Transcript 14 - InGesFor

EVALUATION
How much is an e-company
worth?
BA 572 - J. Galván
1
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.

BA 572 - J. Galván
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THREE CASES

E-Greetings


Neoforma


The opportunity of avoiding transaction costs
The opportunity of disintermediation
Priceline

The reverse auction model
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1st CASE: E- greetings
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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.
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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.
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Sellers’ Transaction Costs

Order Taking Costs:


Recording Costs:


Eliminate stores, employees in these stores, and paper catalogues,
by maintaining a virtual store.
Mailing Costs:


Avoid the manual data recording process by connecting the users
electronically and allowing them to enter the data themselves.
Display Costs:


Reduce physical facilities and number of employees dedicated to
process orders by accepting and processing orders electronically.
Reduce physical mail sent to customers by sending E-mail instead.
Marketing costs:

Replace mass marketing channels by direct marketing to relevant
BA 572 - J. Galván
customers only.
7
Buyers’ Transaction Costs

Transportation Costs:


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 waste of time and money spent on travel to
a physical store.
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.
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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.
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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?
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CASE:
Egreetings Network, Inc. (EGRT)
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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.
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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.

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EGRT – Transaction 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).
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EGRT – Transaction Costs

Marketing costs:
Savings through personalization
(customer tastes).
 Complementary products.




No network externalities.
No price transparency.
No creation of a new market.
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EGRT – Ability to Generate
Revenues




Customers are willing to pay for paper cards.
They should also be willing to pay for ECards.
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!
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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.
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E-Greeting Traffic
Reach
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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.
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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.
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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).
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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?
BA 572 - J. Galván
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EGRT PERFORMANCE
(1997-TODAY)
NYSE
EGRT
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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 Ebusiness.
Assess long-term costs to operate the
business.
Is the business viable? Can competitors
erode profits?
BA 572 - J. Galván
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CASE: NEOFORMA
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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.
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B-to-B Report (Neoforma)
Ray Falci (Bear Sterns)

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
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all amounts.
B-to-B Report (Neoforma)
Ray Falci (Bear Sterns)



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.
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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.
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STOCK PRICES OF
NEOFORMA (2000-2006)
BA 572 - J. Galván
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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).
BA 572 - J. Galván
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Real – Option Valuation



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.
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Real – Option Valuation



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.
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CASE: PRICELINE
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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
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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.
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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.
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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.
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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

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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.
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Opportunities

Ancillary revenues


Exploiting other markets:


Customers sign up for other services
(credit card, car rental, etc.)
Telephone calls
Expanding into other areas:

New/Zealand and Australia
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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?
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Priceline.com 1999 10-K



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.
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Priceline.com 1999 10-K



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.
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Priceline.com 1999 10-K



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.
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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.
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Financial Data
Quarter REVENUES
CGS G. Margin SELL&MAR
G&A
R&D W ARRANT
Q 2/98
7.0
8.0
-0.9
6.6
3.1
3.4
6.6
Q 3/98
9.2
8.9
0.4
8.2
9.4
2.8
8.2
Q 4/98
19.0
16.7
2.3
8.5
3.8
3.0
11.5
Q 1/99
49.4
43.7
5.8
17.1
3.7
2.2
0.4
Q 2/99
111.6
100.7
10.9
17.7
5.5
3.5
0.4
Q 3/99
152.2
133.6
18.6
21.4
8.4
4.6
88.8
Q 4/99
169.2
145.1
24.1
23.3
10.0
3.8
910.8
Q 1/00
313.8
264.8
49.0
40.4
18.6
5.9
0.4
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Income Statement Ratios
Quarter G. Margin Sell&Mar
Q 2/98
-13%
94%
Q 3/98
4%
88%
Q 4/98
12%
45%
Q 1/99
12%
35%
Q 2/99
10%
16%
Q 3/99
12%
14%
Q 4/99
14%
14%
Q 1/00
16%
13%
BA 572 - J. Galván
G&A
44%
102%
20%
7%
5%
6%
6%
6%
R&D
49%
30%
16%
4%
3%
3%
2%
2%
48
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.
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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?
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STOCK PRICES PRICELINE
(2000-2006)
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