By David Sterman
It appears as if we've finally shaken the ghost of the dot-com bubble. The Nasdaq Index has been moving up sharply during the past few years and now trades at levels seen back in 2000, and a few recent dot-com IPOs are now valued in the billions of dollars. Yet as I noted in this article, investors may be setting themselves up to repeat history, assigning market values to companies that still have a lot to prove.
Simply put, any company that is worth $8 billion, $9 billion or even $10 billion needs to be treated as a hot young growth stock for years to come if investors are to see any further upside. That's why I reflexively gravitate to stocks that appear to embed a much lower level of expectation.
I also like to see these stocks move out of favor, at least temporarily, when a real sense of value can emerge. That's why I recently put Zipcar (ZIP) in my $100,000 Real-Money Portfolio. It's also why I tend to hold off pursuing a recent gainer like real estate data service firm Zillow.com (Z). Zillow's shares have risen roughly 40% in the past three months, and I'd rather check it out on a pullback.
But a pair of other dot-coms is squarely in the doghouse, and their current valuations seem to sharply discount potential strong growth to come...
1. Ancestry.com (ACOM)
Tracking a family tree has always been a lot of fun, and this company makes it easier than ever, offering a set of online tools that track the branches as they spread outward from the tree. The company has garnered great buzz from a companion TV show, called Who Do You Think You Are?, which airs on NBC.
After a late 2009 debut, Ancestry.com settled into a predictable groove. The company topped estimates, issued bullish forecasts, and shares marched ever higher. Analysts began to speak of 30% or 40% annual growth, and investors got pretty carried away.
Shares are now far from the peaks of last spring, in part because management warned investors last fall that growth was starting to cool from a torrid pace. This was partially the result of a change in pricing schemes to emphasize longer-term subscriptions and reduced customer churn.
Clearly, this is a company entering into the second phase of its growth cycle. Sales rose more than 30% in 2010 and 2011, but are likely to rise at half that pace in 2012 and 2013. Considering less than 2% of all Americans have looked into their family histories, it's reasonable to assume decent long-term growth as the metric moves up to 3% or 4%.
Analysts at Dougherty & Co. say investors are now too bearish on the company's prospects, and predict shares could rebound back to $35, or nine times their projected 2013 EBITDA estimate. Goldman Sachs has an identical price target, noting that peers tend to trade for 12 or 13 times EBITDA. And this is my main point: it's best to pursue more reasonably-valued dot-com plays.
Ancestry.com, with a multiple lower than its core earnings growth rate, fits the bill.
2. Carbonite (CARB)
Talk about cheap. If you exclude this company's cash balance, its enterprise value (a metric that calculates roughly what a company would be worth in an acquisition) stands at just $160 million, or less than two times projected 2012 sales.
Carbonite offers cloud-based data storage for consumers and small businesses. It's a crowded field with plenty of competition, but the company has built a strong base of more than a million customers that's likely to grow along with the market. Cloud computing is a $1 billion market now and analysts expect it to grow to $2.5 billion by 2014.
Yet investors have fretted that it's hard to gauge this company against its earnings prospects. Carbonite is spending heavily on marketing to build up its customer base, so the company is unlikely to be profitable before 2014. Carbonite's $72 million in cash should help mitigate any concerns of financial troubles. More important, on a per-customer basis, Carbonite is quite profitable. The company expenses all costs associated with attracting a new subscriber in the early months of a contract, even as revenue is deferred over the life of a contract. This means the company's cash flow should build nicely as the subscriber base matures.
Still, this busted IPO sells for less than half the peak levels it saw soon after its August 2011 IPO. From a recent $9.30, Merrill Lynch says shares should rebound to $16. This target equates to four times projected sales, which is still below the multiples seen by other cloud-based businesses such as Cornerstone OnDemand (CSOD) and Concur (CNQR).
Risks to Consider: Though investors no longer hold these companies to exceedingly high expectations, they are still expected to grow at a good pace in coming years. Any signs that growth is stalling out should probably seen as a reason to sell the stock.
The market is full of new dot-com business models that carry high expectations. If you want to ride the dot-com wave, then focus on lesser-priced stocks like these two examples.