Rule Breaker To Buy @Home Corporation
December 3, 1998
**This trade is being made under the regular portfolio policy, namely, once The Fool announces an intention to trade, that trade will be made within the next WEEK, as opposed to the next day. For more detail, please read the "New Trades" section of the Fool Portfolio.**
Rule Breaker Portfolio Buy Report
At some point in the next five market days, The Rule Breaker portfolio is BUYING $25,000 of:
@Home Corporation (Nasdaq: ATHM)
425 Broadway Street
Redwood City, CA 94063
Price (12/3/98): $52 7/8
Average daily volume: 1.8 million shares
Daily dollar volume: $94 million
Market Cap: $6.5 billion
Sales: $132 million
Price-to-Sales ratio: 149
@Home Quote | @Home Snapshot | @Home Chart | @Home Financials | @Home Estimates
>$89,000 WON'T GATHER DUST
We didn't put in five sell orders earlier this week for nothing. No, no. The Rule Breaker portfolio sells in order to buy, and this new buy announcement will be the first of several over the next few weeks as we identify and purchase Rule Breakers. And maybe a short or two.
With this report, we will be soon welcoming the @Home Corp. (Nasdaq: ATHM, closing price Thursday $52 7/8) to our Rule Breaker portfolio. (Otherwise known as "At Home" -- and its home page is http://www.home.net.) Frankly, we were feeling bereft with such traditional Internet company names like "America Online." Online used to be cool, but no more. We had then thought we were stylin' again last year when we bought a stock with ".com" in the name when we bought Amazon.com. But then came all the EXCLAMATION POINT! companies, and the eThis and eThat, making ".com" clearly passe. Once again behind the times, we are obviously now elated to welcome into the fold a company whose name employs the "@" symbol, its own version of iChic (that's Internet chic, of course).
But before we begin, let us mention our new format for the portfolio's buy announcements. Namely, we lay you out all our information according to the six Rule Breaker attributes we use to guide our decisions. (These attributes are fully laid out, explored, and illustrated in our upcoming January book, The Motley Fool's Rule Breakers, Rule Makers.) If you're not familiar with theseattributes, you will at least learn them in our report below. But you can explore them further by clicking directly into our Portfolios section at fool.com. From there, select the Fool Portfolio (a.k.a. the Rule Breaker Portfolio -- official name change coming soon). Then just view the listbox, where you'll locate all five of our portfolio principles, a still incomplete list, a work in progress. The attributes of the Rule Breaker are covered in principle #4.
Now, to this new Rule Breaker...
#1: TOP DOG AND FIRST MOVER
IN AN IMPORTANT, EMERGING INDUSTRY
Created in 1995 by a consortium of leading cable companies, @Home is the premiere provider of high-speed broadband Internet service, coming to you through the nation's cable TV infrastructure. Broadband? Internet service? "Cable infrastructure?" Wha-?! Heck, all we mean is just that you're accessing the Internet via cable modem -- connected to a cable TV jack in the wall. Cable modems provide you Internet access at speeds literally 100 times faster than what AOL dial-up provides. Yet, @Home doesn't cost 100 times more than AOL. Subscribers pay $75 to $175 in startup costs (which are in some cases waived) and then, on average, $40 per month compared to America Online's regular monthly fee of $24. (Some of the cable companies offer the service for just $30 a month if you're already a cable TV subscriber.)
What's $6 or $16 more a month if you're moving at 100 times the comparative speed (especially for people who can cancel that second phone line they'd been using)? Isn't your time worth the extra cost? Plus, @Home can be infinitely cheaper (almost, anyway) than AOL because you don't need a computer. You can plug this high-speed hot rod directly into your television and watch it go like Speed Racer. Set-top boxes, my friends.
You see, they say that once you go cable, there ain't NO goin' back. (And whoever "they" is, is usually right, by my reckoning.)
As a cable modem user myself (kudos to me for buying what I like and use), I have to tell you that downloading a 30 meg file in a matter of minutes is so much preferable to doing so in a matter of hours. So is actually WATCHING video footage, as opposed to sitting there and squinting at tiny little grainy sequences of interspersed still images. It's called "Fat Pipe."
Here are some typical download times, as printed by Time magazine in November. These are the times that it took to download the text of the entire Encyclopedia Britannica by the listed methods:
56K modem: 27 hours 50 min.
Satellite: 3 hours 40 min.
DSL: 1 hour
Cable: 30 min.
(More about "DSL" below.) Anyway, as you can see, accessing the Internet via high-speed cable will revolutionize the World Wide Web.
Which speaks directly to Rule-Breaking attribute number one. The risk-taking Foolish investor looks for important, emerging industries, and this one fits the bill nicely for both.
Broadband Internet access is indeed extremely significant, advancing the speed of the greatest medium ever created by a factor of several times, within just a few years' passage. Our At Home message board has many a posting traded on the one hand between snide and self-satisfied people like me who have cable access, and on the other hand, between those wounded-sounding, embittered people who don't. (Yet.) What is clear is that this is a product that people really want, one that they'll willingly pay for, and on a regular, recurring basis -- another fine definition of "significant industry."
This industry is only just emerging, as well. Internet cable access will ultimately be possible in all 106 million North American homes that are wired for cable, but for the vast majority of those households today, there's no service. Why? Because in most areas cable companies first have to upgrade their lines to coaxial cable, the stuff that makes possible the necessary two-way transmission. (That's due to the Web's interactivity. Unlike TV, with the Web you are not merely being broadcast at, but you are responding to. It's key for stuff like, oh, I dunno -- E-MAIL.) At last count, @Home had over 210,000 subscribers in 27 states paying $39.95 a month to use the service. Kinetic Strategies, an Internet cable research firm, estimates that the company will increase subscribership to just over 300,000 by the end of this year. Sound small, at less than one-fiftieth (that's 1/50th) of AOL's subscriber base? We said it was "emerging," didn't we?
Rounding out this attribute, @Home has positioned itself as the top dog and first mover at the forefront of this exciting industry by partnering with existing cable companies. Nationwide, ATHM has struck 18 separate partnerships with companies like TCI (which owns 42% of @Home), Comcast, Jones (our own provider here in Northern Virginia), and other big names. While those partnerships represent coverage of 60 million homes -- more than half of all households in North America -- only just over 10 million (17%) are currently built out to run the service. Nevertheless, @Home with its heavyweight partner and part-owner TCI -- whose own acquisition by AT&T remains unresolved -- moved first to address this market and are clearly the top dogs.
They are top dogs that are going to be difficult to outbark.
#2: SUSTAINABLE ADVANTAGE
GAINED THROUGH BUSINESS MOMENTUM,
PATENTS, VISIONARY LEADERSHIP,
OR INEPT COMPETITORS
The sheer momentum of @Home's growth represents a strong indication of sustainable advantage. Not only is ATHM the largest company in its market, but if you click here to see the company's earnings estimates, you'll find an expected long-term annualized growth rate of (get this) 138%. Any company even estimated to do something like that, recurring consecutively for five years, is one worth looking at. Considering it comes from the industry leader, @Home and its business momentum appear to be substantial and sustainable.
Trailing twelve-month sales at present are just over $32 million, with the company's operations losing about a dime every three months. That's a "burn rate" that equates to $10-$12 million per quarter. But the company has over $200 million sitting in the bank, and CEO Tom Jermoluk stated in a recent interview that he expects At Home to reach profitability in late 1999. So while his company has already done one secondary offering of new shares, it may not need another before then.
A second form of sustainable advantage involves the partnerships covering a majority of cable homes across the map. This protects At Home's business almost in the same way that a patent protects a pharmaceutical company's business. Locking up 60% of the market through partnerships is one of the better sustainable advantages we've come across in our years of investing in dynamic and risky Rule Breakers.
We do not, however, consider the competition inept. Let's look at the competition, now. It comes in three forms.
First and most obvious is the #2 player in the industry (the only other significant "competitor," in this context), which is called Road Runner Road Runner is also the fruits of a partnership, here between Time Warner, MediaOne Group, Microsoft, and Compaq. Road Runner offers a very similar service that reaches about 50,000 fewer subscribers, at last report. Anyway, while not a direct competitor in At Home's own various markets (each of which our company has its own rights to), Road Runner does represent the nearest analog to what At Home is doing, and is thus noteworthy as an industry competitor. (Frankly, as a shareholder and a sometime cheerleader of American business, I'll root for both to succeed. Either succeeding will at this point probably only legitimize the other one, anyway.)
The second competitor, and the closest to "inept" without passing Go and collecting 200 dollars, is the Bell companies and the xDSL technology they are pushing. DSL stands for "Digital Subscriber Line," while the x is a generic placeholder for any one of several different flavors of DSL (there's ADSL, CDSL, HDSL -- you get the idea). Aided by a DSL modem, this technology uses the existing copper phone lines far more efficiently, digitally, as compared to the standard analog use made of copper, lo these many years. What we're talking about here is a Baby Bell solution that is 5-25 times faster than standard dial-up rates today, though still slower than a cable modem. However, there is no clear xDSL standard yet, and technology brings with it additional restrictions (for instance, you can only realistically get one of these modems and subscribe to the service if your within 12,000 feet of a switching station -- which many people are not). Consequently, xDSL has been slow to market. Estimates suggest that the phone companies may have 25,000 customers signed on by the end of this year (just 1/20th the number of expected cable modem users). The costs of expanding the number of switching stations also appear to be prohibitive. No surprise, one reflects, that AT&T went after TCI, a cable company, as probably the best way of enjoying the future of the network business...
OK, the first competitor was a copycat, while the second is attempting to introduce a completely different technology standard. The third competitor comes at ATHM from a different direction: as the largest present Internet access provider in the world, using the fading dial-up technology: yup, AOL. More than anything, @Home and AOL may clash as portals, as "media companies." One of our more eloquent message-board postings addressing this topic was this one, from HIHOZE, who argues that AOL and At Home are on a potential crash course to see who might provide that "First Page" that tens of millions of people see every day when they use the Internet. Steve Case and AOL have a huge head start, but they are operating on the connection technology of the present and past, not the future. @Home and Jermoluk appear to be better positioned for the connection technology of the future. That's why it's amusing to read, in HIHOZE's post (assuming this is accurate), that, "Several months ago, Tom Jermoluk and his team visited Steve Case & Co. at AOL headquarters in Dulles, VA. They were 'dissed' big time by Case. The meeting broke up with ATHM walking out. AOL tried to dictate terms to ATHM as though ATHM didn't exist and had no real bargaining power."
Obviously, as owners of AOL stock as well, we have a particular interest in these interactions. And of the three competitive threats, I'm more impressed by AOL than the other two. So let's go a bit deeper.
AOL has about 50 times the customers, and 22 times the sales. But its $41 billion market cap is presently only 6 times @Home's $7 billion market cap (slightly less, in fact).
The market's valuation of these companies reveals a few insights. First, we can see that @Home has a higher ratio of revenues per customer than AOL. That's not surprising, given that its monthly cost is about twice as much. But second, we also see that a dollar of present sales is worth much less than a dollar of future sales. AOL has lots of sales, but a much smaller price-to-sales ratio; @Home has much less sales, but a much higher multiple. The market is confirming for us that the trend toward cable modems is real, it is valuable, and @Home is in an interesting position to compete in this future world. This does NOT mean it's the odds-on favorite to win -- it's still valued at just a fraction of AOL. This also doesn't mean that if @Home does "win" (succeed), that AOL won't win, too.
To begin closing up our consideration of sustainable advantage -- our longest section -- we take very seriously the needs and opinion of the customer. It is the customer, in the end, who naturally selects the businesses that will end up evolving and thriving, in the survival of the fittest. The businesses that create a profitable model around attracting new customers, making them happy, and retaining them can never really lose. So consider these words posted to our message boards by Gdlight: "I recently signed up with @Home through Comcast cable. After using it for one week I say praise the lord and adios AOL. It costs me $40.00 a month. It's always on. It's fast."
(And did we mention that it's always on? That's another thing about cable-accessed Internet. No dial-up. You're always online, if you want to be. Seidman's Internet Insider quotes Charles Moldow, the company's VP of media development as saying: "@Home users repeatedly report that their usage behavior has fundamentally changed since they can access the service throughout the day. They check [the Internet] quickly for weather, traffic reports, stock updates, news headlines, phone numbers, directions, recipes... We often get user quotes like 'this is the way the web was supposed to be used.' ")
A few things to watch for or consider, as the connection wars rage on. AOL recently opened up the possibility that it might work with the cable companies directly, by attempting to get them to share their bandwidth with alternate partners. The government (the FCC) might possibly move in to regulate Internet cable access and take away @Home's exclusive monopolistic partnerships with its regional cables. That could hurt.
Then again, speaking of AOL and @Home, the latter currently uses Netscape Communicator as its standard browser; when you sign up for the @Home Network service, the installation guy comes and loads Netscape on your machine. Wait, did we write "Netscape?" That's going to be AOL. So assuming the AOL-Netscape merger goes through, that's AOL that now provides the browser that @Home customers use to browse the Web -- a browser that is itself pointed at the @Home home page, rather than the aol.com home page.
Confused? We hope not. If you are, you better stay the heck away from this stock! If you're not, you'll enjoy following this story with interest as we cover it in the coming weeks, months, and perhaps even years ahead, as stakeholders both of AOL and @Home. (We wouldn't be surprised to see them team up in some form, ultimately.)
>Silicons In His Closet?
#3: GOOD MANAGEMENT
AND SMART BACKING
@Home was one of those well-known Kleiner, Perkins (KP) initial public offerings, KP being the best-known venture capital firm in Silicon Valley. As we write in our upcoming book, this is exactly the sort of pedigree you like to see in your Rule Breaker. The best known venture capitalist in the world today is John Doerr, and in a swanky piece in the New Yorker last year he was depicted as a very happy man at the beginning of the article as @Home was going public that day.
You want KP to back you. You want John Doerr to be smiling at your IPO. There are few better forms of backing.
(Of course, venture capitalists are usually looking toward their exit strategies around now, so I'm not saying they're all going to stay in the stock. Very few stocks in our portfolio have ever had hugely significant holdings maintained in them by the venture capitalists!)
Getting to management now, @Home's CEO is the already mentioned Tom Jermoluk, who was previously president and chief operating officer of Silicon Graphics Inc. (NYSE: SGI). Take a look at SGI's stock chart in the early 1990s and you'll find it a testament to the drive and charismatic leadership attributed to Jermoluk. He was instrumental in propelling SGI from a $1 billion company in 1993 to a $3 billion company by 1996. That's good management.
Only problem is, follow that stock chart long enough and you'll see that Silicon Graphics unraveled from that point forward. Its low-end graphic workstations got pinched by increasingly high-end (and much cheaper) Intel machines. Meanwhile, its high-end market was taken over by more powerful, less expensive mainframes issued by the likes of IBM. However, most observers fault CEO Ed McCracken, a techie who was in charge of running a company. (As I did this write-up, I was assured by Dwight Gibbs, our own Chief Techie in Fool HQ, that techies shouldn't run companies!) Thus, we will not hold the SGI debacle against Jermoluk. We prefer this line from a posting submitted by Travling1: "He is an asset to @Home. His dynamic growth personality is exactly what @Home needs at the moment. And hopefully that is what he will bring to the team over the next few years. At the same time, I hope that the rest of 'em will keep a lid on flagrant spending, and watch out for growing shareholder value."
A final sign of good management that we always look for is whether a company has a mission statement or not, and if so, what it is. In fact, we take mission statements dead seriously as the key indicator of what a given company wants to be when it grows up. Here is @Home's mission statement:
"@Home Network's mission is to provide a high-speed, fully integrated multimedia service that revolutionizes the way people interact with information and each other at home and at work."
OK, nothing earth-shattering, though phrases like "fully integrated" and "interact with information," while seemingly dry, are actually quite interesting if you dwell on them. Additionally, "at home" and "at work" also gives us a sense of the company's scope. By knowing a company's mission statement, small private investors like us essentially have a yardstick now that we can use to measure our company's progress. We use it as an accountability mechanism; we'll be keeping our eyes peeled.
>GOOD TASTE CONFIRMED?
#4: STRONG PAST PRICE APPRECIATION
MEASURED BY RELATIVE STRENGTH
OF 90 OR MORE
This one is always very simple. The company's relative strength is presently 98, according to Investor's Business Daily. That basically means that ATHM stock has outperformed 98% of all stocks in the United States of America over the past 12 months.
Long-time Fools know that we favor this statistic when selecting dynamic growth stocks. We view strong performance as "confirmation" of our own good taste in picking the stock. We can rest assured at least knowing that this company is right smack dab on Wall Street's radar, rather than toiling in relative obscurity (the opposite of relative strength). We continue to believe that in our form of investing -- and this is a generalization only -- the trend is your friend. It's Isaac Newton's First Law of Motion all over again. You can read about it in The Motley Fool Investment Guide.
>JUST FOLLOW AOL
#5: THE GREATER THE CONSUMER BRAND,
@Home is not a household word. However, it has the potential to be one. And for many of our Rule Breakers, that will be enough.
From a branding standpoint, @Home essentially has the same aim as AOL: become synonymous with the phrase "online access." Aggregate the information and content of your partners, while beginning to mix some of your own proprietary stuff in there, too. I remain unconvinced that AOL has done much from a content end, and it may be that @Home fails ever to do much on its own. I continue to believe that content brands like "ESPN" are going to be much more compelling to the mass market than "AOL Sports" or "@Home Sports." But it probably won't stop AOL and @Home from continuing to try. If they could actually be good original content companies, in addition to dominating distribution, that would be the cat's meow. But I don't think chances are great that the cat will meow.
But any Fool looking at this company from a branding standpoint can't really get too caught up with the content side of things. AOL has demonstrated that if you create an attractive and easy-to-navigate service -- bells and whistles, or not -- and focus all your efforts on creating CONVENIENCE, that you can dominate the national Internet dial-up scene, and become the service of choice, the default option, the eAutoPilot (if you will) (and you shouldn't) for anyone new looking to start on the Internet today. @Home has similar aspirations, and you don't need to know much more than that as a Rule Breaking investor. They should just focus on branding their superior access technology.
Of the many fine posts I've read on our @Home message board, I remember at least one in which a fellow Fool was discussing the packaging that the @Home gear comes in. It's so @Home-branded that he said you couldn't even really tell who made the cable modem -- it just looked all like it was @Home. Tap into the company's main Web page to get a look at the slick image they're trying to craft.
>FAILING TO MEET DEMAND
#6: A SIGNIFICANT MEDIA CONSTITUENT
HAS RECENTLY CALLED IT OVERVALUED
I am tempted to write that the entire Internet is considered so overvalued in every article I read, every CNBC interview, every message-board posting, etc., that the "significant media constituent" is EVERYTHING. EVERYONE. In fact, I will yield to that temptation. While no article specifically flaming @Home's valuation has come out in the past couple of weeks, it is the conventional wisdom today that the Internet is so overvalued that it's a joke.
That's the very sort of situation we like to buy into.
Additionally, the company has come in for some criticisms for its service being rocky, or slower than initially anticipated. The San Francisco Chronicle in particular, the past few days, has run a couple of stories about how the company isn't managing to meet demand. And then there was this post to our message boards yesterday -- more negative sentiment from the media. Reminds me of what AOL used to go through. The beauty of all of these situations is that a service is TOO much in demand. That's going to be the case with @Home.
So while the @Home service is not universally loved, every time a flame article used to come out about AOL not providing sufficient service to meet demand, it only made me more bullish!
>THE MEDIUM THAT SWALLOWS THEM ALL
At Home is breaking all the rules. The Web isn't supposed to be QUICK and EASY to use. It's not, for instance, supposed to be ALWAYS ON. And heck, you shouldn't eventually be able to conduct your own videoconferencing over the Web! For a cheap flat rate? Multiple open screens with clearly audible sound and dynamically updated pictures of your conference participants? You kidding me? Where does that leave the phone companies? That's breaking the rules, too. You get the idea.
We'll be buying $25,000 of the stock in the next five days. We may well not buy tomorrow, since the market makers have a way of getting wind of a new Fool buy and pushing up the price in advance. So don't be surprised if the stock pops open tomorrow at a higher price than you thought it would. (You can bet we won't have an open buy-it-at-the-market order tomorrow at 9:30 a.m.!).
In the end, we just want to own this company and its stock. The Internet is the medium that swallows all the other mass media (print, data, sound, and video all in one, ALONG with communications). And the access provider that can make that happen best -- that can help us all exploit it the most -- should profit from this. So should its shareholders.
In answer to one other poster questioning the "fundamentals" of the situation (as if anyone can get a perfectly clear read of those, given the revolution we're living through), I think I side with what fellow Fool Mzb wrote:
"You may not agree with my definition, but I have a heckuva factual fundamental for you: I got hooked up to @Home two weeks ago and it CHANGED MY LIFE!!! No kidding. I work out of my home and now instead of my modem line competing with my fax line, they both co-exist happily. And, now, I'm online all day long. My research takes a fraction of the time it used to. I was so impressed with how @Home changed the way I work and play that I bought the stock. I based my purchase on the strongest fundamental of all -- customer bliss!!"