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September 30, 1998

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Subject: Pixel Dust Fundamentals
Author: TMFNico

A member in the Fool's AOL Yahoo folder said:

"As the economy slows fund managers need to find stocks in high growth industries. Where's the high growth??? Internet right - now which stock is the leader (blue chip) - Yahoo! right. A 12 billion market cap seems high based on historical data - but fund managers aren't looking back - they are looking forward. IBD said ad revenue will grow 10 fold over the next 5 years - then Yahoo! says - our margins are increasing to 30-36%. The market is looking for high growth stocks that consistently beat expectations - Yahoo! sounds like that kind of stock."

All that's great, assuming it pans out. Right now, I see a lot of that stuff mostly as nice-sounding supporting evidence for a general trend which is, as I see things, more solid than that evidence is. I would call the trend self-evident, except that it hasn't happened yet.

The numbers are just what bulls and bears flip at each other. And when it comes to number flipping, I'm happy to give the game to the bears, whose numbers probably add up more soundly and roundly, and responsibly, and more soberly.

  "What's funny about this is, by referring to "creativity" and "imagination" and "vision" in the context of an "obviously overvalued" company like Yahoo, I appear to be cementing the bear's case that the bulls have been snorting pixel dust for so long that they've lost all touch with reality."

Where the bears fall short, I think, is in their consistent lack of imagination and vision when it comes to Yahoo and the industry overall. "A mighty uncreative bunch," is the way Fool writer Dale Wettlaufer described the Amazon shorts a few months ago. Right.

What's funny about this is, by referring to "creativity" and "imagination" and "vision" in the context of an "obviously overvalued" company like Yahoo, I appear to be cementing the bear's case that the bulls have been snorting pixel dust for so long that they've lost all touch with reality. "Look at these numbers!" implore the hardheaded bears, like teetotalers at an Ama Zona Yhoo kegger.

I love the bears. They make me think. But what I think is, they've got some things backwards.

For all the hard economic reality in their numbers, da bears are overlooking some of the hardest fundamental facts going, first among those being (pass the pixel dust, please) that we are witnessing today the forming outlines of an emancipated capitalism, its organs of information set free from the restrictions of linear time and contiguous space -- with "web" not merely a cool metaphor, but a cold reality. Under the circumstances, there are few certainties as to how things will unfold. But they will unfold forward.

The bullish bet being made on the key Internet tulips, most notably Amazon, America Online, and Yahoo, is that their current positions -- whether seen as advanced and accelerated, or hyped, bloated, and metastasized -- if maintained on a period-to-period basis, will eventually result in their attaining a sufficient enough mass to compel or draw a broad range of economic activity through their portals. The eyes will have it.

  "The bears do know, however -- and the bulls should too, although I think many sometimes ignore it -- that there is NO certainty that THIS company will make it to THAT point and be worth THIS much modemoola in THAT many quarters."

With marketshare and mindshare, these services become centers of gravity, and so they benefit from the periodic great events, or pivotal developments that, in an almost tectonic process, shake up the landscape and change the very shape and structure of an industry. They are among the agents that make or influence how things happen, defining the industry itself, and thus the terms of their own existence. I will refrain from calling these organizations gorillas, because it's just too trendy.

What the bears don't factor into their analysis is the inevitability of these great events and pivotal developments that change the online equation. So the bears project revenues and earnings and sales ratios, perhaps even page views and unique visitors if they deign to handle such flakey metrics, as though things will progress linearly. They won't. (And for the record, these developments and events are not always headline grabbers. They sometimes go by unnoticed, or dismissed entirely. Sometimes it is only in retrospect that you realize what happened. They're also fun to try and predict, as when we play the Dating Game with companies as contestants, and one-time charges as the grand prize.)

The bears do know, however -- and the bulls should too, although I think many sometimes ignore it -- that there is NO certainty that THIS company will make it to THAT point and be worth THIS much modemoola in THAT many quarters. But alright already. These are speculative stocks. Now, tell me something new.

As I see it, the bear bet being made against the key Internet tulips (and are we done trying to equate Yahoo with K-tel???) is actually being made against the fierce logic and momentum of emancipated capitalism, powered by next-big-thingism and a gold rush mentality. Those are fundamental.

TMF Nico

A great rubuttal from our AOL Yahoo! folder:

Subject: Re: Pixel dust fundamentals
Author: GVTucker

"What the bears don't factor into their analysis is the inevitability of these great events and pivotal developments that change the online equation. So the bears project revenues and earnings and sales ratios, perhaps even page views and unique visitors if they deign to handle such flakey metrics, as though things will progress linearly. They won't."

Nico:

As much as anything, your post seemed a challenge to the bears. And as such, as one of the ursine crowd, I'll be glad to draw the line.

The bears do understand such things. Indeed, I rather think that the bulls are not really thinking about how the future will unfold. Ten years hence (and to be a bull on YHOO anywhere near this level, you really need to think ten years hence) portals will most probably be invisible. Your microwave will be wired to directly access the manufacturer on the 'net. Your phone will be wired directly to the phone company's directory, so that all you need to do is say who you want to call into the receiver and the number will be dialed. For retailers, the same thing. Say "books" into your internet microphone, and a list of booksellers will appear like a 'net yellow pages. Pick-n-choose.

But 'wait' you say, won't YHOO be the supplier of those 'net yellow pages? Certainly possible, but given that the RBOC's have that information first (and 'net addresses most likely will be part of everyone's address) odds are that the RBOC's will supply that information themselves. And whoever supplies that information, it will be a very low margin business, not the 30% or so gross margins that YHOO anticipates next year.

Thus, you need to look further at YHOO. Do they have any proprietary technology. No. A year ago, YHOO's portal was by far the easiest to navigate, and the information was superior. Now, everyone's site looks the same. Go to Netcenter, Snap, anywhere, and it is hard to tell the difference.

But the bulls continue to maintain that investing in YHOO is like being on the ground floor of CBS or NBC when television was in its infancy, with the exception that YHOO has a worldwide audience, not just a domestic audience. This belief ignores what gave NBC and CBS their main value in the early days--scarce bandwidth. There were only limited channels, and the networks were given those by the FCC. This scarcity drove value. The wonderful thing about the 'net is that there is no scarcity. Disney wants to start a portal? Rather than be limited with YHOO, XCIT, and NSCP, they instead chose to partner with a smaller company, SEEK, and with no cash invested, were able to establish a site. Contrast that with what DIS had to do to enter broadcasting--purhcase CCI (which was ABC) for a huge premium, because GE wasn't selling NBC and Westinghouse was still restructuring CBS. And NBC, rather than spend a billion or so on one of the leaders, chose to spend a small fraction of YHOO's cap, and now has the fastest growing portal on the 'net, in essence duplicating YHOO for less than 5% of YHOO capitalization.

Indeed, I look ten years from today and I see a world where we are always connected--the ISP is as invisible as our long distance provider. The key here is the ISP, who controls the access. And here, YHOO is so far behind the players that they cannot catch up. Whether the player is AOL, MSPG, T, or anyone else, they will control the process, and either will run the portal themselves (such as AOL) or will contract out to YHOO-like providers.

Because there will not be proprietary content here, the margins will be controlled by the ISP, not the portal. And because of this, YHOO's dreams of maintaining gross margin of 10%, much less 30%, is a pipe dream. And so is investing in YHOO at today's price.

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