An echo of a boom?

Jun 10th 2005
From The Economist Global Agenda

Dotcom shares are booming again, with Google leading the way. Is this stellar performance justified? Or should investors worry that another correction is on the way?

REMEMBER etoys.com? What about Webvan.com? Do Boxman.com or Boo.com ring any bells? Pets.com, perhaps? The casualties of the dotcom bust have long closed or changed hands since the heady days of the late 1990s turned to the crash of the new millennium. But of the internet firms that survived the demise of the “new business paradigm”, many are now enjoying soaring market values as investors regard online enterprises with renewed confidence. And new firms are coming to market too, amid no small amount of excitement: for instance, PartyGaming, a gambling website, is working on an initial public offering (IPO) that values the firm at about $10 billion. Is this a new fit of over-exuberance?

This week Google’s share price rose to take the firm’s imputed market capitalisation to just above $80 billion, pushing the internet search engine past Time Warner to become the world’s most valuable media company. Its shares are now worth $285 apiece, three times more than at its IPO last August. That Time Warner has been overtaken by an online upstart is symbolic for the growing band of sceptics who detect a return to the overvaluation and hype of the tech-bubble days.

Time Warner was involved in the most disastrous merger of the period, when in 2000 it joined forces with America Online. Fans of the deal said that the brash AOL would drag the staid but solid media giant into the new business age. But the deal failed to live up to expectations. The renamed AOL Time Warner’s colossal valuation melted away as the bubble burst. A couple of weeks ago, Time Warner (tellingly, the AOL has gone from the name) was said to be considering a spin-off of its underperforming web-based partner, so bringing the ill-fated venture to a close.

But those who would draw parallels between then and now should note that much has changed since the tech revolution faltered five years ago. Investors, battered by the stockmarket crash that accompanied the demise of the dotcoms, are now a little wiser. Certainly they are unlikely to hand over considerable sums of cash to any online “entrepreneur” with a half-baked business plan. The hype and hysteria that accompanied every new scheme to build market share through first-mover advantage is over.

These days, the online giants such as Google, Amazon, MSN, Yahoo! and eBay operate in a different business climate. Since the bursting of the dotcom bubble consumers have logged on to the internet in increasing numbers and have become more comfortable conducting business online. In 1999, some 150m people worldwide used the internet; today, over 1 billion use it regularly. And those who venture into cyberspace are increasingly willing to spend money there.
Overall, Americans, the most enthusiastic adopters of e-commerce, spent just over $69 billion buying things online in 2004. According to emarketer, a research firm, that figure is set to double to $139 billion by 2008. Similarly, those firms that depend on advertising have enjoyed growing revenues. Last year, internet-advertising revenues in America hit $9.6 billion, up from $7.3 billion the year before. However, despite early predictions that the web would be a free-for-all, the lion’s share of this market is now in the hands of a few giants, with the top ten commanding 71%.

So in many ways the hopes for the internet of the dotcom boom years are now coming to fruition. Yahoo!, which peaked at a market value of $125 billion in early 2000, had slumped to $4 billion by late 2001. Now it is worth $52 billion. And like numerous other internet firms that were once worth a fortune despite making no money, it is now actually turning a tidy profit: $840m after tax, on revenues of $3.6 billion, in 2004. Google itself enjoyed revenues of $3.2 billion last year and made a profit of $400m. But they are still far behind the biggest “old media” companies. Time Warner’s revenues for the year were $42.1 billion, for instance, and its operating profits $6.2 billion.

Despite the obvious dissimilarity between the performance of today’s online leaders and older, more mature firms, the rapidly improving financial performance of the dotcom survivors has persuaded investors to open their wallets. This has pushed the Dow Jones internet index up by 10% in the past two months (see chart). Google’s worth could top $100 billion sometime this year if the trend continues.

But investors with stakes in big internet companies, and Google in particular, might pause for thought. Although revenues and profits are rising steeply, valuations are rising disproportionately quickly—suggesting that another correction is likely at some point. Also, advertising revenues on the web—on which firms like Google rely heavily—are not growing as rapidly as online sales of goods and services. And although Google commands over half the worldwide market for online searches, its share is falling.

In response to such threats, the online giants are encroaching on each other’s territory. The leading auction site, eBay, recently bought shopping.com, a shopping comparison site, a service already offered by Yahoo! and Amazon. Google, Amazon and Yahoo! also host auctions, though they have some way to go before posing a serious challenge to eBay in this business. And while profits are growing fast, other new competitors may be tempted to join the fray—the barriers to entry in most online businesses remain low.

Undoubtedly, today’s big online ventures are on a surer footing than those that fell in the last dotcom crash. They are, unlike most of their erstwhile but now defunct peers, being run like proper companies. And there is a bigger pool of customers willing and eager to pay for their services. “Google” has even entered the language as a useful verb for describing a web search. For now it seems inconceivable that it, or a big competitor, might disappear. But there is little doubt that Google’s valuation looks suspiciously frothy. Do investors in internet stocks really need reminding that what shoots up can just as easily come crashing down?

Copyright © 2005 The Economist Newspaper and The Economist Group. All rights reserved.