Foolish Special
[ Friday, December 17, 1999]
A Foolish Year -- The Motley Fool looks back at 1999
By Nigel Roberts (TMFNigel)
The Year on the Internet
1999 will go down as the year that UK investors realised that the Internet was something special, and even more that it was something "over here" rather than just "over there". We ended 1998 looking enviously across the Atlantic at the US stock market excitement generated by those great Internet stocks Amazon and AOL, and a host of others, but what did we have on this side of the Atlantic? Virtually nothing. Then all of a sudden Freeserve (LSE: FRE) 'happened' and everything changed.
The flotation of Freeserve in August marked the real birth of Internet fever on this side of the Atlantic, and it sparked a mad rush of companies to list on the London Stock Exchange and on AIM. Suddenly the UK has an Internet sector to be proud of. During 1999 the following Internet-related companies listed on the London market, and the average price performance has been stunning.
Company Month of Price at Price on %Change
listing listing (p) 8/12/99
Sports Internet Group Mar 25 725 2800.00%
Affinity Internet Apr 70 1815 2492.86%
Future Networks Jun 385 892.5 131.82%
Rex Online Jun 50 93.5 87.00%
Gameplay.com Aug 135 408.5 202.59%
Freeserve Aug 150 445 196.67%
Netvest.com Aug 25 145 480.00%
VoyagerIT.com Aug 5 23.5 370.00%
The eXchange Holdings Aug 200 385 92.50%
StartIT.com Aug 5 22.75 355.00%
Property Internet Sep 25 127.5 410.00%
Oneview.net Sep 86 680 690.70%
ThreeW.net Oct 25 167 568.00%
QXL.com Oct 195 885 353.85%
NewMediaSpark Oct 10 158 1480.00%
Pure Entertainment Games Oct 60 114 90.00%
Harrier Group Nov 110 407.5 270.45%
Thus Nov 260 409 57.31%
ChannelFly.com Nov 50 106.5 113.00%
Freecom.net Dec 108 311.5 188.43%
365 Corporation Dec 155 234.5 51.29%
SDL Dec 134 422.5 215.30%
Globalnet Finance.com Dec 170 237.5 39.71%
Average 510.28%
This looks like a sure-fire way of making a killing on the market, doesn't it? Invest an equal amount in every Internet-related new issue and you would have increased your money nearly 6 times -- in other words, a total investment of £10,000 would have turned into £58,782! A better strategy even than the mechanical Relative Strength strategies developed by our own TMFJonnyT on the Foolish Workshop message board. But just one small note of warning; many of these flotations were not open offers, which means most retail investors would never have been able to buy into the shares at the listing price. The other note of warning is that these are exceptional times, and a 'sure thing' does not exist!
Not only did the newly floated companies perform well; the Internet-related companies that were already listed on the market topped the list of best performers of 1999. Looking at a list of the top 15 performing shares up to the start of December 1999 reads like a list of who's who of the UK Internet scene:
Price at start Price on
of year(p) 10/12/99(p) % change
Infobank International 44 1917.5 4257.95%
Recognition Systems 11.3 370 3174.34%
On-Line 12.5 336.5 2592.00%
eVestment Corporation 2 34.75 1637.50%
E-Capital 2 25.5 1175.00%
SCi Entertainment 40 417.5 943.75%
ARM 317.5 3299.5 939.21%
Rodime 0.75 7.5 900.00%
Pacific Media 0.74 6.8 818.92%
Baltimore Technology 468 3687.5 687.93%
MultiMedia Corporation 3 17.5 483.33%
Highbury House 11.3 60 430.97%
Systems Integrated Research 7.75 35.5 358.06%
Medi@Invest 3 13.5 350.00%
Durlacher 395 1627.5 312.03%
They all have some sort of involvement in the Internet, and their share price increases have again been quite stunning, reflecting investors' seemly insatiable wish to own any dot.com (or dot.co.uk) company. The larger Internet companies are now becoming some of the biggest companies in the land by market capitalisation. Freeserve is now in the top 100 UK business by market capitalisation, and is only prevented from entering the FTSE 100 index because Dixons (LSE: DXNS) holds 80% of the shares and is also a FTSE 100 company, so including Freeserve would involve an element of 'double counting'. These rules seem set to be relaxed in the New Year, though. QXL (LSE: QXL) and Baltimore (LSE: BLM) are entering the FTSE 250 and many other companies are reaching market capitalisations that make them some of the biggest companies in the country.
One of the big features of the Internet boom is that many commentators, especially in the middle of the year, said that valuations were absurd and unjustifiable, and yet the share prices have gone on to double, treble or quadruple. Investors seem to have forgotten about fundamentals and been sold on the idea.
Of course the Internet is going to be big -- no, it is going to be huge -- no, that's still not strong enough -- the Internet is going to be gi-bloody-enormous. And it may be that the valuations of some of these companies are justifiable based on future growth potential. Bruce Jackson recently wrote an article where he concluded that the current share price of Freeserve already builds in an annualised increase in sales of 30% a year for the next 19 years! 30% a year for 19 years? Surely they must be overvalued? Well, not necessarily so; it is quite likely that for the next few years, they will grow at a massive rate, hundreds of percent per year -- they may even manage to grow at 30% a month during the increase in traffic on the Internet. If we accept that as a possibility, then maybe the current valuation is not so absurd after all.
We can look forward to many more high profile Internet flotations in 2000; the biggest is likely to be Lastminute.com, the website offering late availability deals at bargain prices. Lastminute is likely to list on both the London Stock Exchange and NASDAQ early in 2000, and is expected to be valued at more than £400 million. Interactive Investor, the financial website, and one of the first UK Internet companies involved in the online investments and personal finance information market, announced its intention to float recently, at a price tag of upwards of £200 million. Teamtalk.com will probably follow in the footsteps of 365 Corporation (LSE: TSF), when the current owners IMS (LSE: IMS) eventually bow to the pressure to realise some of its value. The biggest excitement will come if Egg, the online banking arm of Prudential (LSE: PRU) is split off from its parent. Egg is thought to be worth anything up to £4 billion, and if listed would probably be the UK's second-largest Internet company behind Freeserve. Can the Pru' resist the temptation to sell Egg? As an interesting comparison, the Prudentialhas a market capitalisation of £22 billion, so Egg may well represent almost 25% of that value now! Not bad for a company that is less than 2 years old.
So what about the future of the web? Internet penetration across Europe will almost double by 2003, according to Forrester Research. 33% of Europeans, nearly 60 million people, will have access to the Internet by then, compared with the current figure of 19%. The obsession with mobile phones will become even more intense, as almost 100 million Europeans are expected to own one by 2003. Almost a third of Internet users will use their mobile phones to access the Internet, but mobiles will be the primary means of access for only three percent.
Personal computer ownership in Europe will surge over the next four years, overtaking the US in some countries. Use of computers in the home across Europe will grow from 36% to more than 46% in 2003. The Internet is the killer application that will motivate most of these purchases. As the 20th Century ends, cheaper access to the Internet in the UK has been promised. BT plans to introduce unmetered access, allowing customers to connect for as long as they want for a fixed monthly fee. Unlimited access to the Internet for a fixed rate benefits heavy users most, but even light and off peak users should benefit from the move. These new rates will bring the cost of Internet usage in the UK down very close to the costs incurred by a US Internet user, and so the numbers using the Internet and the amount of time spent online is likely to increase significantly. In the United States, where unmetered access is the norm, people log on, on average, for three times as long as in the UK. The change to unmetered access in the UK is likely to help continue to fuel the boom in e-commerce, and is likely to have a beneficial effect on the price of Internet stocks.
This move is also likely to bring about consolidation within the Internet service provider (ISP) sector, and should help Freeserve maintain its prominent position as the UK market leader. At the moment there are more than 200 free ISPs -- this is likely to fall to only 5 or 6 main competitors by the end of 2000.
1999 was the year that online share dealing came of age. According to a report from the Association of Private Client Investment Managers and Brokers, the number of online share transactions was 155,000 in the third quarter of the year, compared with 51,000 in the previous quarter. There are now about 38,300 online share dealing accounts, each of which makes about 12 trades per year. Charles Schwab remains the biggest UK Internet broker, with about 21,000 Internet trading accounts. The rate of growth is expected to increase in 2000, as more brokers start up, and it is forecast that the number of shares traded over the net will triple by the middle of next year. Probably the most important event for online trading will happen in the first half of 2000, when Freeserve launches its online trading service in the UK. Freeserve has millions of unique visitors each month, and following its flotation earlier in 1999 has a database of many tens of thousands of potential online trading customers that will be the envy even of Charles Schwab. Its highly successful online trading simulation game has also given it another database with even more tens of thousands of names and addresses of individuals who may be persuaded to open up an online trading account. Look out for Freeserve to change the business of Internet share dealing as much as it changed the business of Internet service providers!
Freeserve will bring Internet stockbroking to the masses. Ultimately I believe that Freeserve will pose an increasingly significant competitive threat to many other traditional financial institutions. There is absolutely no reason why in a short space of time Freeserve will not be able to offer a competitive Internet banking service as well. The traditional, high-overhead "bricks and mortar" banks will be forced to transform their businesses in the new millennium in order to compete with the low-overhead Internet "clicks and no mortar" banks.
The rise of the Internet is only just starting, and the success of Internet operations like Egg shows how quickly a new entrant can build market share. In its first 18 months of operation, Egg had won 600,000 customers -- 1% of the UK market. More importantly, their customers carry, on average, savings balances that are six times those of a traditional bank!
Finally online shopping is forecast by Verdict Research to grow tenfold in the next five years. By 2004, Verdict expects consumers to be spending £7.3b on e-commerce, compared with an estimated £581m this year. This would still only be 3% of total retail spending, but the impact is likely to be felt most strongly in specific areas. For example, Verdict forecasts that 35% of all computer software is expected to be purchased online, 17% of all books, and 15% of all music and videos. Sales on the Internet are unlikely to be new sales -- they are not expanding the market, they are taking sales directly away from the bricks and mortar retailers. While only 3% of total retail spending will be online, the effect on offline retailers' profits could be dramatic, as they lose sales while still retaining the high offline overhead costs. And with retail operating margins so slim at the moment, a 3% loss of sales could tip many into losses.
Supermarket chains may be one of the big beneficiaries of online shopping. Who wants to have to go out on a cold winter's evening to buy their weekly grocery shopping? You have to hunt around a store for what you want, queue up to have it scanned and pack it yourself, possibly with two crying children in tow, when you could log on, order what you want and have it delivered directly to you. The problem for supermarkets is: what will they do with all of their massive warehouse-style retail units, which may be made redundant if this really does take off in a big way? Tesco (LSE: TSCO) is already thinking about this, and has commissioned some design students to do some "blue sky" thinking and come up with suggestions of uses that these could be put to, in a way that would reinforce the Tesco brand.
The real impetus for Internet shopping is not going to come from people accessing the Internet via a PC as most people do today. The widespread adoption of digital TV will make using the Internet seem as natural as watching your favourite soap. People are more comfortable using their TV than they are using a personal computer, and will have more confidence in ordering via the TV than they currently do ordering via a PC. In the next three years there will probably be more digital television sets in the country capable of accessing the Internet than there will be home-based personal computers linked to the Internet. Most people have lived with the 'box' in the corner of their living rooms all of their lives (and also probably one in the kitchen and another one in the bedroom) -- we all trust TVs in a way we don't trust a PC.
Internet shopping will never replace shopping in the real world. Shopping is a leisure pursuit for many people, and shopping on the Internet or via the TV will never be able to replace the ability to pick the goods up, touch them and inspect them. The problem will be for the offline retailers to prevent people from searching for goods on the high street, then buying them more cheaply online.
The Year In Review
Introduction
1. TMFEagle looks at the gold medallists of 1999.
2. TMFMayn visits the kennel: who were the dogs of the past year?
3. TMFEssex ruminates on a sector by sector basis.
4. TMFNigel thumbs through the year on the World Wide Web.
5. TMFTiger reviews the rise of intellectual property companies.
