CMGI: Don't do the math
By David Simons
Red Herring Online
March 23, 1999
CMGI (CMGI) stock has soared on the general perception that it's an
Internet venture capital fund. But the stock's valuation implies that
these venture investments will return up to thirty times what
high-tech venture capital funds aim for. Is CMGI really 30 times more
special than every other venture fund out there?
Before diving into that issue, it's worth noting that CMGI also has
large positions in publicly traded Internet companies, most notably
Lycos (LCOS) and GeoCities (GCTY), and that the market appears to be
insensitive to the volatility of these holdings. CMGI's other
positions in public companies include $100 million's worth of video
retailer Hollywood Entertainment (HLYW) and sub-$10 million stakes in
Amazon.com (AMZN), USWeb (USWB), OpenMarket (OMKT), and Informix
(IFMX).
As of March 19, the value of those holdings is down 17 percent from
CMGI's January 29 quarter end. Yet CMGI's stock now trades just 8
percent off its all-time closing high set March 8, and 50 percent
higher than it did January 29. If Lycos were to gain back the 27
percent lost since hitting an all-time closing high in the week
before the February announcement of the USA Networks (USAI) deal, the
value of CMGI's public holdings still would be down 5 percent from
January 29.
In other words, the market is ignoring the most basic benchmarks and
trading CMGI on emotion -- and a poorly quantified hope that the
damage done to CMGI's Lycos position through the USAI deal will be
undone by one that will restore valuation of Lycos to its all-time
high.
CMGI'S TRUE VALUE
As of March 19, CMGI's market value is nearly $9 billion. Based upon
CMGI's 10Q earnings report filing for the January 1999 quarter, we
estimate the March 19 net asset value of CMGI at $1.5 billion,
including the $1.8 billion market value of GeoCities and Lycos
holdings that are carried on CMGI's balance sheet at original cost.
Investment in non-public companies, also carried at cost, is $110
million. The market value of CMGI's public holdings is $1.9 billion
as of March 19. (It's $400 million greater than the $1.5 billion net
assets, due to debt and other liabilities.)
Boiled down, that means the price of CMGI stock is valuing the $110
million of non-public holdings at a multiple north of seventy. In
other words, the expectation is that all of CMGI's non-public
investments will return 7,000 percent -- although over what period
isn't clear.
By contrast, high-tech venture capital funds today seek three- to
five-year annualized returns of 50 percent, equal to 237 percent over
three years, 400 percent over four years, and 660 percent over five.
7,000 percent is 40 percent greater than CMGI's 5,000 percent
four-year return to date on all of its Internet investments -- most
of which is via 35,000 percent returns on Lycos and GeoCities.
However, the increasing maturity of Internet sector investing and
intensified business competition among Internet companies makes
future strikes of 35,000 percent far less likely. And the broader
experience of even the most stellar venture capital funds gives
strong odds that CMGI's investments won't repeat anything near 5,000
percent over the next four years.
For example, investors eagerly await the impending IPO of Critical
Path, which provides outsourced Web-based email to ETrade (EGRP),
Verio (VRIO), US West (USW), and America Online's (AOL) ICQ. But the
math is less exciting than the imagination provoked by the story.
CMGI owns only 5 percent of Critical Path -- 1.7 million shares,
which cost about $1.5 million. The current projected IPO price range
is $9-$11. Even if that's bumped to $13 and the stock doubles in
initial trading, CMGI's return will be only 2,900 percent. That's
spectacular as a twelve-month return, but it's a long way from the
Lycos and GeoCities returns that originally dazzled investors in CMGI
stock.
The Critical Path investment illustrates another factor: the cost of
stakes in startups has grown geometrically, which can reduce returns
despite the fact that valuations of IPOs are increasing. In 1998,
CMGI paid $1.5 million for 5 percent of Critical Path. By contrast,
$2 million bought CMGI 100 percent of Lycos in 1995; 38 percent of
GeoCities in 1996; and just 18 percent of Magnitude Network (increase
in stake from 5 percent) in 1998.
Escalation of investment cost can increase concentration of
investments, and therefore risk. Offsetting that risk requires
diversification, which CMGI has been pursuing feverishly. Six new
investments were made during the company's January quarter versus
three in the prior one. The total of nine in six months is four times
the rate of the prior two years. However, diversification also tends
to lower overall returns.
THE MECHANICS OF VALUING CMGI
Valuing CMGI isn't easy. The company's earnings are a poor measure of
the performance of its investments. Though less than 3 percent of
operating earnings are from CMGI's direct marketing business (which
has pathetic 3 percent pre-tax margins), the earnings related to
CMGI's Internet holdings include capital gains from sales of shares
in publicly traded companies such as Lycos and GeoCities and CMGI's
pro-rated share of operating losses of non-public companies in which
CMGI has holdings.
CMGI's share of losses in Internet startups says nothing about
valuation (lack of profit doesn't hinder Internet stocks). The
capital gains from sale of securities are similar to capital gains
recognized by mutual funds -- except that unlike a mutual fund, CMGI
does not regularly distribute them to shareholders. Cap gains, of
course, do not directly reflect what's most important: the net asset
value of CMGI's holdings.
What are those holdings worth? Even that is difficult to determine.
Public companies in which CMGI's stake is less than 20 percent are
reported on the balance sheet at market value as "available for sale
securities." However, investments in public or private companies in
which CMGI's stake is between 20 and 50 percent are reported at
original cost as "Minority Interests," and stakes greater than 50
percent are reported, also at cost, as "Investments in Affiliates."
This is further complicated by vast amounts of CMGI's investments
being held by CMGI's @Venture Funds, which are operated as private
venture capital funds. CMGI does provide some detail via confusing
narrative in its SEC filings. But there's no comprehensive and
formatted schedule of investments, including original cost and
investment date, shares, and current public or estimated "fair market
value."
Mutual funds provide such disclosure. Investors don't seem to mind
that CMGI does not.
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