Michael Armstrong, the CEO of AT&T, is by all accounts a serious executive,and not the kind of guy given to seat-of-the-pants decision-making. So the news that AT&T offered to buy America Online for a sum somewhere close to $25 billion is a problem for all of us who view the current valuations of Internet stocks as evidence of short-term mania on the part of investors looking for somewhere to put their capital. AT&T's not going to invest that much money in an acquisition unless it believes that it will reap huge long-returns from that investment, and that means Armstrong must think AOL is worth considerably more than the market currently believes it to be (around $19 billion when AT&T made the offer). At the same time, AOL wouldn't have turned down the deal without a second glance if Steve Case didn't think that AT&T was making a lowball bid. (Rumor has it that AOL wouldn't even think about anything below $30 billion.)
Now AOL is the one truly successful Internet company (Yahoo! may qualify as well), and it has regularly delivered steady earnings growth over the last year. And one can see the logic of a combination between AT&T and AOL, particularly at a time when MCI/WorldCom has been looking to corner the Internet infrastructure business. But the evidence still seems to suggest that Armstrong was, though not crazy, then just wrong, and that AT&T was lucky to be rebuffed so quickly.
We're not talking, after all, about a $19 billion investment in AOL stock (though even that seems more than sketchy at a time when Internet valuations have overflowed the boundaries of anything that could be considered rational--click here for an earlier column on this subject). We're talking instead about spending $19 billion to acquire a company whose real assets are its customer base, its brand name, and a whole lot of modems. AOL has leveraged those assets into a powerful business model. But it has not leveraged those assets into a business powerful enough to justify the incredible premium that the Street now gives to each penny that it makes. Once AOL became part of AT&T, all of its dollars would go to the same bottom line, yet AT&T would have paid literally 10 times more for each AOL dollar. No matter how fast the Internet is growing, no business that derives all its revenue from subscriptions and advertising will ever be worth that kind of money.
Potemkin Villages in Cyberspace
What, though, about the burgeoning market in e-commerce, which AOL will presumably be taking a slice of? The only reasonable answer to that question is: "Who knows?" E-commerce will undoubtedly become an important part of the way people shop and the way companies do business. But it's hardly certain that, as the most recent issue of Business Week suggests, Internet commerce will be "a powerful agent that will transform the way nearly every product and service is created and sold." Still, perusing the magazine makes obvious the allure of the Internet for companies like AT&T. The medium is still so young, and the economics of it are still so flimsy, that entire Potemkin villages can be erected in a flash.
For instance, Business Week's Peter Coy suggests that e-commerce may increase U.S. GDP by $10 billion to $20 billion annually by 2002. Set aside for the moment the fact that, in a $7 trillion economy, $20 billion is a drop in the bucket, and consider instead how Coy got this number. He takes a projection by Forrester Research--a key Internet analysis firm--that e-commerce will reach $350 billion by 2002 (up from just $22 billion this year), then argues that doing business on the Net saves business 5 percent to 10 percent in costs, then assumes that half of those savings are passed along to consumers, and that consumers will spend all the money they save. Presto! You've got your GDP increase.
The problem here is that the entire scenario is based on four assumptions for which there is literally no hard evidence. Considering that Forrester's entire business depends on the importance of the Internet, it'd be hard to see their estimates as completely unbiased. But even if they are, how can we realistically judge whether or not the projections are accurate? The rest of the assumptions are, if anything, even flimsier. Five to 10 percent savings sound good, but all Coy cites is "the experience of a wide variety of early adopters." Are early adopters, who tend to be tech-savvy, typical of most businesses? Again, who knows?
All businesses need to plan, of course, and while the future is contingent it's not entirely undecipherable. But the Internet's future, for all intents and purposes, is, and what's troubling about the rush--by both investors and real companies--into the business of the Net is that the only news they seem to be hearing is the good news.
A Fun Exercise
Just for posterity's sake, save these predictions by Forrester, and four years from now, pull them out and see how well the firm did:
E-commerce in 2002: $350 billion
Durable goods manufacturers' e-commerce by 2001: $99 billion
Wholesale e-commerce: $89 billion
Books, music and entertainment in 2001: $3.8 billion
Travel by 2001: $7.4 billion.
By the way, when you realize Amazon.com has a market cap of $4 billion, and Forrester says the entire online market for books and music three years from now will be only $3.8 billion, how can the word "tulip" not come to mind?