RULE MAKER PORTFOLIO
Yahoo! versus Lycos
...is Yahoo! worth 15x more than Lycos?

By Matt Richey (TMF Verve)

ALEXANDRIA, VA (December 30, 1999) -- On an otherwise quiet day, another attention deprived analyst made a go for the limelight by lifting his target price on Yahoo! (Nasdaq: YHOO) to $550. Not surprisingly, the stock jumped on the news, running so far as $448 before turning back and settling at $416 1/16. At that price, Yahoo! is now valued (on a fully diluted basis) at an astonishing $123 billion. That makes Yahoo! the MakerPort's sixth most highly valued company, and puts it in spitting distance of Pfizer's $127 billion price tag.

A more interesting comparison, perhaps, is that Yahoo! is now valued at more than 15 times its rival Internet portal, Lycos (Nasdaq: LCOS) -- a $7.8 billion company. Yet, Yahoo! has less than three times more sales than Lycos on a run-rate basis (current quarter multiplied by 4) -- $620 million for Yahoo!, versus $224 million for Lycos. Is the market nuts?

For comparison purposes, take a quick gander -- a mere glance will do -- at the main pages of each respective company:

Hmm, mighty similar, wouldn't you say? Almost a mirror reflection of each other, in fact. What on earth could possibly account for the huge disparity in values between these companies? Has the market gone totally loony? Is it all just a speculative bubble based on greed, stock splits, and analyst euphoria?

Sure, there's some froth in this market. The market see-saw between fear and greed seems to be leaning a bit more strongly toward the latter emotion -- right now. No big deal. In time, natural market forces will correct these imbalances. But even when it does, I expect Yahoo! will still have a substantially higher market value than that of Lycos. I even think Yahoo!'s current value is justifiable based on the fundamentals. Let's take a look.

First, Yahoo! is much more of a repeat-purchase business model than Lycos. Not only does Yahoo! have more users, but also its users stick around and use Yahoo! a heckuva lot longer, almost five times more based on minutes of use per month. Check out the usage stats from November's Media Metrix survey:

Media Metrix (Home/Work Survey -- November 1999)
                   Avg. Unique Pages  Avg. Minutes
       % Reach of     Per Visitor      Spent Per
      Web Audience    in a Month      Usage Month

Yahoo!     64.7%          71.7            73.1
Lycos      45.1%          19.2            16.3
In all likelihood, these numbers don't surprise you a bit, because you are a savvy Web user. You know that Yahoo! is the innovator, and Lycos is the copycatter. You won't find services like online bill payment at Lycos. Nope, you have to go to Yahoo! Bill Pay for that. That's just one example, but the numbers bear out the fact that users prefer Yahoo!. And that, quite simply, gives Yahoo! more eyeballs, which it then sells to advertisers and merchants.

It's a virtuous cycle: Yahoo! has the most users; those eyeballs attract the most advertisers and merchants; that strong merchant presence allows for the best selection of goods and services at places like Yahoo! Shopping; the best selection and shopping experience attracts even more users; and so the cycle continues. These types of powerful network effects give Yahoo! a sustainable competitive advantage in the portal space.

This advantage shows up in Yahoo!'s financials. Here's how Yahoo! and Lycos stack up on our five core financial criteria:
                   Yahoo!     Lycos
Sales Growth       133.9%    126.1%
Gross Margins       83.1%     79.2%
Net Margins          9.6%    -49.1%
Cash-to-Debt      No Debt     55.30
Flow Ratio           0.37      1.10
As you can see, Yahoo! wins out in every single category. More sales growth (off a higher base), better profit margins, less debt and more cash, and much better working capital management, as can be seen in the flowie comparison.

Yahoo!'s superiority stands out even more vividly on the cash flow statement. Here's how the two companies compare on operating cash flow (OCF) and free cash flow (FCF) as a percentage of sales:
                    Yahoo!    Lycos
OCF Margin          43.3%      2.7%
FCF Margin          33.5%      2.1%
Stop here for a moment, especially you Yahoo! naysayers. Yahoo! is one heck of a profitable enterprise. There aren't too many companies out there that generate 33.5 cents of pure cash profit on every $1.00 of sales. Best of all, Yahoo! has the ability to substantially grow its profitability in the years ahead. Here's why: Most of Yahoo!'s expenses will grow much less quickly than sales. (It's the type of situation I described on Tuesday.) Yahoo! has already built the brand, and it already has the infrastructure in place from which to scale its e-properties. Thus, in the years ahead, Yahoo!'s revenues will outpace expenses, and profit margins will expand. I foresee free cash flow growth well ahead of revenue growth.

Consider that Forrester expects $24 billion in online advertising by 2004 -- and that's only in the U.S! The international arena offers tons of growth potential, as well. To justify its current valuation, Yahoo! will probably need $1 billion in free cash flow by 2004. Is that feasible? Out of a pool of $24 billion (or more), I most definitely think Yahoo! can reach such levels of profitability.

That said, I have no idea where the stock will go in the near-term. I never do. But Yahoo!'s prospects for the future still look tremendous to this Fool. Here's one last piece of evidence in Yahoo!'s favor: The company passes as a top tier Rule Maker based on this comparison to rivals America Online, Microsoft, and Lycos.

Last but not least, we executed our purchase of 6 additional Intel (Nasdaq:INTC) shares this morning at a price of $84.625. With no commission charge (woo hoo!), the total transaction value was $507.75.

Happy New Years, everyone. See ya in 2000.

-Matt Richey

Time is running out for Foolanthropy '99. Donate now!


 




Rule Maker Portfolio

12/30/99 Closing Numbers
Ticker Company Dly Pr Chg Price
AXPAMER EXPRESS1/4$165.75
CHVCHEVRON CORP-1/2$85.50
CSCOCISCO SYSTEMS1/16$106.19
DPHDELPHI AUTOMOTIVE SYSTEMS-3/8$15.25
EKEASTMAN KODAK-1$65.50
GMGENL MOTORS1/16$72.63
GPSGAP INC-1/16$46.25
INTCINTEL CORP-3/16$83.69
KOCOCA-COLA CO-1/2$58.44
MSFTMICROSOFT CORP-5/16$117.63
PFEPFIZER, INC-3/16$32.69
SGPSCHERING-PLOUGH-3/8$41.56
TROWT.ROWE PRICE ASSOC-1$36.00
XOMEXXON MOBIL CORP-3/4$80.44
YHOOYAHOO INC12 3/8$416.06

  Day Week Month Year
To Date
Since
2/2/98
Annualized
Rule Maker .04% .96% 15.58% 40.62% 74.45% 33.86%
S&P 500 .07% .42% 5.43% 19.14% 49.39% 23.41%
S&P 500(DA) .07% .42% 5.43% 19.72% 51.16% 24.18%
S&P 500(DCA) n/a n/a n/a n/a 33.40% 16.30%
NASDAQ -.11% 1.70% 21.00% 84.11% 149.29% 61.39%

Trade Date # Shares Ticker Cost/Share Price LT % Val Chg
2/17/9916YHOO126.309$416.06229.40%
6/23/9875CSCO32.865$106.19223.10%
2/3/9859MSFT49.352$117.63138.34%
5/1/9882GPS22.708$46.25103.67%
5/26/9818AXP104.067$165.7559.27%
2/13/9865INTC53.762$83.6955.66%
3/12/9820XOM64.335$80.4425.03%
3/12/9817GM60.399$72.6320.24%
2/3/9866PFE27.433$32.6919.15%
2/3/9856TROW33.673$36.006.91%
3/12/9820EK63.148$65.503.73%
3/12/9815CHV83.343$85.502.59%
3/12/9811DPH17.202$15.25-11.35%
8/21/9844SGP47.993$41.56-13.40%
2/27/9827KO69.107$58.44-15.44%

Trade Date # Shares Ticker Cost Value LT $ Val Ch
6/23/9875CSCO$2,464.86$7,964.06$5,499.20
2/17/9916YHOO$2,020.95$6,657.00$4,636.05
2/3/9859MSFT$2,911.79$6,939.88$4,028.09
2/13/9865INTC$3,494.54$5,439.69$1,945.15
5/1/9882GPS$1,862.06$3,792.50$1,930.44
5/26/9818AXP$1,873.20$2,983.50$1,110.30
2/3/9866PFE$1,810.58$2,157.38$346.80
3/12/9820XOM$1,286.70$1,608.75$322.05
3/12/9817GM$1,026.78$1,234.63$207.85
2/3/9856TROW$1,885.70$2,016.00$130.30
3/12/9820EK$1,262.95$1,310.00$47.05
3/12/9815CHV$1,250.14$1,282.50$32.36
3/12/9811DPH$189.22$167.75($21.47)
8/21/9844SGP$2,111.70$1,828.75($282.95)
2/27/9827KO$1,865.89$1,577.81($288.08)
  Cash: $141.95  
  Total: $47,102.14  


Notes
The Rule Maker Portfolio began with $20,000 on February 2, 1998, and it added $2,000 in August 1998 and February 1999. Beginning in July 1999, $500 in cash (which is soon invested in stocks) is added every month.