For all the talk of Bubble 2.0, the Internet has investment characteristics that investors normally have to wait decades to see: phenomenal growth in front of it, and deep-value characteristics.

When is a company a deep value?

  • A great balance sheet: Cash on the books and no debt, so that you know there is zero chance the company will have financial troubles anytime soon.
  • Strong cash flow: Hypothetically, if a company has a market capitalization of $100 million and earnings of $10 million, that's a 10% earnings yield. Compare that earnings yield with other comparable investments (for instance, a Treasury bill at 4%) and you can determine which is the better investment. Part of the calculation involves determining if those cash flows are stable. Will the company consistently earn 10%? If the company is growing, then you've got the best of every world -- it's like a bond, where the coupon is actually increasing over time.
  • Right now, there are several deep-value plays in the Internet world; I've written about some of them in my Internet Review newsletter.

    RealNetworks

    RealNetworks ( RNWK) posted earnings Thursday night that failed to impress the market. Let's take a step back and look at the fundamentals.

    The company announced it will have $800 million in cash at the end of the fourth quarter. It will have $100 million in debt, so that's $700 million in net cash. The company also will have about $250 million coming to it as a result of its antitrust settlement with Microsoft ( MSFT). Those payments will be made over the 15 months following the fourth quarter. So now we're at $950 million net cash. That's $5.33 a share in cash, leaving the company with an enterprise value of $340 million, or $2 a share.

    Prior to the settlement, analysts were projecting earnings of 11 cents a share, which would amount to an EBITDA (earnings before interest, taxes, depreciation and amortization) of roughly 16 cents, giving RealNetworks a multiple of enterprise value divided by EBITDA of 12, or an earnings yield of about 8%. Note that 11 cents per share is significantly below its run rate of 24 cents a share.

    How stable is that earnings yield? With Microsoft now an ally and income having grown for the past five quarters, it's a fair bet that it's stable and growing. For the fourth quarter, RealNetworks forecast revenue of $81 million to $85 million. Analysts were hoping for $87.5 million, but RealNetworks said that the benefits from the Microsoft relationship won't really kick in until 2006. This is the reason the stock fell.

    And in case we were worried about its customer base, paying subscribers grew in the third quarter to 1.3 million, up from 625,000 in the third quarter of 2004.

    Does the company believe that its shares are a good value? RealNetworks, which is a member of the Internet Review's model portfolio, announced last quarter that it will be buying back up to $75 million worth of stock. It's already bought back $30 million worth, leaving another $45 million to go.

    I think the downside here is that the stock could fall to about $7 per share. I think upside is $9-$9.50 per share.

    VeriSign

    VeriSign ( VRSN), which is also a holding in the model portfolio, is the second deep-value play on my radar.

    The company has a healthy balance sheet, with $932 million in cash. Once the sale of the payments division to eBay ( EBAY) is completed, it will have another $370 million on the balance sheet, bringing cash and cash equivalents to about $1.4 billion. That's a bit more than $5 per share in net cash.

    It generated $433 million in cash from operations over the past 12 months. With a market cap of $6 billion and net cash of $1.4 billion, its enterprise value over EBITDA is now just over 10, giving it an earnings yield of about 10%.

    Over the past three months, the company has bought back more than $250 million worth of shares.

    Nonetheless, the stock is down more than 25% this year. Part of it has to do with the company's mobile content business, Jamba!. It suffered a severe slowdown this year, shortly after VeriSign paid $270 million for it.

    But VeriSign's core business is doing fine. It's the exclusive provider of the ".com" and ".net" domain names. If you register a dot-com with any domain name registrar, that registrar has to pay VeriSign $6.50. VeriSign just extended this agreement with the nonprofit Internet Corporation for Assigned Names and Numbers, ICANN, from 2007 to 2012. The number of paying users of their domain-name business has gone from 34 million a year ago to 44 million. This is steady cash revenue that goes straight to the bottom line.

    VeriSign's security business is also doing fine and is about to beat all prior expectations. With the sale of the payments business to eBay, eBay also guaranteed to buy 1 million security tokens from VeriSign.

    I'm also expecting the mobile content business to surprise people, particularly after VeriSign's recent (and cheaper) acquisitions of weblogs.com and Moreover Technologies, two aggregators of blog content -- content that can be distributed to mobile phones.

    I think the downside on this stock is where it just came from, the $19-$20 range, and upside is $30-$35.

    James Altucher is a managing partner at Formula Capital, an alternative asset management firm that runs several quantitative-based hedge funds as well as a fund of hedge funds. He is also the author of Trade Like a Hedge Fund and Trade Like Warren Buffett. At the time of publication, neither Altucher nor his fund had a position in any of the securities mentioned in this column, although positions may change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Altucher appreciates your feedback; click here to send him an email.

    Interested in more writings from James Altucher? Check out his newsletter, TheStreet.com Internet Review. For more information, click here.

    TheStreet.com has a revenue-sharing relationship with Amazon.com under which it receives a portion of the revenue from Amazon purchases by customers directed there from TheStreet.com.

    More from Investing

    Stocks Move Lower on Trade Fears and 4 Other Stories You Must Know Wednesday

    Stocks Move Lower on Trade Fears and 4 Other Stories You Must Know Wednesday

    9 Stocks Goldman Sachs Thinks Will Blow Wall Street's Performance Away in 2019

    9 Stocks Goldman Sachs Thinks Will Blow Wall Street's Performance Away in 2019

    Adobe-Magento Deal Highlights Escalating Cloud Wars

    Adobe-Magento Deal Highlights Escalating Cloud Wars

    Lowe's Q1 Miss Emerges as Home Depot Veteran Arrives

    Lowe's Q1 Miss Emerges as Home Depot Veteran Arrives

    Quick Read: 3 Things for Investors to Know Before Wednesday's Trading Session

    Quick Read: 3 Things for Investors to Know Before Wednesday's Trading Session