VALUATION: The High Price of Potential

By George Donnelly
CFO Magazine
Date Posted: 9/1999

Those insane internet-company valuations have created quite a buzz on Wall Street of late. Although they've come down closer to Earth recently, it remains hard to divine rational explanations. Now a study of the Internet industry has found at least a little rhyme, if not reason, to the values--and also hints at their ultimate direction.

After dividing the Internet world into four broad categories, "CyberValuation," a study by Bond & Pecaro, a Washington, D.C.-based media consulting firm, found some patterns behind the hysteria. The study analyzed 595 recent transactions within the industry, and found Internet service providers (ISPs) generally were valued at 5 to 7 times trailing revenue. Business-to-business ventures averaged in the 12 to 13 times trailing-revenue range. The highest valuations went to the portal (29 to 37 times trailing revenue) and Internet retailers (33-37 times trailing revenue).

Why such a wide gap between the various players in the electronic new world? Maturity and potential, explains Jeff Anderson, a principal at Bond & Pecaro who authored the study. He notes that the ISP industry is relatively mature, while the potential of the Yahoos and Amazon.coms of the world are anyone's guess at this point. Anderson sees parallels between the high Internet multiples we're now seeing and the early days of the cellular-phone and cable industries, before those sectors matured and market interest mellowed.

Of course, there are wide discrepancies even within Internet subgroups. When @home bought Excite recently, the company paid $6.7 billion, about 44 times trailing revenue. Yahoo's purchase of Broadcast.com cost the portal $5.7 billion, or 255 times trailing revenue. Both targets were portals, says Anderson, but Yahoo paid a premium for the potential of Broadcast.com, which is the leading aggregator of streaming media.

Anderson sees multiples rising as the industry expands. Then, after consolidation occurs, revenue growth rates will decline, as will valuation multiples, and "more traditional measures of value will have to apply."