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Rule Breaker Portfolio

<THE RULE BREAKER PORTFOLIO>

Creating Value
Plus, eBay's strong second quarter

by Jeff Fischer (TMFJeff)

ALEXANDRIA, VA (July 26, 1999) -- Value is not easy for a company to create. All companies begin in a difficult position. An organization typically starts with high expenses and low income. It must then build by spending aggressively, and it strives to achieve eventual income that tops piling expenses. The creation of value in a business is not easy. The rash of Internet-related companies coming public to instant windfalls has made it seem easy to create value. However, there are three kinds of value:

Shareholder Value
Business Value
and Market Value

Most Internet-related companies coming public are not yet creating ongoing business value, and therefore they are not able to insure any kind of future shareholder value. They are -- so far -- only creating market value, and they are not even creating that. They are granted market value by the public. Market value can be a very tentative kind of value.

Companies are counting on money from new shareholders (and a healthy market value supported by interested investors) to help put them in a position to create business value -- or value via operations. Company executives become wealthy on the IPO day, true, but business value for new shareholders is not inherent in the IPO transaction. Shareholders, now more than ever like venture capitalists, risk their money with these new companies to eventually see a reward. Many new online companies won't offer much reward.

Consolidation of online businesses will continue, but not always at today's prices. Prices granted to all online companies -- though still rising now, generally -- will eventually contract as the best real estate is taken. Many companies will eventually be acquired at prices well below the valuations granted to them on the first day they traded. And why will they be acquired at all?

Because value is not easy to create. Most companies fail. Getting bought out, even at relatively low prices, often becomes the best success possible.

I respect America Online, eBay, and Amazon because I continue to believe that they will create real value for long-term shareholders. I'm not talking about market value the likes of which can be created by bombinating investors who are tripping over each other to buy the latest IPO. Market value of this kind can simply be created by enthusiastic investors, and it often proves deceptive. Business value is created by a business and it leads to lasting shareholder value. Market value is tentative when not backed by business value. We see the business value behind our three main Rule Breakers: AOL, eBay and Amazon -- and we take a lot of flack for seeing business value in Amazon.com (Nasdaq: AMZN).

Given the sure-footed enthusiasm of Amazon bears (although they often lack strong analytical arguments), perhaps we'll be wrong on Amazon. Perhaps we're missing something. We'll probably know within five years who was right: bulls or bears. I believe that Amazon is on track to build one of the greatest franchises. I have not seen stronger customer service from any company. I have never seen any company add so many business lines so quickly and expertly. I have not seen elsewhere such excellent use of shopping habits to offer customers advice (that I often thankfully utilize), nor have I seen such adept use of data and customer feedback. Amazon's customer reviews typically lead me to buy or avoid certain products -- and I've never been disappointed.

I believe in the business value that AOL, eBay, and Amazon all stand to offer. AOL has already begun to create it. It has the management to continue. AOL knows what it is to its customers, and it knows what it wants to be to them in the future. Meanwhile, eBay is starting to create value. It is profitable and it has a business model that will scale like dandelions on untended grass. Amazon knows what it wants to be, too. It has a long-term plan that we're seeing in action -- impressively.

In fact, everything that Amazon has accomplished regarding online retailing has been wonderful -- that's largely agreed. The only complaint most people have is that it isn't profitable. But profits are not usually in the cards when companies like this are young. Value is not created easily. The reason that Amazon has already created shareholder value for early investors (unlike most Internet companies) is because the possibility for true business value is present.

As wonderful as the Internet is and will be, I believe that history is going to show these days as creating more unmerited (and therefore temporary) value than almost any other. Incredible market value is being created and insiders are made wealthy, but much of this market value will be lost because business value will never rise up to support it. Perhaps years from now the rash of IPOs that rose three- and four-fold this year -- from trade one -- will come to serve as a reminder of what a highly speculative, excited market of irrational investors involves. It involves investors who are ignoring or forgetting the fact that lasting value is very hard to create.

I don't believe that AOL, eBay, and Amazon are ignoring this fact in running their businesses.

eBay (Nasdaq: EBAY) announced second quarter earnings at 5 p.m. ET tonight. The shares were up $6 to $110 in after-market trading, although that's not a guarantee for tomorrow -- it just indicates that some of Wall Street liked the results.

The results were solid. Registered users climbed a record 1.7 million to 5.6 million, well above many estimates. eBay hosted 29.4 million auctions in Q2, up 28%. Pro forma revenue topped estimates at $38.1 million. Total revenue (including Butterfield & Butterfield) was $49.4 million, up from $19 million last year. Pro forma earnings per share totaled four cents, topping the estimate by a penny.

We'll have more on eBay in the days ahead, of course. Right now, the conference call replay can be heard at eBay's Investor Relation page. Grab a cool drink, sit back, and give your company a listen.

To close, this weekend Fools posted their vision for the future on the Rule Breaker message board -- interesting thoughts from all! For example, click here for Fool frhs00's visions (sounds like a futuristic name alone), here for Fool beg's thoughts, and finally see CECMOON's very Foolish post for insight of a certain kind.

Fool on!
- Jeff Fischer

07/26/99 Close
Stock  Change    Bid 
------------------ 
AMGN  -2 3/8     73.00
AMZN  -8 5/8    105.94
AOL   -7 5/8     99.88
ATHM  +  1/8     46.19
CAT   -1         60.00
CHV   -1 7/16    92.38
DD    -1 1/4     69.75
DJT   +  1/16     4.88
EBAY  -3 7/16   104.38
GT    -  3/16    55.00
IOM   -  1/16     4.13
SBUX  -1 1/16    24.81
TDFX  -  3/8     13.50


                  Day     Month  Year   History   Annualized 
      R-BREAKER  -5.33% -11.22%  14.22% 1046.40%   63.33%
        S&P:     -0.68%  -1.83%  10.22%  208.27%   25.41%
        NASDAQ:  -2.72%  -2.49%  19.45%  263.69%   29.65%


    Rec'd    #  Security     In At       Now      Change
   8/5/94  2200 AmOnline       0.91     99.88   10889.16%
   9/9/97  1320 Amazon.com     6.58    105.94    1510.18%
  5/17/95  1960 Iomega Cor     1.28      4.13     222.16%
 12/16/98   580 Amgen         42.88     73.00      70.26%
  12/4/98   900 Excite@Hom    28.04     46.19      64.72%
  4/30/97 -1170*Trump*         8.47      4.88      42.44%
  2/23/99   300 Caterpilla    46.96     60.00      27.76%
  2/20/98   260 DuPont        58.84     69.75      18.53%
  2/23/99   180 Chevron       79.17     92.38      16.68%
  2/23/99   290 Goodyear T    48.72     55.00      12.90%
  2/26/99   300 eBay         100.53    104.38       3.83%
   7/2/98   470 Starbucks     27.95     24.81     -11.24%
   1/8/98   425 3Dfx          25.67     13.50     -47.40%

    Rec'd    #  Security     In At     Value      Change
   8/5/94  2200 AmOnline    1999.47 219725.00  $217725.53
   9/9/97  1320 Amazon.com  8684.60 139837.50  $131152.90
 12/16/98   580 Amgen      24867.50  42340.00   $17472.50
  12/4/98   900 Excite@Hom 25236.13  41568.75   $16332.62
  5/17/95  1960 Iomega Cor  2509.60   8085.00    $5575.40
  4/30/97 -1170*Trump*     -9908.50  -5703.75    $4204.75
  2/23/99   300 Caterpilla 14089.25  18000.00    $3910.75
  2/20/98   260 DuPont     15299.43  18135.00    $2835.57
  2/23/99   180 Chevron    14250.50  16627.50    $2377.00
  2/23/99   290 Goodyear T 14127.38  15950.00    $1822.63
  2/26/99   300 eBay       30158.00  31312.50    $1154.50
   7/2/98   470 Starbucks  13138.63  11661.88   -$1476.75
   1/8/98   425 3Dfx       10908.63   5737.50   -$5171.13

                              CASH   $9924.87
                             TOTAL $573201.75
 
Note: The Rule Breaker Portfolio was launched on August 5, 1994, with $50,000. Additional cash is never added, all transactions are shared and explained publicly before being made, and returns are compared daily to the S&P 500 (including dividends in the yearly, historic and annualized returns). For a history of all transactions, please click here.

</THE RULE BREAKER PORTFOLIO>

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