In Wired 2.09, I decried investing in Internet infrastructure, either hardware or software, concluding that the hardware folks are earning money but selling at unattractively high valuations, and that most of the software guys are just never going to earn a dime. Now I'll take on the content providers, end-user software producers and access providers. Although I see long-term possibilities in some Net-related markets, my short-term advice is to watch and wait.
Content with Content
Content is where the big money will be made - eventually. But there are only a handful of content producers I'd want a piece of, and the public offerings are slim. San Francisco-based C|net, of television and Web fame, marked the first content IPO when it went public in a moderately hot deal in July. But I suspect even the C-execs would admit they haven't a clue what the company will look like in five years. It makes no sense to invest in a company whose business model is so unclear.The first profitable content IPO should be E*Trade, the online brokerage system - its business model is sound, it earns money and it's large enough to sustain a public offering. The similar e.Schwab is too new and too small to affect the overall valuation of Charles Schwab & Company's stock. For the same reason, I wouldn't buy into McGraw Hill, Dow Jones, Time Warner, or Tele-Communications Inc as Internet plays. If Internet gaming catches on, Brøderbund and Electronic Arts will be well positioned, but I expect a slow Christmas season for video game sales and wouldn't look at either stock until 1997.
In evaluating companies, I look for five key factors: fast revenue growth over 50% a year, strong profitability above 15% pre-tax, at least 10% of sales spent on research and development each quarter, a management team with prior experience at a successful high-growth firm and a total company valuation of no more than 15 times growth flow (after-tax earnings plus R&D spending).
Call me a short-term pessmist but a long-term optimist. Wall Street sees content growing from less than US$100 million this year to $1.5 billion in 1998 and $10 billion in 2000. I think the market will in fact reach $35 billion in 2000 as businesses rush to market over the Net.
End-user Friendly
There are no public companies in the end-user category and no private ones anywhere near an IPO. In fact, this area is so nebulous that Wall Street doesn't even track it yet. But in the long term - when software comes not shrink-wrapped but in Net-delivered applets and we all buy our cars online - opportunities abound for creating little bits of software to make the Net more useful.
Access Denied
Pure Internet access is a commodity, and the luxury prices that ISPs are charging will fall to $3-$5 a month for unlimited access. Still, the local and long distance telephone companies need to "own" this market at any cost, which explains the bizarre price MFS Communications paid for UUNet, a plain vanilla ISP.The proprietary Internet-access model is even worse. The Microsoft Network abandoned its proprietary software soon after launch. Prodigy followed, then CompuServe threw in the towel. AOL has to be next. Wall Street pegs the Internet-access market at $250 million in 1996, $1.5 billion in 1998, and growing. That's about right - 75 million users in 1998 at $50 per user per year. Trouble is, no one makes any substantial money at $4 a month. Sell all ISP stocks in your portfolio until the price-cutting ends and investors can identify the survivors. Taking all five Internet segments into consideration, the market now totals $1.5 billion, mostly in hardware. By 1998, the total market will be $8.8 billion - a 230% growth rate - well balanced with content. By 2000, I expect a $43.4 billion market - representing a 225% growth rate from 1998 to 2000 - and content will be king.
TWIT$
Last summer, technology stocks plunged. The key driver for a great December quarter will be the rate of adoption of Windows NT by corportions. I'm gearing up for a year-end rally - and putting the rest of the TWIT$ cash to work - by purchasing shares in Seagate Technology, the dominant disk-drive supplier.
The Wired Interactive Technology Fund (TWIT$)
Company Primary Business Symbol Shares Price Oct 1 Since Sept 3 Action LSI Logic Corporation Semiconductors LSI 7,800 19 1/8 - 3/4 hold Applied Materials Inc. Semiconductor equip. AMAT 4,000 23 7/8 - 1 1/2 hold The Walt Disney Company Entertainment DIS 1,500 57 3/8 + 2 1/2 hold Apple Computer Company Hw/sw AAPL 4,800 21 1/4 + 4 1/16 hold Tele-Communications Inc. Cable television TCOMA 4,800 14 7/8 + 1/16 hold Intel Corporation Microprocessors INTC 3,000 77 + 7 7/8 hold Adobe Systems Inc. Software ADBE 5,000 30 7/8 + 13/16 hold Mattson Technology Semiconductor equip. MTSN 30,000 8 3/4 - 1 hold Euphonix Audio sw EUPH 17,000 7 3/4 + 3/8 hold Diamond Multimedia Multimedia hw DIMD 7,000 7 3/4 + 3/4 hold New Stocks Seagate Technology Inc. Disk drives SEG 300 48 7/8 buy
Portfolio Value $1,354,131.25 (+ 35.41% overall) +1.58%
Portfolio Value (£) £873,008.42
The Wired Interactive Technology Fund is a portfolio of share recommendations, which began investing a virtual stake of US$1 million on December 1st, 1994. Wired UK follows its fortunes monthly.
TWIT$ is a model established by Wired, not an officially traded portfolio. Michael Murphy is a professional money manager who may have a personal interest in stocks listed in TWIT$ or mentioned in this column. Wired readers who use this information for investment decisions do so at their own risk.
Michael Murphy is a money manager who publishes the California Technology Stock Letter.