Internet boom may have local spillover THE surge of money into internet stocks in the US has raised questions of whether another technology bust is on the way or whether the euphoria behind the successful listing of LinkedIn and other internet businesses could spill over into Australia's small but quickly growing internet sector. May 2011 was the busiest month in the US for technology initial public offerings (IPOs) since 2000. Several internet businesses listed at mind-blowing valuations, including business social networking company LinkedIn, which scored the largest valuation for a US internet company since Google went public in 2004. The IPO of these companies is seen as a curtain-raiser for the expected listing in the next 12 months of Facebook. Zynga, which supplies online games to Facebook, is also expected to list, as are Twitter and group-buying site Groupon. Australia's listed internet stocks, including Seek and REA Group, majority owned by News Limited, publisher of The Weekend Australian, command high price-earnings (PE) ratios, reflecting investors' strong growth expectations. The high margins they enjoy and their ability to lift revenue without significantly raising costs is attracting investment dollars. LinkedIn listed on the New York Stock Exchange (NYSE) on May 19, with its shares surging from an IPO price of $US45, valuing the company at $US4.3 billion, to as high as $US122 on the first day of trade. That's not bad for a company with profit of just $US15.4 million in 2010 and a net loss of $US3.97m in 2009. Its PE ratio is mind blowing, somewhere over 1000, depending on the day. LinkedIn is one of several internet companies that have recently listed in the US at staggering price premiums. All eyes are now on Facebook, with an IPO expected before April 2012. The company is valued somewhere between $US50bn and $US100bn, which is staggering because Facebook has only recently become profitable. Belinda Cooney, division director at Macquarie Capital Advisers and a survivor of the 2001 dotcom crash, expects strong listings for the US internet companies, irrespective of recent stockmarket volatility. Not only that, she says the expected high valuations are justified, to a degree, unlike the last technology boom. I would expect a high valuation on these companies, which reflects the expectation of investors of strong growth and earnings and it also reflects, in the case of Facebook, a very strong brand. So I can see it being an exceptional IPO. Groupon, Zynga, Twitter all have well-articulated business models and they are making revenue and growing strongly. Cooney, who worked for Macquarie Capital in San Francisco from 1999 to 2001 advising, investing in and raising funds for technology companies, says the current boom is different. There's some degree of exuberance. There's a lot of money on the sidelines chasing too few deals. However, there's a big difference between LinkedIn, for example, and the technology companies who listed in the last boom, in that it is making cashflow, growing strongly, and many of the companies which are listing today, or planning to list, have clear revenue models. Back in 1999-2000, many technology companies didn't have that. But many observers are not convinced by the numbers or the flow of money. Alvin Chan, a portfolio manager with AMP Capital Investors and an analyst of domestic stocks, including the technology sector, says a bubble is in the making. "The current values garnered by LinkedIn, Facebook -- mooted to be as much as $US100bn -- and Groupon certainly seem like bubbles, in our view," he says. To date, most of those companies have not clearly articulated how their earnings are derived and, as such, investors are being asked to 'trust me' yet again. While the US has been a buzz of activity, the Australian markets are quiet. But with so many high-profile floats in the US, the mood could change. "If there is a bunch of listings this year in the US, I would expect there would be a positive effect in Australia and it will get people thinking about an IPO to raise capital," says Tony Glenning, investment director with venture capital firm Starfish Ventures. "There's increased interest in the group buying sector; we're seeing more acquisitions and interest, such as Yahoo7 buying Spreets and Consolidated Press buying an interest in the Catchoftheday site," adds John Dyson, who co-founded Starfish Ventures and has listed technology companies on the Nasdaq and the ASX. Yahoo7's January purchase of daily deal website Spreets for $40 million follows Ninemsn's launch of deals site Cudo in 2010. Recently, a consortium including Seek chief Andrew Bassat and James Packer's Consolidated Press Holdings invested $40m in online retailer Catchoftheday, which owns Scoopon.com.au. Macquarie's Cooney identifies group buying businesses as a possible source of future IPO activity in Australia. These deals sites are similar in model to the US sites. They are not of a substantial size right now, but they are growing rapidly. But with six sites leading the Australian market -- Cudo, Spreets, Jump On It, Living Social, Scoopon and Our Deal -- "there would likely be consolidation before any one business goes public, so as to be a reasonable enough size for a successful IPO," she says. Rob Hopkins, co-founder of Smallco Investment Manager, says Australia's successful internet companies are commanding price premiums well above those of other industrial stocks in expectation of their strong earnings. That includes Seek, with a PE of 29 for the 2010-11 financial year (though that has been marked down from 40 due to disappointing earnings from its education division) and REA Group, operator of realestate.com.au, which has a PE ratio of 23 and "is doing very well despite a downturn in the property market," Hopkins says. The market still likes internet stocks a lot. I think that's because we are still getting a big shift out of print advertising to online and that still has a long way to go as there are still quite a lot of advertisers who have yet to move ads online. But that's changing. These internet companies will be the beneficiaries, at the expense of traditional media companies like Fairfax. They have a high return from funds employed, so their marginal costs are low but their marginal profits are very high, which is reflected in their relatively high valuations. REA group, for example, are changing their business model from billing agents to getting home owners to pay premium rates for advertising online, so they are getting a lot more money out of individuals. AMP Capital Investors' Chan says local internet companies have different business models from those listing in the US now -- and they are bound for growth irrespective of what happens there. Many of our listed internet and technology stocks like Seek, Carsales.com, Melbourne IT and iiNET are companies with a positive track record of earnings. They all use the internet as part of their business model to connect consumers to consumers or businesses to consumers, and more of their revenue is transaction based. That's unlike the social media companies, such as Twitter and Facebook, which rely heavily on advertising for revenue. Not only that, they have achieved critical mass in their sectors, says Macquarie's Cooney. These are very well-established companies. Seek has been a fantastic success. Carsales.com, Realestate.com, Wotif.com, they are market leaders in their category. For investors seeking to cash in on the technology boom, here or in the US, there's still hope. Most of the international share funds available to Australian investors already have some varying exposure to technology stocks (as well as to other sectors). This currently averages 11.5 per cent," says Phillip Gray, communications manager at Morningstar Australasia. The giant $9bn Platinum International Fund, for instance, had 16 per cent of its assets in technology and related companies at May 31, 2011. So if investors want to get access to Facebook and other similar upcoming floats, these companies are likely to be considered by their existing fund manager. If you want greater exposure, there are just five Australian-offered technology-specific investment trusts available. They are BT Technology (Retail), CFS MIF-Global Tech & Communications, CFS Wholesale Global Tech & Communications, Fiducian Technology and Platinum International Technology. Only time will tell how they will perform.