Follow the Money
Cooling the Net Hype II
In Wired 4.09, I decried investing in Internet infrastructure – either hardware or software – concluding that the hardware folks are earning money but selling at unattractively high valuations, and that most of the software guys are just never going to earn a dime. Now I'll take on the content providers, end-user software producers, and access providers. Although I see long-term possibilities in some Net-related markets – especially in the content area – my short-term advice is don't buy, just watch and wait.
Content with content
Here is where the big money will be made – eventually. Not by today's movie studios (although they will benefit from the Net), and not by the broadcasters (unless they can come up with entirely new services). There are only a handful of content producers I'd want a piece of in the private sector, and the public offerings are slim. San Francisco-based CNET, of television and Web fame, marked the first content IPO, going public in a moderately hot deal in July. But I suspect even the C-execs would admit they haven't a clue what the company will look like in five years. It makes no sense to invest in a company whose business model is so unclear.
The first profitable content IPO should be E*Trade, the online brokerage system – its business model is sound, it earns money, and it's large enough to sustain a public offering. The similar e.Schwab is too new and too small to affect the overall valuation of Charles Schwab & Company's stock. For the same reason, I wouldn't buy into McGraw Hill, Dow Jones, Time Warner, or Tele-Communications Inc. as Internet plays – the tails are too small to wag the dogs. If Internet gaming catches on, Br�derbund and Electronic Arts will be well positioned, but I expect a slow Christmas season for videogame sales and wouldn't recommend either stock until 1997.
I'm hopeful for this sector, though, and when attractive content companies do enter the public market, I'll be an opportunistic investor. In evaluating companies, I look for five key factors: fast revenue growth over 50 percent a year, strong profitability above 15 percent pretax, at least 10 percent of sales spent on research and development each quarter, a management team with prior experience at a successful high-growth firm, and a total company valuation of no more than 15 times growth flow (after-tax earnings plus R&D spending).
Call me a short-term pessimist but a long-term optimist. Wall Street sees content growing from less than US$100 million this year to $1.5 billion in 1998 and $10 billion in 2000. I think the market will be three times as big, reaching $35 billion in 2000 as businesses rush to market over the Net.
End-user friendly
There are no public companies in the end-user category and no private ones anywhere near an IPO. In fact, this area is so nebulous that Wall Street doesn't even track it yet. But in the long term, opportunities abound. Shrink-wrapped software will be replaced by problem-specific applets delivered over the Net for a small fee or packaged with data and services. Shopping for a car online, for example, you'll enter your requirements, get a computer match of half a dozen likely models, check those Web sites for data, reviews, pictures, et cetera. Then you'll review the lease-versus-buy decision and various financing terms using an imbedded applet that takes your information (entered by you or read straight from your Quicken file) and calculates the best option. You may pay 25 cents to use the applet online; your Internet service provider will itemize those quarters in a monthly bill. (AT&T is pretty good at this.) For the moment it would be too speculative to even estimate the size of this market, but I think it will provide numerous opportunities as we approach the millennium.
Access denied
Pure Internet access is a commodity, and the luxury prices that ISPs are charging will fall to $3 to $5 a month for unlimited access. Still, the local and long distance telephone companies need to "own" this market at any cost, which explains the bizarre valuation MFS Communications paid for UUNet,a plain vanilla ISP.
The proprietary Internet-access model is even worse. The Microsoft Network abandoned its proprietary software soon after the network launched, Prodigy followed, then CompuServe threw in the towel. America Online has to be next.
Wall Street pegs the Internet-access market at $250 million in 1996, $1.5 billion in 1998, and growing. That's about right – 75 million users in 1998 at $50 per user per year. Trouble is, no one makes any substantial money at $4 a month. Stay away from this sector, and sell all ISP stocks in your portfolio until the price-cutting ends and investors can identify the survivors.
Taking all five Internet segments into consideration, the market now totals $1.5 billion, mostly in hardware. By 1998, the total market will be $8.8 billion – a 230 percent growth rate – well balanced with content. By 2000, I expect a $43.4 billion market – representing a 225 percent growth rate from 1998 to 2000 – and content will be king.
TWIT$
Last summer, technology stocks plunged deeper than usual. The key driver for a great December quarter will be the rate of adoption of Windows NT by US corporations. I'm gearing up for the year-end rally – and putting the rest of the TWIT$ cash to work – by purchasing shares of Seagate, the dominant disk-drive supplier.
The Wired Interactive Technology Fund
|
Company | Primary | Symbol | Shares | Price Aug 1 | Since July 15 | Action
LSI Logic Corporation | Semiconductors | LSI | 7,800 | 19 1/8 | 3/4 | hold
Applied Materials Inc. | Semiconductor equip. | AMAT | 4,000 | 23 7/8 | 1 1/2 | hold
The Walt Disney Company | Entertainment | DIS | <1,500 | 57 3/8
Apple Computer Company | Hw/sw | AAPL | 4,800 | 21 1/4 | + 4 1/16 | hold
Tele-Communications Inc. | Cable television | TCOMA | 4,800 | 14 7/8 | + 1/16 | hold
Intel Corporation | Microchips | TCOMA | 3,000 | 77 | + 7 7/8 | hold
Adobe Systems Inc. | Software | ADBE | 5,000 | 30 7/8 | + 13/16 | hold
| Mattson Technology | Semiconductor equip. | MTSN | 30,000 | 8 3/4 | 1 | hold
| Euphonix | Audio sw | EUPH | 17,000 | 7 3/4 | + 3/8 | hold
| Diamond Multimedia | Multimedia hw | DIMD | 7,000 | 7 3/4 | + 3/4 | hold
Seagate Technology Drives | Disk Drives | SEG | 300 | 48 7/8 | buy
Portfolio Value | $1,354,131.25 | (+ 35.41% overall) | +1.58%
The TWIT$ fund is a model established by Wired, not an official traded portfolio. Wired readers who use this information for investment decisions do so at their own risk.
Michael Murphy is a money magager who publishes the California Technology Stock Letter in Half Moon Bay, California.
