Mail & Guardian reporter
What is an Internet company worth? The spiralling values of Net stocks now make it a quasi-scientific question. And two Salomon Smith Barney analysts are just the latest to attempt an answer.
London-based Gerard van Hamel Platerink and Morten Andersen have recently completed a detailed note on the subject which provides a clear analysis of Web economics.
But for all the different methods they say could be used to value Internet stocks and the sensible comment they offer, the duo say a healthy dose of common sense should always be used when picking a web winner.
Van Hamel Platerink and Anderson say there are now more than 300 “pure-play” listed Internet stocks in the United States, with a capitalisation of more than $500-billion. Each week a further $1- billion to $2-billion is added to that figure by the average of 15 to 25 companies which join the rush to market every week.
In Europe the numbers are much less heady.
“Basic economic theory clearly illustrates the advantage that Internet companies have over their ‘old world’ counterparts,” they say. “Lower variable cost means that scale and reach are of paramount importance.”
The drive to achieve scale has seen investors cheerfully fund massive marketing expenses, but no one can guarantee profitability in the online world, they say.
Market leaders stand the best chance of becoming the first to record a profit and hence investors are happy to pay premium dollar for the likely winners.
Commonly one of two valuation approaches are used: the “discounted cash flow” technique (guessing future cash generation and then working backwards) and the “comparable company analysis” method (copying the valuations attributed to similar Internet companies).
But the Salomon two are fans of the “discounted price-earnings” approach and take the example of Yahoo!, the leading portal and online media firm, which derives most of its revenues from advertising.
Making a series of assumptions on the growth of the US advertising market and the Internet’s share of it, Yahoo!’s share of the online ad market and its income margins, and finally by comparing the valuation of similar high growth firms, Salomon says that Yahoo! should be valued at about $40-billion. In reality the market values Yahoo! at about $44-billion – not a bad match.
But then analysts everywhere might also take a look at Benjamin Graham’s seminal Security Analysis (1934). Commenting on the hot stocks of that era he wrote: “The buyer of such securities is not making an investment, but a bet on a new technology, a new market, a new service … Winning bets on such situations can produce very rich rewards, but they are in an odds-setting rather than a valuation process.”