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August 2000, Volume 68, Number 4 |
| Stock Valuation Traffic Drives Internet Stock Price
WHEN INTERNET PORTAL Excite@Home purchased electronic greeting card site Bluemountain.com for $780 million in 1999, the card site had neither revenues nor profits. Yet it was the third most frequently visited stop on the Web, with more than 9.2 million monthly "eyeballs," as Web site visitors are known in the dot-com world. What Excite@Home bought was precious customer traffic. When it comes to valuing Internet businesses or stocks, traditional measures of sales, assets, and profits largely fail, since most dot-coms have no net income, no hard assets, and few inventories. With virtually no financial clues to go on, Mohan Venkatachalam, an assistant professor of accounting, and two others have tackled the problem of how one begins to place value on such companies. By focusing on operational factors, they found that, as in the case of Bluemountain.com, Web traffic has become the key determinant in the valuation of Internet companies. Working with Assistant Professor of Accounting Shivaram Rajgopal and Associate Professor of Management and Organization Suresh Kotha, both of the University of Washington School of Business Administration, Venkatachalam examined 42 acquisitions of Internet companies in the year ending September 1999. The study uncovered a strong relationship between acquisition price and Web traffic: Acquirers paid a significant price $167 per Web visitor on average for traffic. The researchers also calculated that the number of "eyeballs" accounted for 77 percent of the variation in price among the companies in the sample. "We conclude that the stock market uses traffic as one important non-financial driver of Internet stock prices," says Venkatachalam. Being good accountants, the researchers naturally searched next for a correlation between Web traffic and revenues. But they found no robust links. What then, they wondered, was driving investors to value Web traffic so highly? What they found was that acquirers were paying for "network effects" or potential future sales that the traffic can bring. Alternatively, firms are aiming to get themselves acquired by more successful competitors. One should remember that many of these acquisitions are stock-based. Hence, firms may be using temporarily over-valued stock to buy out their competition. For example, Excite@Home bought Bluemountain.com for its huge visitor base. By incorporating that into the portal's base, more visitors might mean more transactions for some of the companies that advertise on Excite's pages. Excite could charge more for its advertising. And those who advertise are betting more traffic will lead to sales growth. "Perhaps what's happening is that these Internet companies are creating a massive virtual community," says Venkatachalam. "Users interact with one another and eventually this will generate revenues. Everyone will begin window shopping and after a while they will start shopping." The researchers noted that Internet companies typically invest heavily in developing a customer base, much as offline businesses invest in advertising and other cross-marketing to draw people into their markets. On the Internet, these marketing strategies include affiliate programs in which one site acts as a referral for another site and sometimes enjoys remuneration for completed transactions, alliances with Internet giants like America Online, and getting visibility in the traditional media, such as newspaper articles about a site. Some online companies, such as E*trade, even offer people as much as $75 to register at their site, effectively buying their customer base. So, using established Web traffic as a valuation metric makes sense. The researchers also note that such marketing efforts require cash, so financial constraints can prevent firms from chasing traffic. "We expect firms to be more forthcoming in non-financial disclosures because it will be some time before these companies make money," says Venkatachalam. Voluntary disclosures are especially important for small firms that do not get tracked by rating agencies such as PC Data Online or Media Metrix. Nevertheless, he says, financial measures are not completely useless even now. "You have marketing expenses that tell how well the company is using funds to enter the marketplace and R&D numbers to tell you how well the company is doing in technical development." Until real revenues and profits materialize, the marketplace will have to be content with forward-looking and nonfinancial indicators such as traffic. —BARBARA BUELL
"The Relevance of Web Traffic for Internet Stock
Prices,"
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The number of "eyeballs" on a Web site accounted for 77 percent of the variation in acquisition price. |
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