Warren Buffett shuns technology companies, because he believes "they are beyond his circle of competence". That is great wisdom because "knowing what we know and don't know", believe it or not, is a trait that not many people can claim. Didn't we witness the mad days of late 1990s when everybody thought he or she was a stock-picking genius? Not coincidentally, most of the mayhem happened in the technology sector, which few people fully understood but all believed it would change our lives forever.
I do not claim to be an expert technologist, but I happened to have worked in a number of technology firms for many years. There are many technologies that will truly transform our lives, such as the internet, but they do not always come with high investment returns for the general public. Technology is a double-edged sword. It holds incredible promises, but sometimes the promises are either illusive, or although real, are nothing more than the cheese on a mouse-trap. It has these perilous characteristics:
- Because the promises are high, it is usually a crowded field. But it is also a field where the winner takes all. If you bought stocks of PC makers in the 80s, are you sure you would have picked Dell? Or Yahoo and Ebay for the internet stocks?
- The field is incredibly dynamic and disruptive. New players come on the field every day, and the old guards are continuously toppled. Who have heard of Cray Computer now, once the pinnacle of high-tech? Sun Micro Systems thought Linux could dethrone Microsoft's Windows operating system, but it was itself who got critically wounded. "Economic Moat", in the tech field, is often a transient concept. The established companies, in order to keep their edge, have to keep devouring the upstarts to either keeping them from competing or acquiring the new technologies. They are also forced to pour increasely larger sum of capital in R&D to fend off competitors. The investors are dealt with a delimma: investing in an upstart means a rocky and uncertain road ahead; investing in an established old guard means shareholders' values often getting destroyed by acquisitions or increasing capital spendings.
- Stocks of tech companies are often more volatile, imposing a much more severe testing of investors' psychology, patience and war chest. A hands-off approach like Warren Buffett did with his companies may not be practical.
In short, it is hard to pick a winner in technology, and harder to pick a winner that excels in delivering shareholder's values. However, money can still be made from a tech company, just like from any other company, as long as one forgets about the technology part of the technology company. By ignoring the promises and the aura of technology, one can apply the same time-proven value investing principles, and profit handsomely off the occasional opportunities afforded by volatility of quality tech companies. The future promises, even quite possible to materialize, should be treated as icings on the cake, rather the cake itself.
In previous issues I discussed my valuation of three software companies, BEAS, HYSL and EMBT. In the first case, an opportunity presented itself two years ago when the stock was virtually downgraded by every analysts. It has more than doubled since, and upgrades piled in. For the latter two cases, I am still waiting for opportunities to strike.
Here I will try to valuate another company with a technology flavor, IAC/InterActiveCorp (IACI). IACI is not technology company in its standard sense. Its main stables are Home Shopping Network and TicketMaster. But it also holds many popular internet upcomers such as Match.com, Ask.com, LendingTree.com, RealEstate.com, CitySearch.com and Evite.com. These different moving pieces are not easy to have their values pinned down. Maybe that is the reason why IACI does not get much lime light.
|IAC/InterActiveCorp: Market capitalization $8.2B (5/26/2006); Predictability Ranking|
|Business Segment||Revenue (2005)||Revenue Growth (2005)||Operating Income (2005)||Valuation||Valuation Basis|
|HSN US||$2b||6%||$140m||$1.3b||8x op. income for a slow-growing business|
|HSN International||$380m||11%||$5m||$0.25b||65% of sales as in HSN U.S.|
|Cornerstone||$700m||$80m||$0.7b||8x op. income|
|TicketMaster||$950m||24%||$190m||$3b||16x op. income for a fast-growing business|
|Lending||$368m||$55m||$0.4b||8x op. income for mortgage-related business|
|Real Estate||$58m||($30m)||$10m||hard to estimate|
|Call Center Teleservice||$337m||15%||$23m||$230m||10x op. income for the growth rate|
|Media & Advertisement|
|Ask.com||about $360m||$80m||$1.85b||price paid by IACI to acquire the company|
|CitySearch and Evite||$30m||($13m)||$15m||half of sales|
|Timesharing||$273m||6%||$86m||$700m||8x op. income for a slow-growing business|
|Personals||$250m||26%||$44m||$0.7b||16x op. income for the growth rate|
|Discount/Coupon||$217m||flat||$11m||$90m||8x op. income|
|Corporate||($200m) excluding one-time||($1.6b)||8x op. income|
The total value of IACI comes to about $7.7 billion, or $22 a share. The basic assumptions used in making these guestimates are: 1) for a business growing at single digits, a valuation of 8x operating income is applied, so that the PE coming out of it would roughly be 13; 2) for a business growing at mid twenties, I use 16x operating income, or a would-be PE of roughly 27; 3) for business just emerging into or about to emerge into profitable territory, a percentage of sales is used. The biggest question in the equation is the value of Ask.com. IACI paid $1.85b for it in 2005. It is pouring a large sum of money into it to try to compete with the top three search engines: Google, Yahoo and MSN. The leader of the pack, Google, with 42% share of all searches, enjoys a $110 billion market cap. Should Ask.com, with 6% of search share, be valued at one-seventh of Google? Apparently not. A search in Ask.com does not equate a search in Google in terms of generated revenue. But the comparison does point out the potential upside Ask.com may get, if it can keep up its search share and grow its revenue. There is a possibility that search itself may become commoditized in the future, as different search engines become indistinguishable in terms of the quality of search results. Google may continue to gain search shares through its brand name, but there may still be enough room for smaller players (much like today's PC industry).
Besides Ask.com, Match.com also holds plenty of promises, as singles increasingly find mates online instead of offline. The market in U.S. is still not fully developed, but Match.com already attained a leader status. It is possible that it will develop into another billion dollar company like Expedia which IACI span off last year.
Dispite hefty promises, it is dangerous to buy IACI at prices much higher than $22. I am glad the recent market shakedown pulled its stock price toward this target. But I am still holding my breath waiting for it to drop a little more.
Although such patience may rob an investor's pleasure to ride the Google's IPO, it will almost certainly save an investor from participating a silly game of greater-fools.