Observations on FreePC, Free Everything, and such

Doug Bailey (Doug.Bailey@ey.com)
Wed, 10 Feb 1999 12:05:42 -0500

The Myth of Ubiquitous Freeness

The extrapolation that the advent of FreePC and other innovative business models harks to an emerging era where everything is free is misguided. FreePC's business model depends on the value of the information it gathers about its customers. If the people who purchase that information can't sell something of value for a profit to these people then the information FreePC gathers has no value. Even in Drexler's wildest dreams, value will exist in the form of nanobot software techniques, creativity, algorithms, and protection from the nanonightmare scenarios. Regarding FreePC, one problem I see with their model is that the people most likely to take advantage of their offer are the ones with minimal disposable income. A mailing list of every household with gross income of $20,000 or less is of minimal value to someone trying to sell exotic vacations, new cars, or high-priced clothing.

Net Worth

The idea that Amazon's gravy is in driving up sales with no regards to whether it is in the red or the black is a serious misunderstanding of what drives market valuations in the long-term. Amazon and other "Net" stock valuations are a product of two converging phenomena: (1) the belief that the Internet is the next great profitable commercial frontier, and
(2) a very small offering of visible securities attuned exclusively to
this new frontier. Big demand driven by most unsophisticated investors matched with a paltry demand equals rocketing prices. Why is the eBay CEO salivating for the date when he can cash out? Why is Compaq ready to spin off Altavista? Why did Books-A-Million jump on the news it was opening an internet commerce portal (though rationality settled in there and the stock retreated)? I don't mind saying I shorted Amazon and Yahoo in January and made a bundle. I hate that I made money off the ignorance of the unsophisticated investor.

These instances have occurred before. The railroad stocks of the 19th century, the airline stocks of the early 20th century
(as an amusing aside, when the airline stocks were forcing the railroad
stocks into the abyss one railroad company decided to IPO with the word "airlines" in its name and its IPO was a huge success), the biotech stocks of the early 90s all mirror whats happening with net stocks and tech stocks on a larger scale. Just as the word "Bio" or "Pharmaceuticals" or "-tech" seemed to carry some inherent cash flow with it in the early 90s, a firm that has a novel idea, maybe an interesting business model, and a majority of its business related to electronic commerce, is assumed to have some huge cash flow in the distant future just waiting to be had.

Unfortunately, no one has produced a model for justifying why Amazon has a market value higher than that most of the other booksellers combined. No one knows where Yahoo's market value is coming from. The common method of valuing securites is discounted future cash flows. Even once all its aggressive expansion costs are eliminated, Amazon's future cash flow predictions hardy warrant a $1 billion market cap.

The Information Economy

Much has been written about the new information economy of late, e.g., Shapiro's "Information Rules", et. al. I concede information will be more of a commodity in the future as its capture and transfer become less costly. However, if there is nothing of value to sell by leveraging this information then the information itself is useless. An information economy may exist one day but only in the realm of uploaded minds, competing superintelligences and robust MNT.

Doug Bailey

Obviously, my opinions stated above reflect my own opinions and not necessarily those of Ernst & Young, LLP.