[Mb-civic] Buttonwood Searching for an explanation Economist

Wed Nov 17 16:08:42 PST 2004

Buttonwood 

Searching for an explanation

Nov 16th 2004 
>From The Economist Global Agenda

Once again, investors are rushing to buy internet stocks. Will they never
learn?

FIRST, an apology. Last week, in a search for the world¹s most expensive
security, Buttonwood suggested that technology stocks, though decidedly
pricey, were not quite worthy of the title. But he was forgetting about a
particular segment of that market which defies any investment logic:
internet stocks. Since its flotation in August, Google¹s shares, which were
already ridiculously expensive, have doubled in price, and the company now
has a market capitalisation of $50 billion. There has also been something of
a Google effect: the excitement about the company¹s shares since its listing
has dragged up the internet sector as a whole. Four of the biggest internet
stocks‹Google, eBay, Yahoo! and Amazon‹now have a combined market
capitalisation of $190 billion.

This columnist bows to no one in his admiration for Google, the search
engine of choice for journalists (and almost everyone else) the world over.
Only this weekend, thanks to the wonder of Google, he was able to look up
lots of interesting stuff about the Trans-Alaska Oil Pipeline (don¹t ask).
Nor does he have anything but respect for the likes of eBay: indeed, his
oldest friend spends many a pleasant hour on the online auction site, buying
and selling second-hand books. But by what possible epistemology, what
reasoning, what logic, could anyone believe that these companies are worth
anything like the ludicrous sums the market now attaches to them? You could
almost be forgiven for thinking that there had not been an almighty bubble
in technology stocks, after all, and that the market had merely got a little
ahead of itself.

 As it happens, that is indeed what many hardened technology aficionados do,
in fact, believe. ³The enthusiasm was well placed, it just got ahead of
itself in many respects,² said Mary Meeker, Morgan Stanley¹s cheerleader for
all things internet in the go-go years, at a recent conference. ³As we have
said for a long time, from a wealth-creation standpoint, we believe we lived
through a boomlet, followed by a bust, followed by a boom.² She cited as
evidence the rapidly growing market capitalisations of the big internet
companies and claimed that this time round the market was better supported
by revenues and profits.

 That is the more (-or-less) rational face of internet boosterism. But for a
feeling for the new zeitgeist, Jim Cramer, television pundit and sometime
hedge-fund manager, is hard to beat. Mr Cramer is quoted by Fred Hickey,
editor of the High-Tech Strategist newsletter, as saying: ³The only way to
catch up is to join the crowdŠThey are buying Google because, what the heck,
when the market¹s up buy GoogleŠThere simply aren¹t enough trading days left
to make a lot of moneyŠThe clock is tickingŠThe downside will be very
limited here because the feeling you felt in your stomach when the market
opened up huge is the feeling that comes from recognising ŒDarn it all, I
gotta get in¹. Because you do.² It is fair to say that cool rationality is
not Mr Cramer¹s thing.

Not that even Ms Meeker¹s views would stand up to much scrutiny by anyone
interested in such antediluvian concepts as value. As James Montier, a
splendidly acerbic strategist at Dresdner Kleinwort Wasserstein, points out,
the four top internet stocks have a price-to-earnings (p/e) ratio of 121.
That means that, at current prices and current profits, it would take 121
years for investors to recoup their money. Google¹s p/e ratio, you might be
interested to know, is now 222.

Ah, cry the techies, but fast-growing profits are fast eating into those
heady ratios. Well, up to a point. The combined profits of eBay, Google,
Yahoo! and Amazon last year were only $873m (eBay accounted for about half
of this). And these are the companies left standing; many others have gone
bust. In such circumstances, you might have thought, investors should demand
something of a discount for buying shares of such stomach-churning
riskiness. Au contraire: for fans of the internet survivors, this simply
means that, with many of their competitors having fallen by the wayside, and
their business models tested almost to destruction, those left standing will
generate huge mountains of cash as the world is gripped anew by the ongoing
information revolution.

Tosh. Barriers to entry for any business on the internet are hardly high.
Take Google. The fad of the moment it may be, and it has certainly developed
a nice way of generating advertising revenues. But that does not mean that
no one else will ever get a look-in. A company called Microsoft is trying to
do just that. On November 11th, the software giant launched a new search
engine (it had previously used Yahoo!¹s), with lots more pages available
than it used to have, and a few other new whizzy features, such as the
ability to ask a straightforward question.

 Microsoft, you may recall, has had some success when it comes to stomping
on the opposition. It was Bill Gates and his band of merry men who almost
destroyed Netscape, the company that produced the first commercially
available web browser and kicked off the original bubble when it was floated
in 1995. Though there were a few gripes about Microsoft¹s new search engine,
the whole point about its release was to allow the company to tweak it. And
the costs of doing so, you can be sure, will not be a problem. The market¹s
reaction to this ³disappointing² launch was to send Google¹s shares up
another 9% on the day.

Buttonwood guesses that foolhardy investors will regret their enthusiasm
rather quickly. The lock-up period for sales of shares by Google insiders is
much shorter than the usual 180 days after an initial public offering. They
will be able to sell another 39m of them this week. Since so few shares were
sold when the company floated‹22.6m, with another 4.7m made available in
September‹the number of shares on the market will more than double, and will
increase tenfold by mid-February. Given the vast sums of money that insiders
will have made, and the extraordinary value placed on the company by the
stockmarket, it would be surprising were those insiders to do anything other
than head for the exit.

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