Are These Internet Stocks Overhyped?
Bobby is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
If we’ve learned one thing from the dot-com bubble, it is that we’ve really learned very little. Sentiment, rumor, and in general, hype still tends to carry greater influence than cold hard facts, financial results, or even profits. When companies create their revenue through the internet or promise to start creating revenues somewhere in the future, the market sometimes regards this as a mystical process that does not follow the same laws the market normally adheres to. Currently we have a number of stocks that are overinflated by hype, but a correction is sure to follow just as a bubble will always burst.
Not that long ago, Yahoo! Inc. (NASDAQ: YHOO) was the leader in two markets, but it has slipped into third spot behind Google (NASDAQ: GOOG) and Facebook in the display ads market, and as a search engine, it barely commands 6% of the market. Its market share in display and search advertising is set to slip further in coming years as Google’s dominance grows.
As though that isn’t bad enough, its investment in Alibaba.com, contributing more than 40% in value to the Yahoo! share price, is not being handled well by chief financial officer Tim Morse. Morse has been overcome by vagueness when speaking about issues surrounding its holdings in the Asian company. I expect more bad news from Yahoo! as it struggles to sell its Asian assets and its stock is sure to bear the brunt, causing longsuffering shareholders to wonder whether Scott Thompson will be another name in a succession of short lived CEOs.
The Chinese internet television company Youku, Inc. (NYSE: YOKU) is the closest equivalent to a Chinese Youtube, but it also includes professional productions like serial television shows, movies, variety shows, sporting events, and music videos. The other common denominator between the companies is their lack of profits. This has not deterred Youku in any way from trading with a market capitalization of $2.26 billion. Despite the share price falling from the heady highs of $69.95 in April of last year, the share price is still overvalued at around $22.
Looking at Youku’s figures, there is hardly a number that isn’t in the red. It starts out with a gross margin of 24.8% in the black, but this quickly runs into trouble with a net profit margin of -0.22% and earnings before interest, taxes, and depreciation margin is -18%. Clearly it is only a matter of time before this overvalued stock will get its just deserved correction from the market.
Another copycat of a U.S. model, E-Commerce China Dangdang Inc. (NYSE: DANG) tries to replicate in China exactly what Amazon.com has done so successfully in the U.S. and in the rest of the world. From a business model standpoint you must say that this has been proven to work.
Dangdang’s results aren’t backing this up though. Its latest set of results has shown growth in sales, but there’s an ever-increasing loss per share as its margins continue heading in the wrong direction. In the last quarter its operating margin has increased to -12.1%.
Dangdang’s problems originate from being the third biggest player in the online retail market in China behind Yahoo!’s Alibaba.com which owns 49% of the market and 360buy.com with 18% market share. Dangdang’s margins will only be squeezed further by price pressure and increasing marketing costs to compete against the two bigger players. This battle is an exercise in futility.
A common problem for internet stocks is the low barriers to entry the industry inherently carries. SINA delivers a host of services to online users, including email, search, classified listings, blog, micro-blog (the twitter of China), and social networking solutions. It’s a hegemony that sounds a lot like Yahoo!, doesn’t it?
It has a further problem in that it has yet to figure out how to generate revenues from its twitter-like service despite its growing popularity. There are also two other players in the micro-blogging market in China, Tencent Holdings and Sohu, causing it to throw more of its resources into marketing.
While Sina might still come good in future, its stock is highly overvalued on hype at the moment. Trading down from a high of $77.60 earlier in February and $142.83 in April last year, it will still drop further from its current price of around $61 and $4.05 billion market capitalization.
If you thought the companies featured earlier have problems with low barriers to entry, Groupon (NASDAQ: GRPN), has been particularly afflicted as a company that has nothing resembling a protective moat. After all, what’s to keep anyone from assembling a mailing list and sending out daily deals on behalf of other businesses?
Groupon has thus far dealt with this needling issue by acquiring the bigger competitors from the bunch, but there are an estimated 500 businesses offering similar services worldwide, 100 of them in China. It’s patently clear that Groupon cannot buy out all of its competitors indefinitely.
More bad news that could be waiting just around the corner is a legal question whether Groupon is selling gift certificates in the form of shopping vouchers. According to legislation in some states vouchers are not supposed to expire or in some cases, only after 5 years. This could be a game changer for the whole industry if legal opinion finds against Groupon.
The final threat in this three-pronged attack on the company is a pressing problem of rising costs, in particular marketing, selling, general and administrative expenses. As its cash reserves become depleted, Groupon will have to find a way to combat competitors instead of buying them out – it faces the challenge of creating a moat. Until then its share price around $19 and market capitalization of $12.47 billion looks grossly overvalued.
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