Finding Value on the Net


By Timothy J. Mullaney For investors in big-name Internet stocks, Jan. 19 was a painful day. When online auctioneer eBay (EBAY) blew an earnings report for the first time in 26 quarters as a public company, it didn't matter that the miss was by a mere penny a share. And it didn't matter that eBay earned nearly $800 million last year (see BW Online, 1/26/04, "How eBay Can Restore Its Luster"). Web investors have always known that eventually they will have to stop paying 65 or 80 times earnings for Internet stocks as the companies get bigger and start growing more slowly.

But as eBay shares bellyflopped by $20, to about $83, investors started to wonder whether that time had now come. So what's an investor, especially one with a nose for value, to do? The pros can't afford to skip the Big Four -- eBay, Google (GOOG), Amazon.com (AMZN), and Yahoo! (YHOO), which are members of indexes the pros are supposed to beat. But retail investors can hedge bets on the Big Four by buying smaller Net companies whose stocks are much more reasonably priced. In fact, most Internet stocks aren't nearly as expensive as armchair pundits think.

A look at these companies' prices compared with their estimated profit growth over the next five years makes them look even cheaper. Indeed, of the 20 blue-chip Web companies in BusinessWeek's BW Web 20 model portfolio, only six have PEG ratios -- the price-earnings ratio divided by the expected annual profit growth of the company over five years -- higher than the Standard & Poor's 500-stock index average.

UP-AND-COMERS. Investors hunting for Web bargains should certainly look in Asia. E-travel agency Ctrip.com International (CTRP) and online game producer Shanda Interactive Entertainment (SNDA), both based in China, sport modest p-e ratios and PEGs lower than the U.S. market's. Shanda's PEG is 35% lower than the S&P 500's, even after third-quarter profits doubled.

Online-media companies such as Sina Corp. -- often called the Yahoo! of China -- are cheap partly because of fears of government interference, but Sina (SINA) costs half as much as the average S&P company on a PEG basis. With China's economy growing 9.5% last year, betting on Sina to boost profits half as fast as the S&P 500 doesn't seem nutty.

Investors should be especially comfortable with Ctrip, which caters to the burgeoning China travel market. Its business model, focused on the more profitable hotel business instead of lower-margin airline tickets, closely resembles big U.S. winners Expedia (IACI) and Hotels.com (IACI). If you had put $1,000 each into Expedia and Hotels at their IPO prices, you would have walked away with about $15,000 when they were acquired in 2003. With Piper Jaffray & Co. analyst Safa Rashtchy expecting Ctrip to earn $1.25 a share this year, or $19.6 million, up from 45 cents a share in 2003, a similar outcome for Ctrip isn't too much of a stretch.

Back in the U.S. there are low-cost companies in e-finance and online advertising. Even e-commerce plays have gotten less expensive as profits catch up to valuations. CheckFree (CKFR), which makes software that banks use to provide online bill-payment facilities to customers, has the same PEG as the S&P 500. Online ad agency aQuantive (AQNT) is picking up a following. Its range of services -- from creating banner ads to tracking the performance of search keywords -- is more diversified than most of its rivals. And its p-e of 32, combined with projected 25% annual profit growth, produces a below-market PEG.

BLOOMING STOCKS. One of the hottest second-tier Net stocks has been Provide Commerce (PRVD), whose ProFlowers.com is stealing market share from 1-800-Flowers.com (FLWS). By shipping flowers directly from growers, it cuts out local florists and distributors. It says its flowers are cheaper, even with shipping -- and up to a week fresher. The shares are up 90% since August, yet they're still less pricey, on a PEG basis, than the market.

Most fund managers and analysts still place their biggest Net bets on Google, eBay, and Yahoo. And even their valuations have come down: Google is at about 50 times S&P's 2005 earnings estimate. eBay's p-e is 53, down from 65 to 80 in recent years, and its PEG is almost the same as the market's. Amazon.com's is around 42. History says to stick with them: Among the BW Web 20, the best performers since 2002 have been well-known companies with high-multiple stocks.

But they can't be retail-investors-only Web bets -- and don't have to be. What investors can count on is that the $144 billion U.S. e-commerce market will keep growing exponentially. And a market that's getting so big so fast will generate good investments -- some of which you've never heard of. Mullaney is BusinessWeek's e-Business editor in New York


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