1

Internet Industry

Paul BridgesBeverly ChinXinlin HuangJulia LeeAkif Unal

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Outline

Industry Overview: Beverly Chin and Akif Unal

Xinlin Huang

Julia Lee

Paul Bridges

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History of the Internet

Started in the 1960s Nov 1990 – 1st Web Server Aug 1991 – FTP 1992 “www” was released 1993 – 1st Browser

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Internet Overview (World)

679.7 Million people use the internet for various purposes.

%10.76 of the population uses internet Market => Not saturated yet, opportunities in the

market still exist 2004 estimate of internet users is 940 M. (with a

growth rate of 38.29%)

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Internet Usage

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Worldwide eCommerce Growth

Revenues        

  2001 2002 2003 2004

North America $908.6 $1,498.2 $2,339.0 $3,456.4

Asia Pacific $117.2 $286.6 $724.2 $1,649.8

Western Europe $194.8 $422.1 $853.3 $1,533.2

Latin America $6.8 $13.7 $31.8 $81.8

Total ($ B) $1,233.6 $2,231.2 $3,979.7 $6,789.8

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Size of the Internet Business

To illustrate the massive market size of the internet business, in 2003:

Forecasted Canadian GDP=>$ 860 Billion

Internet Business Revenue=>$3,980 Billion

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Internet Overview (USA)

2002 Internet Users => 118 million

2003 Internet Users => 151 million

%27.9 Growth from 2002-2003

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Significance of the US

The online markets in the USA are still witnessing strong growth as demand for the services continue to grow.

%22.2 of all internet users are in the US. Americans form%4.4 of the world

population.

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Growth in Selected Online Activities by U.S. Consumers: 2000-2002

 Growth rate

(2000 -2002)   (%)

2000 Number of U.S. Users,

2000

2002 Number of U.S. Users,

2002(% of all U.S.

Users)(% of all

U.S. Users)

Bank online 164 17 14 million 32 37 million

Buy or make a reservation for travel

90 36 31 million 50 59 million

Buy a product 78 48 41 million 62 73 million

Participate in an online auction 69 15 13 million 20 22 million

Play a game 45 34 29 million 37 42 million

Buy or sell stocks 40 12 10 million 12 14 million

Get hobby information 38 76 65 million 77 90 million

Get financial information 32 44 37 million 42 49 million

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Hypes of the Internet Industry

1995 - $5.3 Billion of revenues 1996 – Internet stocks filled the market

Demand > Supply 1997 – New Co. gains of 200% 1998 - $301 Billion of revenues

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National Survey of Canada

Geographical Coverage Full – Time Employees Age of Companies Most Widely Used Web Server Software Most Widely Used Web Operating System

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Crash of the Internet Industry

1999 – Supply greater than demand Major price correction Common stock fell as much as

80%

2000 – Crash of the Internet Industry

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Reasons for the Crash

Assuming the publishing model will workBased solely on advertising Inefficient strategies

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US Online Advertising Spending

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Reasons for the Crash

Getting there firstTry to get the first mover advantageLittle or no planning

Flying blind: No business success metricsTry to get into market quickly

Unstable business modelsAssumed to be infinitely scalableNo realistic plan for achieving profitability

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Reasons for the Crash (con’t)

Build IT and the rest will comeAbsences of market testingBelief that Internet itself will create value

Old economy business principle ignoredThought that the industry was immune to

normal business principles

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Reasons for the Crash (con’t)

New investment strategyMarket inefficiency

Growth at any costThought dominant market share as route to

profitability Inexperienced management

Lack of business knowledge

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Current Trend

Companies are careful about IT spending Past didn’t look at the cost of IT Present Value cost very carefully

Crash back to reality

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Current Trend (con’t)

Technology spending rebounding 1st gradual increases of tech spending

since 2000 However no chance of returning to the

free-spending days in 1990’s

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Future Trends

Personalization will increase

Security / Confidentiality will continue to be an issue

Wireless connections will be the norm

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Netopia (Utopia and Network)

In the near future the world will find itself in the Net’s embrace.

2005 – Sony One => telephone, a television set and a computer in one revolutionary set

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Netopia – (predictions)

Virtual education will be common 2010

In 2015 there will be so many viewers on the Web that television will be absorbed

In 2017, Japanese companies will offer virtual reality systems for home use

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Yahoo! Company Briefs Conceived by co-founders Yang and Filo in a

Stanford trailer in 1994; IPO in April 1996 The first online navigational guide to the Web No. 1 Internet brand with the largest audience

worldwide One of few profitable, publicly traded Internet

companies Much of its popularity built on its search directory Major competitor: Google – currently the most

popular destination for Web searches

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Yahoo! Company Briefs (Con’t)

Management Team Chairman and CEO: globally-respected media and

entertainment executive, 24 years at Warner Bros., joined in May, 2001

Co-founders as director and chief technologist Management team young and all joined after 2000

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Yahoo! Products Basic Products and Services free to

customers Revenue from fee-based premium services

Marketing services: paid search and online advertising

Fees: personals, enhanced email and DSL, event Webcasting

Listing: consumer and business listings-based services such as HotJobs, Yahoo!Autos, Yahoo!Real Estate

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Key Income Statement Items$ Million Dec-02 Dec-01 Dec-00 Dec-99 Dec-98

Sales 953.1 717.4 1,110.20 588.6 203.3Cost of Sales 74.7 90.5 109 73.3 18.6Gross Profit 878.4 626.9 1,001.20 515.3 184.7SGA Expenses 680.8 592.4 611.5 318.7 126.3EBITDA 197.6 34.5 389.7 196.6 58.4Dep. & Amort 109.4 130.6 69.1 42.3 10.2EBIT 88.2 -96.1 320.6 154.3 48.2Other Income 91.6 77.1 -33.7 37.7 14.6Interest Exp 0 0 0 0 0Net Income - Cont. Op 106.9 -92.8 70.8 61.1 25.6Net Income 42.8 -92.8 70.8 61.1 25.6Dividends/Share 0 0 0 0 0Basic EPS from Cont. Op. 0.18 -0.16 0.13 0.12 0.07

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EBITDA Margin

0.85

0.86

0.87

0.88

0.89

0.9

0.91

0.92

0.93

1998 1999 2000 2001 2002

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Key Balance Sheet Items2002 2001

Cash and cash equivalents $  310,972 $  372,632

Short-term investments in marketable securities 463,204 553,795

Accounts receivable 113,612 68,648

Prepaid expenses and other current assets 82,216 56,458

Long-term investments in marketable securities 763,408 580,418

Property and equipment, net 371,272 131,648

Goodwill 415,225 192,987

Intangible assets, net 96,252 19,457

Accounts payable $   18,738 $   13,218

Accrued expenses and other current liabilities 257,575 235,897

Deferred revenue 135,501 109,402

Minority interests in consolidated subsidiaries 31,557 30,006

Common Stock 611 581

Additional paid-in capital 2,430,222 2,067,410

Treasury stock -159,988 -59,988

$thousands

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Ratios from Balance Sheet

2002 2001

A/R Bad Account Ratio 0.17 0.23

Intangible/Total Assets $0.18 $0.09

Debt/Equity 0 0

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Consumers and Customers - Steady Growth; Product Monetization

Ending Users Q3'02 Q4'02 Q1'03 Q2'03 Q3'03Unique (M) 201 213 232 236 245Active Reg (M) 93 101 112 116 123Daily Views (M) 1,504 1,598 1,865 1,914 2,041Total (M) 1,798 1,912 2,209 2,266 2,409 FeePaying Cust.(Th) 1,550 2,200 2,900 3,500 4,200Total User Growth = 34%; Rev Customer Growth = 171%

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Rev. per Avg Unique User per Month

0.38

0.4

0.42

0.44

0.46

0.48

0.5

Q3'02 Q2'03 Q3'03

$

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Quarterly Revenue Trend by Product

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Quarterly Revenue Trend by Region - Significant Growth both in US and internationally for 2003

$ in Millions Q3'02 Q2'03 Q3'03 YOY QOQUSA 210.1 271.3 299.8 43% 10%International 38.7 50.1 57.1 47% 14%

Total 248.8 321.4 356.9 43% 11%

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Operating Cash Flow Trend

0

20

40

60

80

100

120

140

Q1'02 Q2'02 Q3'02 Q4'02 Q1'03 Q2'03 Q3'03

$million

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5 Yr Stock Performance

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1 Yr Stock Performance

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Fundamental Data

P/E  125.10 Mkt Cap.  27.36 BilEPS  0.34 Shares Out.  657.3 MilDiv/Sh  NA Exchange  NASDAQCur Div.Yield  NA Ticker YHOO

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5 Yr Comparison to Ind. and S&P 500

Yahoo! Industry S&P 500Sales growth 37.08 13.63 5.41

Dividends Growth Rate NA NA 0.48EPS Growth Rate NA NA -11.66Avg Gross Margin 89.8 68.3 47.4Avg Net Profit Margin 4.8 -93.8 5.4Avg Return on Equity 2.2 NA 12.1Avg Return on Assets 1.8 -27.6 2Avg Return on Capital 2.2 -33.4 5.8

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Current Comparison w/ Ind. and S&P 500 -1

Yahoo! Industry S&P 500Sales Growth (yr ago qtr) (%) 43.4 29.5 7EPS Growth (vs yr ago qtr) (%) 126.4 NA 31.4Current P/E Ratio 125.1 NA 33.7Market to Book Value 10.25 8.27 3.03Gross Margin (%) 93.2 76 47.8Net Profit Margin (%) 16.8 -3.9 4.6Return on Equity 7.7 NA 9Return on Assets 5.1 -1.7 1.4Return on Capital 6 -2.1 4

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Current Comparison w/ Ind. and S&P 500 - 2

Yahoo! Industry S&P 500Debt/Equity Ratio 0.28 0.28 1.24Current Ratio 3.1 2.9 1.6Quick Ratio 2.8 2.7 1.1Interest Coverage NA 2.3 2.8Leverage Ratio 1.5 1.6 6.2Book Value/Share 4.15 2.44 11.11

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Using the Pricing Model

Exp FCFE = 323.8*1.35/657.3 = $0.665 g = 0.35 (next 5 year avg.) Average k = 40% for 1997 - 2002

on the conservative side – excluding the price rise from end of 02

P(0) = $13.3 Current Price = $40

P(0) = FCFE(0)*g/(k-g)/#of com shares outstanding

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EVA Analysis

EVA = IC*(ROIC – WACC) There has been no long term debt and no

interest expense ROIC = ROE = 7.7% WACC >>7.7% EVA <0

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Prospects Growth – imperative for success Revenue Generating Product:

1. Marketing Service: New marketing and business solutions for both small

and medium-sized companies Upsurge in the realization of internet advertisement

usefulness Researchers expect the paid search market to

quadruple in 2005 from 2002. 2. Fees and Listing product volume also increasing

because of the overall demand and Yahoo!’s acquisitions.

3. Revenue per charged user is increasing

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Prospects (Con’t) International Expansion: sales steadily

increasing in the past; increasing opportunity to tap into foreign advertising markets, esp. in Europe and Asia

Alliances: myriad globally for technology and strategic Cooperation; the leading position in the industry enhances alliance opportunities – 5 in 3 months internationally

New Acquisitions: Overture: specializing in selling advertising links that accompany

search results on sites such as Yahoo and MSN Inktomi: Web search technology company, potential to replace

Google as Yahoo’s default provider

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Investor Recommendations Positive:

Profitable Growth Opportunities Solid Financials

Negative: P/B very high Most recent growth largely fueled by acquisition of Overture;

what if nothing left to acquire? $19 million sold by insiders – sign of potential

slowdown/liquidity needs? Recommendation: Hold - for the balancing forces

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Company Overview

Founded in July 1994 by Jeffrey Bezos Opened the “door” in July 1995 in Bezos’

400-square-foot garage (“Earth’s Biggest Bookstore”)

Went public in 1997 Initial mission: to become a leader in online

bookselling

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Company Overview

Jeffrey Bezos

- 32-years-old when he found Amazon

- drew up a list of 20 retail categories, and finally chose bookselling

- now 39-years-old CEO of Amazon.com

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Amazon.Com Today

“Selling anything you want to buy online” - music, DVDs, videos, photo items, toy, baby items, software,

computer, video games, cell phones, travel service and so on….

Operates the Internet Movie Database at www.imdb.com – provide varied service for entertainment industry

Operates six global websites : US, Canada, UK, Germany, Japan, and France

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Financials ( as of Nov. 13)

Ticker Symbol : AMZN Listed in Nasdaq # of shares outstanding : 401.1M Stock price : $ 54.80 Market Capitalization : $21.98 B 52-week high : $61.15 low : $18.43 Dividend : never paid cash dividend

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Financial Highlights

Sales : 4.75 B Income : –35.2 M Net Profit Margin: -0.70% Return on Equity : NA D/E ratio : NA Revenue/Share : 11.83 Earning/Share : -0.09 Book Value /Share : -2.89 Dividend : 0

(All data for latest 12 months)

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Ratio ComparisonAmazon Industry S&P500

EPS na na 43.30

P/E na na 35.4

ROE na na 8.6

BV/share -3.14 2.51 11.14

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Price History

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Dec-02 Dec-01 Dec-00 Dec-99 Dec-98

Sales 3,932.90 3,122.40 2,762.00 1,639.80 610Cost of Sales 2,858.00 2,375.00 2,105.20 1,281.80 145.9Gross Profit 1,074.9 747.4 656.8 358.0 464.1SGA Expenses 881.4 848.2 997.6 673.7 195.6EBITDA 193.5 -100.8 -340.8 -315.7 -49.7Dep. & Amort 87.8 129.9 322.8 282.1 12.1EBIT 105.7 -230.7 -663.6 -597.8 -61.8Other Income -71.2 -5.2 -273.9 -29.6 14.1Interest Exp 142.9 139.2 130.9 84.6 26.6

Net Income -149.1 -567.3 -1411.3 -720 -124.5Dividends/Share 0 0 0 0 0

Income Statement(Values in Millions)

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Performance Trend –Quarterly Results

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Segment Highlights

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Segment Highlights

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Balance Sheet

2002 2001 2000

Total Assets 1,990.4 1,637.5 2,135.2

Total Liability 3,343.2 3,077.5 3,102.5

Total Equity (1,352.8) (1,440.0) (967.3)

Debt to Equity ratio : NAAsset turnover : 2.9

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Cash Flow Statement

Basic Free Cash Flow

= operating cash flow less purchases of fixed assets

= 174,291,000 – 39,163,000

= $135,128,000

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Prospects

Began selling gourmet food on its Web store

Established a beachhead in Silicon Valley to develop a subsidiary called A9. A9 will be a new, separately branded and

operated company. Enables the company to invent and develop the

best e-commerce search technology for the Amazon.com Web site and to license to third-party firms as well

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Launched its new Sporting Goods store

- teamed with leading sporting goods merchants to offer more than 3,000 brands covering more than 50 sports

- announced strategic alliance with the Nautilus Group : its line of branded fitness products are available in Amazon’s new Sporting Goods store

Prospects (con’t)

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Valuation

Traditional valuation model not applicable - net loss for past years - significant stock price fluctuation - no dividend no reliable K can be calculated for the

purpose

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Valuation (con’t)

+ Internet’s No.1 retailer+ Customer centered company+ Strong brand recognition

- Accumulated Deficit- Intense competition - Significant indebtedness- Highly volatile stock price

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Recommendation

Hold

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United Online Inc.

Ticker Symbol UNTD Traded NASDAQ Stock Price $17.71

November 3, 2003 3:2 stock split Shares Outstanding 46,800,000 Market Cap 1,348,800,000

52 week range   $8.47-29.09

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Company Overview

Internet Service Provider (ISP) Specializing in value and free internet access packages

Only national ISP to offer free internet access Brands

NetZero Juno BlueLight

Most common pay package $9.95 Premier Speed Enhanced $29.95

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Company Overview

2.5 million active pay subscribers 150% increase (2002 1 million)

5.2 million active free access subscribers -16% increase from 2002

11% of the estimated 70 million households with internet access 15% of the narrow band households

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History NetZeroMarch

2001

April 2000

September 1999

October 1998

July 1997

Pay subscription Platinum service launched

QUALCOMM invests $144 million in NetZero

NetZero stock begins trading publicly on NASDAQ under symbol NZRO

Free Internet service launched

NetZero founded

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History United OnlineApril 2003

March 2003

November 2002

September 2002

March 2002

September 2001

June 2001

Company launches dial-up accelerator services NetZero HiSpeed and Juno SpeedBand

Juno and NetZero announce value-priced Platinum Internet Access for Mac usersUnited Online acquires Internet access and email assets of Bluelight.com from Kmart Corporation

United Online reports first GAAP Net Income

United Online announces first EBITDA profit

United Online begins trading on NASDAQ under symbol UNTD after the successful merger of NetZero and Juno

NetZero and Juno announce strategic merger, forming United Online

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Business Strategy

Use free access to entice Turn free subscribers to pay subscribers

2003 turned over ½ million Don’t use costly wide spread marketing

CD mail-outs Free trial period

Lower Brand Recognition Lower Cost of Subscriber

Compete on Price Majority of competitors charge over $20 $9.71 average price per pay subscriber

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Possible Threats

Move towards broad band Total narrow band users decreased in 2003

Competitors may decrease price UNTD’s competitive advantage is price

Decrease in ad rev GM not re-signing advertising relationship Change in demand and mrkt for internet advertising

Increase usage of subscribers

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Possible Threats

Telecommunication providers may change term of agreements

Possible litigation Copyright infringement

Seasonality Political instability in India

30% of work force located in India

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Possible Growth

Increase of low-income households accessing internet Historically low penetration rate (for internet) Price sensitive Large market

Release of accelerated internet access Compete with broad band

NetZero HiSpeed Juno SpeedBand

Large free subscriber base If convert to pay subscribers

Large database of subscribers Able to use in target marketing

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Management

CEO Mark R. Goldston Bounced around before joining March 1999

Chief Strategy Officer Jon O. FetveitMay 1999

CFO Charles S. HilliardApril 1999

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Ratios

P/E : 26 ROE 12.9% Dividends: N/A Net Income: 27,792,000 NI –ESOP 6,299,000 EPS 2003: .68

2002 (1.35) P/BV 6.63 FCF 2003 59,123,000

2002 (4,935,000)

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Last Trade: 17.71

Day's Range:

17.70 - 18.54

Trade Time: Nov-14

52wk Range:

8.47 - 29.09

Change:0.63 (3.44%) Volume: 1,037,538

Prev Close: 18.34

Avg Vol (3m): 3,547,181

Open: 18.37Market Cap: 1.15B

Bid: 4.87 x 100P/E (ttm): 34.39

Ask:30.63 x 100

EPS (ttm): 0.515

1y Target Est: 25.71

Div & Yield: N/A (N/A)

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Balance Sheet

There is no loan and very few liabilitiesLiability/Assets= 22%

High amount of current assetsCur Asset/Tot Asset= 77%

Asset Turnover .98

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I/S and Cash Flow

65% Increase in Rev 75% increase Billable Services

Expenses only increased 15% 89% of revenue is from pay services Positive net income and cash from operations Increased purchases of PP&E

300% increase

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Strength and Weakness

Strength No real debt to speak of Large base of subscribers New service package

Weakness Volatile stock price Intense competition Accumulated Deficit

Profitable in 2003

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Equity Valuation

Traditional valuation model not applicable

- annual net loss up until FY02

- significant stock price fluctuation

- no dividend

no reliable K can be calculated for the purpose

85

Recommendation

BUY