG     +0.08     2.78
MSY     -0.08     6.91
PIZ     -0.05     7.65
RTO     +0.01     2.42
ULVR    -0.05     4.70
LLOY    -0.12     8.30


Qualiport Stocks

Last Rec'd  Total # Company    Buy  Current Change

 22/04/99   542     Misys      5.57  6.91    24.0%
 29/09/99   356     Lloyds TSB 7.56  8.30     9.9%
 17/04/98   301     Emap      10.20 11.14     9.2%
 27/10/98  1133     Indep Ins  2.60  2.78     6.9%
 04/11/98   245     Pizza Exp  7.93  7.65    (3.5%)
 27/01/99    74     Dell (US) 44.63 42.80    (4.1%)
 19/12/97   783     Rentokil   2.55  2.42    (5.1%)
 17/07/98   266     Unilever   7.53  4.70   (37.6%)

Last Rec'd  Total # Company     In At  Value   Change

 22/04/99   542     Misys      3065.85 3745.22  679.38
 29/09/99   356     Lloyds TSB 2723.20 2954.80  231.60
 17/04/98   301     Emap       3139.85 3353.14  213.30
 27/10/98  1133     Indep Ins  2990.63 3149.74  159.19
 27/01/99    74     Dell (US)  2007.42 1919.52  (87.90)
 04/11/98   245     Pizza Exp  1966.34 1874.25  (92.09)
 19/12/97   783     Rentokil   2046.53 1894.86 (151.67)
 17/07/98   266     Unilever   2052.00 1250.20 (801.80)

Cash:                                          £ 28.46
Current Total :                             £20,170.19

Total Invested:                             £20,184.62
Profit/(Loss) :                               (£ 14.43) 

Value Per Share

                    Day      Month      Year      
Qualiport         -0.32%    12.34%     -4.50%
FTSE 100           0.11%     6.98%     13.76%
FTSE All Share     0.16%     7.58%     16.85%