TSC Net Stock Summit Transcript: Part 2

TheStreet.com held its Net Stock Summit on Friday in its lower Manhattan offices. This is the second installment of the edited transcript of the Summit, which TSC will be publishing throughout the week. (Click here for Part 1.) This installment looks at what panelists think of the future of the portals. An archived audio version of the Summit is available here.

Dave Kansas: So while we're on the subject, let me just jump right into poll question two, which asks whether portal companies will become obsolete. 73% disagree and 27% think they will become obsolete. But I really don't think that tells you what the issue at hand is. The issue that Andy's really raising is whether the current business model for a Yahoo! is enough to support the valuation that the market's been willing to give it. I think Andy's trying to say like, "What else is in the box that they're going to pull out?" You know, what's the lily pad.

And -- I know, Ryan, are you guys owners of Yahoo! (YHOO) in here?

Ryan Jacob: Yeah, I mean, I would agree with Jim. We think that, relatively, Yahoo! actually looks very inexpensive, especially compared to a company like Amazon (AMZN) or some the e-commerce plays where you have only, really, a limited amount of margin from which you can spend on sales, marketing and promotion.

You know, just to talk a little bit about projections, and what's realistic and what's not -- I actually give Henry a lot of credit for causing all the commotion with this $400 price target on Amazon. Because, in essence, in his report he pointed out, these are what's on the Street as stated revenue, earnings expectations. Then he said, "Here, look. This is what it could be. This is maybe what you haven't heard from the south side before. But this is what it could be." And that would justify its valuation. "The two things at the top of our list are strong, organic growth and scalability. And if you have two of those components in your business model, I hope you're not profitable, because it will scare away some of the institutions." -- Ryan Jacob

And I think what we're seeing -- and what I think investors get duped -- is inordinately conservative estimates by the sell side on the Street. You know, we do our own modeling, and if I were to just rely on sell-side research, I wouldn't have known any of these names. The two things at the top of our list are strong, organic growth and scalability. And if you have two of those components in your business model, I hope you're not profitable, because it will scare away some of the institutions. But from a portfolio manager's perspective, those tend to be the better opportunities, the companies like a GeoCities (GCTY), where someone says, "Two cats on a home page, I don't get it. So it must suck."

Then I look at the meaty metrics numbers each month and they just keep climbing up that chart. I think individuals are catching some of this. But the Street's trying to slot these companies and going through contortions to justify the valuations on inordinately conservative models is just causing a lot of confusion.

And, you know, from my perspective -- I mean, obviously I'm being selfish -- I hope it continues. And based on what Henry's doing and some of the analysts are saying, if a company's going to be a long-term player in their space, and be a leader, not only can it justify its valuation, but three or four years down the road it will probably look cheap.

Kansas: There's one point there that maybe people listening in might want clarification on: It's good if companies don't have a profit? Some people newer to the market might say, "Well, that's a pretty crazy concept. Aren't profits important to running a company?" Tell us why that's such an important thing.

James Cramer: I would say that, generally speaking, it involves investor skepticism. From my perspective -- in terms of, you know, buying into a stock -- we recently purchased eBay (EBAY). It was a company we looked at when it came public. We do a manager's comment on our Web site every month, and I mentioned that, surprisingly, I was never scared of the valuation. What scared me was the impending competition and the worry that they would not be able to charge a seller's commission going forward with the Yahoos, the Excites (XCIT) and whoever else is coming into this market and challenging them.

And then I realized that not only were they keeping their share, they were actually gaining share. Look at something like an AOL (AOL) -- how they raise prices and it doesn't affect subscriber growth. You come to the realization that, "Hey, not only could they charge seller commission, they can even raise them at some point in the future." And what really turned me around was the possibility that this could be a winner-take-all market. And in essence, it's different than the traditional e-commerce model. It's a clean business model. It's profitable today while they're still in the nascent stages of growth of the Web.

My first thought about whether the elusive seller's commission would bear fruit -- if that didn't happen, this would be enormously profitable company. It doesn't surprise me that AOL wants to get closer to them in terms of a business relationship. Because I'm sure they realize that they're helping eBay build a very solid business.

Andy Kessler: May I be cynical?

Kansas: Andy, go right ahead.

Kessler: Allow me to lay out the bear case for Yahoo!...

Kansas: OK.

Kessler: ...if there were one. But what the hell? Let me give it a try. Yahoo!'s revenue stream, for the most part, is driven by both ad sales and sponsorship. And the company keeps feeding out more and more page views. You do a few mergers and you get a few more tens of millions of page views per second, whatever it is. You keep growing the ad sales. You've got to go talk to merchants ask whether those ads are effective or not. It's 50/50. Some say they are, some say they aren't.

But what disturbs me is on the sponsorship side. It's been a while since we've seen one of those big, killer $25 million over a year -- the Mike Piazza contract kind of deals on Yahoo!. And let's rewind a little bit. Let's go back to, I believe it was 1996, when N2K (NTKI) went to America Online. I think they either had Yahoo! or Excite, I think it was Excite. And before they went public, they said, "Look. We'll do this huge distribution deal with you. We'll pay you the $25 million over three years because, if we do that, we'll go public." And that was almost a requirement to hit the public markets -- you bought a distribution deal. And by the way, he said, "I'll pay you after I go public. I don't have that kind of money laying around now, for God's sake." Well, that happened, and there have been a number of those, almost like machine-gun fire over the last 18 months. Bang, bang, bang. Get a distribution deal, you sign up AOL, sign up Yahoo!, sign up Excite, bang. Get out, go public and then figure out a business model.

Well, I think we're at the end of those deals. One, you don't need those big distribution deals to go public. The public now understands. "Uh-huh. This is an Internet company. You can get the distribution by other means than signing a deal with Yahoo!"

And it's been a while since I've seen one of those big distribution deals. They did the home food delivery one. When they do the left-handed scissors franchise on Yahoo!, then it's over. And what I've seen from talking to some private companies is they're saying, "We don't need those deals. Those deals are a liability, not an asset anymore." And that, if that's correct, will end up being the bear case on these companies -- the lack of these big deals.

Kansas: Henry Blodget, any counter-thought on the bear case laid out by Andy Kessler?

Henry Blodget: I think one point on that, I think there's no question that some of the deals that were struck have been incredibly disappointing. And I think others have been home runs. One thing that was very encouraging for me, actually, in terms of the effectiveness of online advertising and direct marketing, was First USA's $500 million deal with AOL a couple of weeks ago. This is a company that had been working with AOL for several years; they've been selling credit cards on the service. They came back and did an exclusive three-year deal at an enormous price. To me, that makes me feel a lot better. When a deal is run well and a company knows what it's doing, it's worth a heck of a lot of money.

And I think in terms of Yahoo! announcing this deal, they've been very conservative relative to their competitors, in terms of reporting backlog and reporting deals. They've also been very conservative in how they broke the deals, in terms of what they've promised. So I think sponsorship there actually is going very well. That's what I hear from a lot of their partners. They say they're really in the business of partnering with their customers on that side, which other of their competitors have not been. So from that side, I'm comfortable.

Kansas: OK.

Nick Moore: There's another bear case. This is not specific to Yahoo! in any way -- it's because the valuations themselves. When you have this excessive access to capital, people go for the "get big fast." Revenue growth was up a ton last year, but most of these companies, expenses were up even faster. So you don't see any benefit from scale. Now AOL and Yahoo! both hit really important scale points in the last 12 months. Although AOL, you know -- I never saw a tech company hitting $2 billion in sales before it could have an operating profit. But they're there, right? So the bull case was borne out.

But here's what happened. For one thing, you have a whole bunch of employees going into a mode that we call "vest in peace," right? Not too motivated, and it's hard to recruit people who can do arithmetic. That's a problem. Another is all your best people leave and start their own company. Those are problems.

And then we see things like Infoseek (SEEK), who this year is going to spend more than, I think, Yahoo! has spent on promotion themselves over the last couple of years, maybe in aggregate. That's an issue because it's going to push whatever the profitability is further and further into the future. So actually, the inflated access to capital was may have a dampening effect on the fundamentals of the company. It's something that shouldn't be ignored. We don't see a terrible manifestation of that at this point. But it's something that shouldn't be ignored.

Herb Greenberg: You know, I think the issue that still perplexes me is distinguishing great companies, or potentially great companies, from their stock prices. And it's a theme I use a lot. Take the case of a Yahoo!, which is a great company, no doubt. I use the product all the time. You ask, "Are portals going to go away?" You know, you can't have all these portals here. I mean, I still don't know who's looking at Snap these days because I don't hear anyone talking about it. But what I do know about a Yahoo! is that you go on there and it categorizes stuff for you. And if you can hit it and they have your category down, that's fabulous. But what's it worth?

So when you look at all these portals and all this potential -- there's just so much out there. You know there's going to be consolidation. You know some guys just aren't going to make it. There will be one or two, I guess, good ones. But by five or 10 years from now, won't people know how to get to many of these places themselves? Won't they have figured it out themselves and created their own databases? I think those are factors.

And we sit here and you hypothesize about what's going to happen in the future, and none of you know. Not even the great Jim Cramer knows the real issue. My goodness. I mean...

Moore: I think you were rational. You were speculating. It's like you had speculative fundamentals and you're speculating because of the price, also.

Greenberg: Right.

Moore: But that's been a feature the entire night. Other than after March 18th, 1996, or another year.

Blodget: One thing that's really important about the question of what they're worth is that nobody knows what they're worth. And when Yahoo! came public and it was a billion-dollar valuation on a million in revenue it looked like the biggest joke in the world. And the business model at that point was: a list. That was it. They were actually trading at 10 times 1998 annual est. earnings. So it was ridiculously cheap and people weren't talking about that.

And I think one thing that a lot of people don't focus on is that the risk of investing in a growth sector with as much open-ended up side as this one has is not losing 50% to 75% of your capital in an investment. It is missing a 5,000% return. And you can talk all day long about what it's worth, why are people paying more than it is worth. I think another way of looking at it is saying, "This is a sector that is strong enough and compelling enough to produce a couple of huge companies." And you don't know which ones they are, but if you build a good portfolio of the best companies, and three of them -- say you take four or five -- three of them go to zero and two do very well, you have a good rate of return over the long-term. So in terms of trying to figure out what they're worth, I think that's something that a lot of people don't do.

Cramer: I think Henry's dead right. I mean, I'm looking at this group the way I looked at the software companies in 1986. You buy a basket of Visicalc, of Lotus, of Software Pubs and of Microsoft (MSFT). And you get wiped out on two, on one you get a push and the other one makes you the richest person in the country. I look at Steve Ballmer, the president of Microsoft, and I see that he bought stock very aggressively in the '80s, and now he is -- well, I don't know, he's lost some huge amount this week because of Microsoft -- but, you know, he made the bet, and I view him as an investor, as opposed to Gates, who is a founder. I don't want to be the guy who says, "I'm so afraid of Visicalc that I'm going to pass on Microsoft."

I want to be the guy who says, "I will stay in Yahoo! and I will stay in AOL. I will drop the one that gets out of the game." I feel, and I hope we address this later, that Bob Davis and Lycos (LCOS) took themselves out of the game when he decided to go into the shipping and handling business as opposed to the Net business. But I don't want to look back and say, "Visicalc kept me out of the biggest hit of my life."

Tomorrow: Will MP3 wipe out the record companies?

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