ba 572 - j. galván1 evaluation how much is an e-company worth?

BA 572 - J. Galván 1

EVALUATION

How much is an e-company worth?


Overview

The underlying logic for an E-Commerce company.

A five-step process to assess the business model.

Classifications of E-Commerce companies. Various business models. Implications of the business model. Long-term viability of business models.


THREE CASES

E-Greetings The opportunity of avoiding transaction costs

Neoforma The opportunity of disintermediation

Priceline The reverse auction model


1st CASE: E- greetings


The Underlying Logic

“Old Economy” contains market failures or transaction costs: Examples:

Information is not freely available, and is costly to gather and process.

Markets may be too fragmented and too dependent on local population (personal items for sale).

The “New Economy” company eliminates or reduces market failure or transaction cost.


The Underlying Logic

Note: The deficiency in the “old” economy is actually the opportunity for the “new” economy company.

However, for the opportunity to be profitably exploited: It should be significant. The company should have adequate resources. The company should have the ability to generate

revenues from customers. The company should be able to deter competition,

or differentiate itself from its competitors.


Sellers’ Transaction Costs

Order Taking Costs: Reduce physical facilities and number of employees dedicated to

process orders by accepting and processing orders electronically.

Recording Costs: Avoid the manual data recording process by connecting the users

electronically and allowing them to enter the data themselves.

Display Costs: Eliminate stores, employees in these stores, and paper catalogues,

by maintaining a virtual store.

Mailing Costs: Reduce physical mail sent to customers by sending E-mail instead.

Marketing costs: Replace mass marketing channels by direct marketing to relevant

customers only.


Buyers’ Transaction Costs Transportation Costs:

Avoid waste of time and money spent on travel to a physical store.

Timing of Transactions: Buyers do not need to change their schedule

according to the opening hours of the business. Web access to the entity’s virtual site is available 24 hours a day, seven days a week.

Information Gathering Costs: Avoid the costly activity of gathering information,

by using information on the Web and Shopbots. Information Processing Costs:

Buyers can save time and effort in understanding and processing information, or by using online software and tools.


Other Benefits of E-commerce Personalization:

By identifying customers, it is possible to offer each individual customer a personalized service and special offerings.

Price Transparency: The Web allows consumers to compare prices more

efficiently and more effectively, anywhere and at any time. Market Making:

The Web allows the creation of efficient new markets by the ability to aggregate cheaply many buyers and sellers from different locations and time zones.

Network Externalities: The larger is a network the more valuable it may be to its

members, rather than a smaller network.


The Five-Step Process

What market failures or transaction costs are addressed by the business model?

How effective can the E-Commerce firm be in reducing the market failures or transaction costs?

Will the E-commerce company be able to expropriate benefits from customers?

What are the necessary resources to conduct the business?

Can competitors erode profits?


CASE:Egreetings Network, Inc. (EGRT)


Egreetings Network, Inc. (EGRT)

http://www.egreetings.com/ EGRT is in the E-Card business:

Customer selects a card from an online selection of cards.

Customer personalizes the card. Customer specifies a recipient. EGRT delivers the card, which can be opened by

the recipient. EGRT also notifies the customer that the E-Card

was sent. Compare EGRT to paper card companies.


EGRT – Transaction Costs

Buyers (customers) save the following transaction costs: Transportation to a physical store. Timing of transaction (24/7). Mailing costs. EGRT retains recipient’s address, so there

is lower data-entry costs.



EGRT saves the following transaction costs (as compared to a paper card company): Display costs (no need for a retailer). Order-taking costs (no need to communicate with

a retailer). Data-entry costs (customer enters the data

directly). Inventory costs (no need for physical inventory). Printing costs (same card can be used by more

than one customer).



Marketing costs: Savings through personalization

(customer tastes). Complementary products.

No network externalities. No price transparency. No creation of a new market.


EGRT – Ability to Generate Revenues

Customers are willing to pay for paper cards. They should also be willing to pay for E-Cards.

However, the marginal cost of an E-Card is very low!

Fixed costs of content and systems are high. Competition may drive the price of an E-Card

to zero. Over 100 E-Card companies!


EGRT – Ability to Generate Revenues

Revenues: 1997 $ 505,000 1998 317,000 1999 3,100,000 2000 (6 mon.) 5,900,000

Converted from fee-paying customers to free service in November 1998.

Advertising revenues in 1999 and 2000! E-commerce sales negligible in 1999.


E-Greeting Traffic

0.01.0

2.03.04.05.0

6.07.0

Reach

0

500000

1000000

1500000

2000000

2500000

3000000

3500000

4000000

4500000

5000000

Reach Unique Visitors


EGRT – Traffic and Expenses

In December 1999, a high traffic month: 21 million visitors 184 million web pages viewed 10 million E-Cards sent

Spent about $50 million through the end of 1999.

Selling and marketing $20 million 1997-9. Operations and development (R&D) $15

million in 1997-9.


EGRT - Content

Gibson supplied 34% of cards and held 20% of equity.

In March 2000, Gibson was purchased by American Greetings, which has its own E-Card business.

NBC owns stock in return for advertising. EGRT can use NBC shows in content.


EGRT - Resources

Raised $60 million through preferred shares in 1999.

Raised $54 million in issuance of common stock in December 1999.

Had about $58 million cash and liquid assets as of the most recent public filing (6/30/2000).


EGRT - Survival

EGRT generates most of its revenues from advertising.

Can it survive for the long run on advertising?

Which companies are likely to generate higher advertising rates?

Does EGRT have a comparative advantage in E-commerce?


EGRT PERFORMANCE (1997-TODAY)

EGRT

NYSE


Summary e-Greetings

Understand well the current business model. Assess the opportunities for changes and

transformation in the business model. Assess long-term revenue sources for the E-

business. Assess long-term costs to operate the

business. Is the business viable? Can competitors erode

profits?


CASE: NEOFORMA


B-to-B Report (Neoforma)Ray Falci (Bear Sterns)

Company operates in the procurement of medical/surgical products.

Fragmented industry. A few large customers (hospital chains), but many

others too. Many suppliers.

Potential for disintermediation. IPO at about $14.

Shot up on first day to $60.9375. Research report indicates target at $79. Current price (10/31/00) of $1.781.



Valuation methodology: Assess size of addressable market. Assess transaction fee (3%). Predict various scenarios of market shares, and

probability of attaining them. Forecast revenue and cash flow for each scenario. Using P/E, get predicted price. Calculate expected price = multiply each scenario’s

price by the probability, and sum over all amounts.



As a second approach, addressable market changes for each scenario.

After finding the price at the end of 2005, one can calculate the annual rate of return to get from today’s price to the 2005 price.

The rate of return is used to calculate the 12-months target price.


Comments

Why do more favorable scenarios have higher P/E ratios?

For a company that had revenues of $1.1 million in 1999, getting to revenues of $660-$840 million in 2005 is not a small task.

Actual attempt to model cash flows. Nice attempt to use probabilities.


STOCK PRICES OF NEOFORMA (2000-2006)


Real – Option Valuation

The real-option valuation approach has one major advantage; it assumes path dependency.

Traditional present value of cash flows methods assume the future cash flows are given for all the specific future periods.

Usually, the assumption is that the firm is operating throughout all the future periods.

Uncertainty can be dealt with using probabilities for each cash flow (similar to Neoforma in 2005).



Real options assume that the firm can decide to stop certain projects (or abandon the whole firm) at periods prior to the ending period.

The option to abandon projects is value-relevant.

One way to model it is through continuous time and path dependency.



Useful in the pharmaceutical area, where a project that does not have promising consequences at a given milestone can be abandoned.

Useful in the E-Commerce area to assess the probability of running out of funds.

Useful in the E-Commerce area to assess the network effects of discrete steps or acquisitions. Signing on a major customer in B-to-B. Acquiring another network.


CASE: PRICELINE


Priceline.com

A reverse auction site The “name your price” concept can be

adopted to many industries. B to C with a twist Providing travel and other services to

individuals Commission revenues


The Business Model A customer makes an offer (the customer “names a

price”). The customer agrees to lose flexibility:

Exact departure times Connections A specific airline.

The customer is bound if the offer is accepted. Credit card is charged for transaction upon fulfillment.

Priceline matches a seller willing to sell at that price.


The Logic

Customers obtain lower prices at the cost of flexibility -- market segmentation.

Sellers can sell excess capacity without eroding current markets.

Sellers do not divulge discounts until a transaction is consummated.

Ideal for perishable goods. Use customers’ power. Enjoy transaction fees.


Potential Weaknesses

Consumers with bad experiences may deter others. Sellers may decide to do it alone, or extract benefits

(see warrant costs later). Others may begin similar businesses.

Patents. Actions against the patents. Governmental regulations may place restrictions on

the business model: mortgages. automobile dealers.


Facts about Priceline.com

Began sales on April 1998 Leisure airline tickets.

Expanded into other areas: Hotel rooms Mortgages Car rentals New automobiles Groceries Through licensee - garage sales


Facts about Priceline.com

April 1999 - IPO - sold 10 million shares for net proceeds of $144.3 million.

August 1999 - secondary of 1 million shares for net proceeds of $62.5 million.

3.8 million unique customers on 12/31/99. 3 million made initial purchase in 1999. Reasonable (at least 70% of lowest fare) offers by

customers in 1999 were 57% of all offers. In 1999, Priceline fulfilled 43.6% of reasonable offers.


Opportunities

Ancillary revenues Customers sign up for other services

(credit card, car rental, etc.) Exploiting other markets:

Telephone calls Expanding into other areas:

New/Zealand and Australia


Priceline.com 1999 10-K

Unqualified audit opinion. Cash and s.t. investments $172 million on

12/31/99. Accumulated deficit of $1.18 billion. Revenues of $482 million. Product costs $423 million. Gross margin of about $60 million. Should revenues be $482 million or the

commission revenues of $60 million?



Split expenses into: Sales and marketing $80 million. General and administrative $28 million. Systems and business development $14 million.

The gross margin of about $60 million is substantially less than the marketing, G&A and R&D expenses.

The business is still consuming resources. This is typical to businesses in their initial stages.



The most significant expense is the warrant costs of $999 million !!!

Priceline wanted to strengthen its relationships with airlines, who supply the leisure airline tickets (85% of 1999 revenues).

It offered airlines warrants (stock options) to purchase 20 million shares at an exercise price of $52-60/share.



The market value of one warrant is estimated at $55 (consistent with stock options to employees, see Black-Scholes assumptions).

Warrants are vested immediately. No restrictions on airlines.

Whose expense is it? Shareholders transfer a portion of the firm to

airlines (20 million over 164 million outstanding shares).

Market value of Priceline (using a price of $50/share is about $8.2 billion.


Priceline.com 1999 10-K Options granted to employees, officers,

directors and consultants in 1999 were 6.5 million.

No expense appears on the income statement for these options.

Barter transactions are immaterial. Cash used in 1999 operations $63 million. Capital expenditures in 1999 $27 million,

probably in excess of typical needs.


Financial Data

Quarter REVENUES CGS G. Margin SELL&MAR G&A R&D WARRANT

Q2/98 7.0 8.0 -0.9 6.6 3.1 3.4 6.6

Q3/98 9.2 8.9 0.4 8.2 9.4 2.8 8.2

Q4/98 19.0 16.7 2.3 8.5 3.8 3.0 11.5

Q1/99 49.4 43.7 5.8 17.1 3.7 2.2 0.4

Q2/99 111.6 100.7 10.9 17.7 5.5 3.5 0.4

Q3/99 152.2 133.6 18.6 21.4 8.4 4.6 88.8

Q4/99 169.2 145.1 24.1 23.3 10.0 3.8 910.8

Q1/00 313.8 264.8 49.0 40.4 18.6 5.9 0.4


Income Statement Ratios

Quarter G. Margin Sell&Mar G&A R&DQ2/98 -13% 94% 44% 49%Q3/98 4% 88% 102% 30%Q4/98 12% 45% 20% 16%Q1/99 12% 35% 7% 4%Q2/99 10% 16% 5% 3%Q3/99 12% 14% 6% 3%Q4/99 14% 14% 6% 2%Q1/00 16% 13% 6% 2%


Other Unique Accounting Aspects

Gross or net revenues Record commission revenues or total revenues

Are Priceline’s 1999 revenues $60 million or $480 million?

Rebates for complementary service 36 months Internet connection

Shipping and handling expenses included in revenues (and selling expenses).

Free or introductory offer is recorded as revenue and selling expense.


Other Unique Accounting Aspects

How is self-developed software accounted for? Over what period is it amortized?

When can an auction site recognize revenues? Sometimes needs to list an item for a specified

period. How should rewards be accounted for?

Current expenses or capitalized acquisition costs?


STOCK PRICES PRICELINE (2000-2006)

ba 572 - j. galván1 evaluation how much is an e-company worth?

Documents

display costs

mailing costs

following transaction

printing costs

egrt slide

transaction costs neoforma

information processing

dataentry costs customer