Internet valuations: The case of Terra-Lycos

Abstract

1. Introduction Terra started trading on the stock market in November 1999. The placement price was 13 euros per share (11.81 for retailers). In February 2000, its price stood at 139.75 euros. Between November 1999 and February 2000, Terra provided a return of 975% for its shareholders. However, by December 2000, the share price had plummeted to 11.6 euros, 8.3% of its February high. The average annual volatility of the Terra share was almost 100%. In this paper, we review twelve valuations of Terra performed by Spanish and non-Spanish bank analysts and brokers (2). We will start with the opinion of one Internet business analyst. Opinion of a Spanish bank analyst regarding the of Internet companies In valuing Terra, we encounter the same difficulties that make the of any Internet stocks problematic. Such obstacles include: the difficulty in finding fully comparable companies, the limited track record of the companies in the sector, which makes discounting cash flow analysis more challenging, the significant volatility of the sector, and the wide divergence of the multiples. To calculate the value of an Internet company, the following methodologies should be considered: a) Valuation by sum of the parts, applying the relevant multiples to each business line b) The application of the Price/sales multiple of listed Internet companies c) The book value, interpreted as the absolute minimum valuation d) A maximum calculated from the multiples of industry leaders (AOL, Yahoo, etc.) We consider that cash flow discounting is not the right tool for valuing a company like Terra. First, given the changes that the industry is experiencing (the Internet revolution) and the changes that the company could experience (new acquisitions), cash flow discounting would provide an incorrect valuation. In addition, almost all the value depends on the residual value. One could also discuss which are the right WACC and the appropriate perpetual growth. The right multiples are price/subscriber and price/sales. As all the Internet companies are still a long way from breaking even, in our opinion, price/sales is the most reasonable multiple for making comparisons. As the above lines show, there are analysts and managers who maintain that the Internet companies cannot be valued using the traditional method of discounting expected cash flows (3). This is not correct, it is a conceptual error, and it is the best recipe for creating speculative bubbles. An investor is prepared to pay a price for a share (which is a piece of paper) if by having this piece of paper, he expects to receive money (flows) in the future. Therefore, the share's value is the current discounted value of the expected cash flows (4). Otherwise, shares would be like sardine cans during the black market days in the 40's. There is a joke (5) that says that one black marketer sold a sardine can to another for one dollar. This black marketer sold it to another for two dollars and the third black marketer sold it to another for three dollars. The can continued to change hands and increase in price until a black marketer bought it for 25 dollars (an enormous sum at that time) and decided to open it. To his enormous surprise, he saw that the can was empty. He ran back to the black marketer who had sold it to him to get his 25 dollars back. However, this black marketer simply told him, How could you be so stupid as to open the can? This can is for selling, not for eating. This joke also illustrates perfectly the distinction (with no basis) that some people make between shares for investing in (to hold them for a long time, so they say) and shares to speculate in (to sell quickly, so they say). Expected cash flow discounting is the right method for valuing any company's shares. However, we should add that cash flow discounting should be complemented in certain cases with the of the real options, but not all Internet companies have valuable real options. …