Above the Crowd

Dot-com Double Take

April 23, 2003:

“You may be right
I may be crazy
But it just may be a lunatic you’re looking for”
     – You May Be Right, Billy Joel

It seems like just yesterday that the Internet bubble burst, and we all came to terms with the fact that our Internet dreams may have been a wee bit optimistic. Why did we all think it is possible to take two MBAs with no work experience and change entire industries? We must have all been loony. Of course, the poster children for the Internet crash were those crazy consumer Internet deals. Those were the infamous “dot-coms” – a term so endearing, it eventually became a direct euphemism for “bad business.”

Don’t look now, but many “dot-coms” are working. While most industries struggle to swallow the overwhelming effect of a prolonged lethargic economy, consumer Internet companies are just now hitting their stride. While telcos are still reducing capital expenditures, and enterprise CIO’s have cut their budget “another” ten percent, consumers are spending more and more dollars online. If you are convinced that there is no growth in this pathetically slow economy, perhaps it’s because you turned your back on these remarkably silly dot-com businesses.

The stock market has certainly awakened. Amazon’s market capitalization has climbed 79% in the past year to $9.7 billion. Yahoo, over the same time period, has climbed 63% to reach a corporate value of $15.0 billion. And eBay, the cream of the crop, is up 61% to a whopping $28.4 billion. That is more than fifty billion in value for the top three players in this newbie industry that seemed so un-business as we crashed to earth in late 2000.

Importantly, the rise in value does not stop with the top three. Barry Diller (who, by the way, never fell for that “consumer Internet deals are stupid” line) has been very busy stitching together a $15.8 billion consumer Internet dynasty. Although these companies will not be reported independently going forward, Expedia, Hotels.com, and TicketMaster/CitySearch had respective market capitalizations of $6.5 billion, $3.9 billion, and $3.1 billion as he paid premiums to bring them exclusively into the USA family. Last December, USAi also snapped up European-based Udate for $150 million. When combined with Match.com, USAi has clearly claimed the lead position in the online dating space.

Other public Internet companies are seeing a resurgence, or at least holding their ground. WebMD, Verisign, TMP Worldwide (Monster.com), and DoubleClick all sport market capitalizations north of a billion dollars. Additionally, Overture, Earthlink, and RealNetworks are hovering in the seven to eight hundred million range. Even newcomer NetFlix has seen its stock jump from a 52-week low of $5 up to a respectable $22 per share.

Private Internet companies are also fairing well. Google is clearly the most watched private company in America. Last Sunday, The New York Times reported that Google may do as much as $750 million in revenues this year. Based on the revenue multiples at eBay, Yahoo, and Amazon, it would not be surprising to see this company worth $5 to $10 billion should it ever decide to go public. While not on the torrid pace of Google, other private consumer Internet companies are also gaining steam. Classmates.com and MyFamily are both profitable and aggressively growing subscription revenue businesses. BlueNile, an Internet jeweler in Seattle, is reported to have profitably recorded sales of $72 million last year.

Within our own portfolio at Benchmark Capital, we are seeing the same phenomenon. BetFair, the leading online gambling site based in Europe processes more than ₤50 million ($80 million) in bets per week. This represents 16,000 bets per minute. Epinions and Dealtime, two profitable companies that recently merged, are providing half a million ecommerce leads per day to thousands and thousands of the nation’s top retailers. With just 50 employees, eBags, also profitable, turns inventory 29 times per year and has a negative 27 day cash conversion cycle (like Dell’s) while shipping upwards of 50,000 bags per month.

Keen.com, a platform for enabling commerce- based information exchange, is enabling $1 million per week in commerce, and completed 750,000 paid transactions last quarter. Over the last 12 months, WorldWinner, the leader in online skills competition, has acquired 4.2 million new registered users who have played 69 million games resulting in over $47 million in tournament entry fees. OpenTable, the premier restaurant reservation network, delivered its one-millionth diner to its restaurant partners last September. Number two million will likely come next month, just eight months later.

Why are these companies working, especially in an environment where many high-tech companies are struggling?

1) They weren’t bad ideas:
In fact many were good ideas. Were there too many consumer startups? Yes! But there were also too many software companies, semiconductor companies, telecom equipment companies, and the list goes on and on. As we later learned, over-funding (i.e., too many startups with too much capital) was the key issue, not the particular investment category. Low-cost, high-scale marketplaces do in fact exhibit increasing returns. And these marketplaces have incredible “moats” (to borrow a Buffetism), that represent unprecedented barriers to entry.

2) Rationality set in first:
As the first to fall, consumer Internet companies were the first that were forced to recognize that money is not in fact cheap, but expensive, and that profitability is the real goal to the game. As such, these companies adjusted and learned lessons earlier than most. The results are apparent.

3) Quick capacity reduction:
Unlike many other sectors, capacity adjustments come quite quickly in the consumer Internet space. There is no such thing as a web site that is selling ads at a discount just to help offset fixed costs. There is also no heavy “infrastructure” that negatively affects the industry dynamics.

4) Internet usage growth is systematic, not cyclical:
Consumer spending may be down 5%, but online spending is still such a small percentage of overall consumer spending that growth results from the continued increase in online usage. With IT expenditures already at 50% of corporate capital expenditures, the opposite is true for traditional information technology spending.

Things are so good that last week Barron’s dusted off its charming fondness for everything Internet with a newly negative article titled Bubble Redux. It turns out that Barron’s is quite unhappy that consumer Internet stocks have risen in value and suggests that the “real” value of eBay, Yahoo, and Amazon are actually far below their current stock prices. Much to Barron’s disappointment, Jeff Bezos has not only survived, but he has recently convinced Barron’s own constituency, the institutional investor, that he is right. And there is one other thing that might be on their mind: much to Madison Avenue’s chagrin, it turns out that performance-based online advertising is the hottest sector in the overall advertising industry. Maybe they are concerned that their traditional “old-media,” impression-based advertisements will one day need to be accountable too.

Perhaps being a dot-com isn’t so bad after all.

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