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November 30, 2000

From Our Correspondent: Hirohito and the War
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APRIL 7, 2000 VOL. 26 NO. 13

How Much Is That Dotcom?
By CESAR BACANI and ASSIF SHAMEEN Hong Kong

So you want a piece of Asia's hot Internet action? Consider Japan's Softbank. Last year, the Internet investment giant saw its share price soar more than 1,300% to 97,800 yen ($914). In February this year, when the stock reached 150,000 yen, U.S. brokerage Lehman Brothers set a year-end target of 400,000 yen. Last week, Softbank fell to 76,500 yen before ending at 91,500 yen March 29. Nikko Salomon Smith Barney in Japan now advises its clients to sell the stock. But Lehman is sticking to its 400,000-yen December target.

What are investors to do? First, they must make sure they know where the analysts are coming from. "The Internet sector, particularly in Asia, is in its infancy," says Pratik Gupta of Salomon Smith Barney in Singapore. "This is a dynamic, very high-growth sector. You cannot apply some of the old methods like price-earnings ratios because Internet companies have no earnings, and some do not even have much sales." In other words, the people who have the training and experience to make stock calls are groping like the rest of us. If they stay on the job, that is. The Lehman analyst who set the 400,000-yen price target for Softbank has left to join an Internet start-up.

 
    TECHNOLOGY

COVER: Asia's Dotcom Shakeout
Internet mania continues, but many of the region's Web start-ups will have short, unhappy lives
Privacy: Online advertisers know (almost) everything about you
Valuations: How to price Internet stocks
Cutting Edge: A microchip helps a paralyzed man walk

Asiaweek/CNN Tech Index: Tracks 20 hot Asian tech stocks
Technology Home

he fact is that valuing a company, even one with a track record and real products, is not really a science. To get an indication of whether a stock is undervalued, analysts divide the share price by how much they think the firm will earn per share in the coming year. (Note the element of a guesstimate here.) They look at the company's book value, cash flow, management, barriers to entry, competitiveness, industry prospects and other factors. Then they come up with a recommendation to buy, hold or sell the stock. Because the call is based on a lot of data, the analyst's judgment is theoretically superior to an ordinary investor's gut feel. In practice, many an expert's judgment has been up-ended by the company's actual results.

With Internet stocks, the art of valuation approaches sorcery. In the absence of profit figures, analysts formulate new measurements as they go along. "It is more accurate to say that we have had to include more items into our valuation worksheet, such as revenue per subscriber and long-term subscriber growth [for Internet service providers], and number of unique users and page views per day [for Internet portals]," says Mido Shammaa of International Asset Advisory Corp. in Florida. Some of these numbers can be inflated - in Asia, there is no independent third party that audits page-view claims, for example.

Other variables enter the picture. "At this stage of Asia's Internet industry, I look at three things," says Rajeev Gupta (no relation to Salomon's Pratik Gupta), a regional Internet analyst with Goldman Sachs. "First, the business model. Next, the management. Can they execute the business model successfully in the time frame they promise? Lastly, the relationships, the strategic ties with large companies at home or with international players. If a start-up has a deal with Microsoft or AOL, then it is going to be better-placed than its competitors." But says Salomon's Pratik Gupta: "The marketplace is changing so fast that some business models that looked great a few months ago are now obsolete."

And valuing relationships is very subjective. Lehman Brothers has a 12-month price target of HK$35 ($4.50) for Hong Kong Internet firm Pacific Century CyberWorks (PCCW) - even though it values the company's assets at only HK$10 a share. The premium of HK$25 is the value of the "world-class" ability of founder Richard Li (a son of Hong Kong billionaire Li Ka-shing) to "consummate value-accretive strategic transactions," says Lehman in a report. In less than 10 months, Richard Li has entered into numerous share swaps with high-flying Internet companies. PCCW is now finalizing a deal to buy Hong Kong's venerable telecom company, Cable & Wireless HKT.

Is that presumed ability worth HK$25? David Webb, a Hong Kong financial analyst and editor of Webb-site.com, says value should be assigned based on completed deals, not on future transactions. Along with other analysts like Thomas Astle of Merrill Lynch, he believes that discounted cash flow - DCF - analysis is a better way to value Internet firms. This method is usually applied to infrastructure companies, whose toll roads or power plants take years to complete. The analyst quantifies future cash flows, adjusts the per-year figures with a discount factor (the riskier the project, the higher the factor), and then totes up the numbers to arrive at a valuation.

True, there are as yet no Internet portals whose financial results can serve as benchmarks for cash-flow growth and discount factors. But DCF at least forces analysts to quantify their assumptions, thus allowing investors to judge how realistic they are. "Internet companies are selling at ridiculous price-to-newsflow ratios," says Webb, referring to press announcements that often hype Net stocks. "We should be able to look at future cash flows and make a judgment as to whether tom.com's current share price, for example, is cheap or excessive." The Hong Kong portal, owned by Li Ka-shing, closed at HK$10.95 March 29, nearly 700% higher than its initial public offering price in February. Says Hong Kong accounting professor Gary Biddle: "What is clear is that it is inconceivable for dotcom companies to throw off huge cash flows to justify their current valuations." Your move, Internet investor.


Stock Valuation 101
Price-Earnings Ratio The traditional way of valuing a company by dividing the stock price by the forecast per-share earnings. The lower the ratio, the cheaper the stock.

Price-To- Book Ratio Loss-making companies obviously cannot have a price-earnings ratio. Dividing the stock price by common stockholder equity per share gives the investor an idea of how cheap or expensive the stock is. Again, the lower the ratio, the cheaper the stock.

Price-To-Sales Ratio A way to value companies with no earnings and very little hard assets, which is the case with so many Internet start-ups. Divide the stock price by the projected revenue. The lower the result, the "cheaper" the stock. The theory is that an online auction site, say, will eventually make money so long as its gross sales leap higher and higher, proof that the company is staking a commanding market share in a virgin territory like the Internet.

Discounted Cash Flow Used to value long-term, high-growth infrastructure projects like power plants and toll roads, this valuation method estimates future cash flows based on such factors as the income of comparable completed projects, the length and duration of the franchise, and so on. To account for risk, both surplus and negative cash flows are discounted by an estimated percentage - the riskier the project, the higher the discount factor. One problem: There is as yet no Internet company whose actual financial results can be used to benchmark cash-flow growth and discount rates.

Value Accretion Based on the company's deal-making track record (or simply assuming it has such an ability because of connections, money, technological expertise and so on), the analyst assigns a premium over and above the value of a firm's assets and projected income. The sum - book value plus value-accretive ability - is the target stock price for the next six or 12 months. The theory is that the continuous deal-making will give the company a big edge in a rapidly evolving industry and ensure future success.

Momentum A target price is set based primarily on the analyst's expectations of continuing and intensifying investor euphoria, stoked by hype over technological advances and Internet penetration growth.

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