Split Signals on Yahoo, Same Wavelength for Hughes

Yahoo (YHOO)

Jim: Well, Mike, we’re back to one of our favorite topics, Internet stocks, and there’s no bigger name in the business than Yahoo. In fact, you could say it’s the market’s Internet bellwether now.

Mike: I suppose so. But to me, Yahoo is the quintessential situation in which you can love the company and hate the stock.

Jim: Then you’ll probably be surprised that I like this stock.

Mike: No! Are you telling me that you actually like a stock that has a price-to-earnings multiple of 770? I never thought I’d see the day.

Jim: I’ll give you a moment to catch your breath. Look, our readers well know that we’re not big on Internet stocks generally, because they trade at outlandish prices relative to the fundamentals of their business.

Mike: Relative to rationality is more like it.

Jim: But I think Yahoo stands apart. The company, of course, is probably the best-known multifaceted “portal” from which to search the Internet.

Mike: It’s more than a search engine.

Jim: Exactly. It also has, among other things, a major linkage to electronic commerce. You can go through Yahoo to reach something like 7,000 merchants.

Mike: In fact, I would say Yahoo is the only real example of what Web followers like to say is the first-mover advantage. It was first and it took off. People talk about Amazon.com being the first-mover in online book sales, but, of course it hasn’t made a dime of profit yet.

Jim: But Yahoo is making modest profit.

Mike: Very modest. I like Yahoo, Jim, and I think it’s run by a lot of smart people--and some of the least arrogant people in the business. The company will do quite well. But I keep going back to that P/E multiple of 770, and I say it’s ludicrous to even think about buying this stock at current levels.

Jim: Now just stop for a second.

Mike: I was in mid-stride!

Jim: You were delivering a soliloquy. It’s clear that a lot of people agree with you. Over the last 12 months, this stock has again tripled in price ...

Mike: But over the last few months ...

Jim: Right, it’s gone nowhere. It’s actually down about 4% since late March, which is about when all Internet stocks started to stumble, and now trades around $170.

Mike: So for several months this wonderful outfit hasn’t made its investors a dime. We’ve said this before, and we often get taken to the woodshed for saying it, but the proponents of Internet stock valuations are blowing smoke. Yahoo is a classic example.

Jim: Thanks a lot.

Mike: I’m talking about the parade of Wall Street analysts who claim to see nothing outlandish in this stock’s valuation. In fact, they call it a virtue that the stock is priced in the ionosphere. As I said, you can love the company and believe it’s going to keep growing, and still not see any reason to buy the stock at this level.

Jim: Well, I’m going to suggest buying it as a long-term, albeit speculative, play on the growth of the Internet, even at this price.

Mike: Speculative, meaning you’re likely to lose all your money.

Jim: No, speculative meaning you’re not buying General Electric. Of course Yahoo will be an extremely volatile stock, Mike. But over the long run, it will remain a leader in this incredibly fast-growing industry. And at least it makes a profit.

Mike: Profit with a small “p.”

Jim: Granted. But its revenue is also growing nicely. It has good management, as you said. It’s also the best-known brand name on the Internet.

Mike: Need I remind you that brand names are not everything? If they were, we’d all be staying at Howard Johnson every time we travel.

Jim: Fine, but it still counts for a lot in the wildness of the Internet, and Yahoo has a great head start in being a brand almost synonymous with the Net.

Mike: And when you’re trading at 700 times earnings and you make any mistakes, get ready to see your stock drop a couple of miles.

Jim: By the way, that P/E you mentioned is misleading because you’re looking at last year’s earnings. It’s trading for only about 350 to 380 times this year’s expected earnings per share, in the range of 40 to 50 cents.

Mike: Oh, I’ll sleep a lot better.

Jim: You know we have no argument about the wild price. I mean, the revenue of Yahoo for the nine months ended Sept. 30 was $388 million, and you know what its total stock market value is now? It’s $44 billion.

Mike: Right, and so are we to take it on faith that other investors will continue paying even higher prices for those kinds of sales and earnings, so you could ever sell your Yahoo stock for a profit?

Jim: You’re referring to the “greater fool” theory of investing, of course.

Mike: And you’ll never find me saying there aren’t a lot of fools out there. I’d just prefer not to join them.

Hughes Electronics (GMH)

Mike: Hughes Electronics is majority-owned by General Motors, but it has its own stock. And Hughes made its reputation in the fields of electronics and space, but guess what? It’s really a television company.

Jim: Yeah, Hughes was one of the first so-called tracking stocks, when GM created it in 1985.

Mike: If you own the stock, you’re simply betting on Hughes’ financial performance, rather than owning even a bit of the company.

Jim: Hughes, based in El Segundo, has long been a leading maker of satellites and telecommunications systems. It’s also the majority owner of PanAmSat, which has its own fleet of TV satellites. And most important, it owns DirecTV, the provider of TV programming that’s beamed to satellites and back down into your living room.

Mike: That’s right. Now, as you said, GM owns about 70% of Hughes right now, but there are a lot of people on Wall Street who believe that GM is going to unload all or part of that stake, and that’s one of the reasons I’d buy this stock right now.

Jim: Same here, because then investors could value Hughes on its own merits--undoubtedly at a higher price--rather than as a GM subsidiary.

Mike: And turn this Pinocchio into a real boy. So far the signals are mixed. Whenever GM is asked about spinning off Hughes, it says absolutely not, never, it won’t happen, don’t even think about it. Yet the Hughes crowd says it may happen pretty soon.

Jim: And Wall Street is convinced it will.

Mike: That’s because investors don’t give GM any credit to speak of for even owning Hughes. GM trades more or less like an auto stock without an electronics subsidiary. Yet it stands to make a pretty penny by spinning Hughes off and collecting that cash for some or all of its stake. And as you said, Hughes itself would do much better and so would its stock.

Jim: Right, and that’s a key reason Hughes’ stock has been bid up so sharply. The stock, now in the mid-60s, has almost doubled in price over the last 12 months.

Mike: But there’s another big reason for the rally.

Investors believe, and I agree with them, that DirecTV is going to be a great franchise for Hughes. It’s a good business, it’s in good hands. And its potential is enormous, particularly if, as we all expect, it gets the right to broadcast local TV signals with all its other programming. That will make DirecTV even more of an appealing buy for a lot of households that are sick and tired of dealing with their monopoly cable companies.

In fact, some people think GM should just spin off DirecTV, which sells for a lower value than its smaller rival, EchoStar Communications, simply because it’s buried within Hughes.

Jim: With DirecTV, you get well over 100 channels of programming beamed through your little pizza-size dish outside ...

Mike: And the signal is much clearer than you get on cable.

Jim: Yet the downside is that DirecTV can’t pick up your local TV stations.

Mike: Yeah. If you live in an area where you can’t get your local stations with rabbit ears, you still need cable even if you have DirecTV. But within a couple of months, we expect Washington to allow DirecTV to carry those local signals. That’s going to give it a huge lift.

Jim: DirecTV already expects to have about 8 million subscribers by year’s end, generating about $3 billion of revenue.

Mike: And 8 million subscribers is a good critical mass. That will enable DirecTV to start doing more of the things that cable programmers do, like making original programming and getting preferential deals with movie studios for first-run movies.

Jim: And there’s speculation that Hughes’ enormous satellite-broadcasting capabilities can be exploited further for delivering high-speed Internet access and data transmissions.

Mike: In fact, there’s a Hughes subsidiary called DirectPC, which offers high-speed broadband Internet access, although it’s mostly aimed at people in rural areas who can’t get it from a cable or telephone company.

Jim: All of which is why Hughes is a buy. But investors should always remember the risks here. Maybe we won’t get that legislation from Washington, and DirecTV’s subscription growth could slow. There’s also always the risk of satellite-launch failures. But Hughes is still worth the investment.

Mike: Agreed. They’re not making any money from DirecTV yet, it’s true. But considering what we just said about Yahoo, who cares about that?

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Write or e-mail with a stock you would like to see discussed in this column. Peltz ([email protected]) covers the markets and corporate financial trends. Hiltzik ([email protected]) covers technology and entertainment and is the author of the book, “Dealers of Lightning: Xerox PARC and the Dawn of the Computer Age.” Either can also be reached at Business Section, Times Mirror Square, Los Angeles, CA 90053.

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