Fit to burst? Has Silicon Valley grown up?

Eight years ago, at the height of the dotcom boom, a company with a
price/earnings ratio of 853 might have seemed a little undervalued to the
fuzzy-minded venture capitalist who seemed in abundant supply back then. After
all, p/e ratios in the thousands were not uncommon.

But today, having learned the harsh lessons of a time when financial controls
seemed to have no place at the table, a p/e ratio this high would surely cause a
few suspicious whispers. Not so, if it belongs to Salesforce.com – one of
Silicon Valley’s hottest post-crash tech companies and since it IPO’d in 2004,
investors have been falling over themselves for a slice of the pie.

It’s just one example of how the confidence has returned to the dotcom world.
Analysis of research into Silicon Valley-based VC funding, carried out by
PricewaterhouseCoopers, Thomson Venture Economics and the National Venture
Capital Association, offers further evidence.

In Q3 2006 there were 237 deals announced with a combined value of $3,953.5m
(£2,953.4m). Go back just a couple of years to Q1 2004, however, and the numbers
plummet to 159 deals worth a relatively paltry $1,366.4m.

So, is six years long enough to forget the lessons learned during the last
dotcom crash?

To some extent, this depends on the appetite for IPOs. Venture capitalists
play in the world of risk, and they are happy to burden a lot of it for the
chance of huge returns. This is not how public companies should be run, however,
where long-term growth is the panacea. If the vast majority of these startups
are kept away from the public markets, then the effects of their potential
failures will be, to some extent at least, marginalised.

Research by VentureOne, a US-based VC research house, shows that while
technology IPOs are beginning to grow again, we are a long way from the heady
days of the dotcom era. In 1999 alone there were 166 IPOs in the technology
space raising more than $13bn. In 2000, this dropped to 105 deals worth more
than $11bn. The numbers plummeted after 2000, with 10 IPOs in 2001 and just six
in 2002. So, while in 2006 there were 20 IPOs worth almost $2bn, we are still a
long way from the late-1990s.

In Europe, there is more appetite for IPOs of technology startups. While
there were 103 deals in 2000, worth over E7bn (£4.6bn), this dropped to single
figures in 2001. It wasn’t until 2004 that Europe regained its appetite, and
with 27 IPOs in the first three quarters of 2006, Europe is ahead of the US in
terms of public offerings of technology startups – in terms of numbers if not
value.

Any industry sector that hopes to achieve substantial growth needs a story,
and the latest buzzword is Web 2.0. While it’s hard to put a concrete meaning to
the phrase, it is clearly driving a mini tech boom. Sites like YouTube (sold to
Google for $1.65bn) and MySpace (sold to News International for $580m) are both
said to be examples of so-called Web 2.0 businesses.

Some claim that Web 2.0 businesses are those which are based around
user-generated content4 and collaboration. However, it is reasonable to suggest
that Web 2.0 refers to a new generation of sites and online businesses which are
flourishing now that the underlying technology is sound. Broadband, in short, is
the key.

According to research by Dow Jones, VentureOne and Ernst & Young, equity
investment in Web 2.0 companies has, more or less, doubled each year since 2002.

In 1999, Financial Director looked into the finances of some of the
major dotcoms, pre-crash, highlighting some the frightening ratios and worrying
strategies. It seems that some of the companies we looked at (eBay, Amazon,
Yahoo!) have matured. Others didn’t.

But with the latest high-tech boom, things seem different. The underlying
infrastructure works; venture capitalist-backed startups are largely being kept
away from the public markets, and business strategies have developed to the po
int where cost control is actually discussed.

You never know, even Boo.com might have survived today.

Craig’s List
Current share price – n/a
Estimated value – $100m
Estimated revenues – $10m
Latest net profit (loss) – n/a
EPS – n/a
Price/sales ratio – n/a
Price/earnings ratio – n/a
Number of staff – 22

Website Craig’s List receives five billion hits a month, making it the 34th
most visited website in the world. Established by San Francisco-based Craig
Newman in 1995, the site, which offers free classified advertising to the
residents of more than 450 cities around the world, hardly noticed the dotcom
boom and collapse. Its CEO Jim Buckmaster said revenue approached $10m in 2004
(it charges for job and property advertising in some cities). The same year,
eBay bought a 25% stake in the company for an undisclosed consideration. Craig’s
List is decimating more traditional businesses which rely on classifieds.
Verdict: A throwback to the early days of the internet. Craig’s
List’s business strategy is not driven by profit, rather by a wish to serve its
users. eBay getting involved, however, shows just how seriously the business
world is taking it. Should Newman decide to sell, analysts expect it to go for
as much as $100m.

Apple
Current share price – $96.56
Current market cap – $82.97bn
Latest annual turnover – $19,315m
Latest net profit (loss) – $1,989m
EPS – $2.27
Price/sales ratio – 4.3
Price/earnings ratio – 42.5
Number of staff – 17,787

As the manufacturer of the iPod, probably the most iconic product of the past
decade, Apple is perhaps the most respected technology company in the world. Net
sales of the iPod outperformed that of the Mac and iBook for the first time in
the company’s history last year. However, it is another line in the company’s
10-K annual filing with the SEC which makes for interesting reading. The
greatest growth that Apple has seen over the past two years has been from other
services – notably the iTunes Store. From just $224m in 2004, net sales reached
$1,885m in 2006. And this is a relatively immature market with huge growth
potential.
Verdict: Much of Apple’s recent success can be put down to
truly innovative design spurred on by its CEO Steve Jobs. Some may worry about
its over-reliance on the iPod (it accounts for more than a third of total net
sales). However, the growth in digital music could take Apple on another –
hugely profitable – road.

Google
Current share price – $511.76
Current market cap – $156.68bn
Latest annual turnover – $6,138.6m
Latest net profit (loss) – $1,465.4m
EPS – $7.86
Price/sales ratio – 25.5
Price/earnings ratio – 65.1
Number of staff – 5,680

The undisputed darling of the dotcom world. But is its strategy sustainable?
With a turnover of $6.1bn and margins of almost 25%, the prospects certainly
look good. However, Google has been trying to broaden its own horizons –
everything from maps to email have been experimented with – to varying degrees
of success. Most importantly,none have offered the company much in the way of
revenue, which still comes almost exclusively from pay-per-click advertising.
For the moment, it’s an extremely lucrative business – revenues have increased
from just $81m in 2001. Last year’s $1.65bn acquisition of YouTube saw the
company thinking of the bigger picture. Quite what that bigger picture is, is a
little less clear.
Verdict: Google seems to have set its sights on the hugely
lucrative software application space by developing Google Docs and Spreadsheets;
personal applications that can be accessed from any computer. If done well, the
company could begin to worry traditional software players such as Microsoft.

Time Warner
Current share price – $22.82
Current market cap – $90.65bn
Latest annual turnover – $43,652m
Latest net profit (loss) – $2,921m
EPS – $1.14
Price/sales ratio – 2.1
Price/earnings ratio – 20
Number of staff – 87,850

When AOL announced it was to acquire Time Warner in 2000, there was a
collective intake in breath. Not only was it the first example of a dotcom
swallowing what was then a hugely successful traditional media business, it was
also the largest ever company merger. The indigestion, however, was bad. The
strategy of Time Warner now seems to be to maintain the AOL brand, but to
extricate itself from the internet access side of the business to concentrate on
content alone (it sold the UK access business to Carphone Warehouse in a £370m
deal). However, it still sees the value of dotcom having recently made a $900m
cash offer for Swedish online marketing group TradeDoubler.
Verdict: A company that has ridden the ups and the downs of the
dotcom economy. It sees the internet as an extension of its traditional
publishing and film and TV activities, and an opportunity to build its
advertising revenues which, at $7.6bn, account for just a sixth of total
revenues.

eBay
Current share price– $29.99
Current market cap – $41.81bn
Latest annual turnover – $4,552.4m
Latest net profit (loss) – $1,082m
EPS – $0.74
Price/sales ratio – 9.2
Price/earnings ratio – 40.5
Number of staff – 11,600

eBay signed two deals last year which go some way to signify how the
e-economy is maturing. A revenue-sharing deal with Google and a separate
partnership announcement with Yahoo! illustrate how dotcoms now work with each
other rather than against. The company has completed several high profile
acquisitions in recent years, including the $2.6bn purchase of internet
telephony company Skype and the $1.5bn acquisition of PayPal. Net revenues for
Skype for the period 14 October 2005 until the end of the year were $24.8m – a
price/sales ratio of 22.4 (it made a loss of $17.2m). Which isn’t saying much –
when we looked at eBay in 1999, the company had a price/sales ratio of 380 and a
p/e ratio of, wait for it, 7,500.
Verdict: If revenues for Skype grow at the rate eBay hopes, it
will prove a sound acquisition. Its strategy of buying listings and classifieds
companies, including a 25% stake in Craig’s List, could also prove shrewd. But
perhaps its shrewdest move of all was the acquisition of PayPal. In 2003, it had
revenues of $437.6m and profits of $194.4m. By 2005 revenues reached $1,028.4m
and profits of $304.6m.

Second Life
Current share price – n/a
Estimated value – $50m-$100m
Estimated turnover – $10m-$20m
Latest net profit (loss) – n/a
EPS – n/a
Price/sales ratio – n/a
Price/earnings ratio – n/a
Number of staff – 100

Some things are beyond logical comprehension. While concerns were raised pre
dotcom crash at the eye-watering ratios that had become the norm (eBay p/e of
7,500; AOL’s of 1,355) nothing compares to Second Life. A virtual world which
hundreds of thousands of users call home. Bizarrely, these users not only pay to
own their virtual real estate, they also pay for goods that only exist in Linden
World. (American Apparel sells digital t-shirts and Adidas trainers made of
nothing but ones and zeros). Linden dollars can be exchanged for real-life
dollars and some users are earning from a few hundred to several thousand
dollars a month by selling services in this brave new world.
Verdict: Where to begin? Linden Lab, the creator of Second
Life, claims Second Life is profitable. Thousands of users earn thousands of
real dollars a month. Real companies from Reuters to Toyota are selling their
digital wares. In many ways, the sky – or more to the point, the server – reall
y is the limit.

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