[Slate] Insane in the Brain: Priceline.com

Rohit Khare (rohit@fdr.ICS.uci.edu)
Thu, 01 Apr 1999 16:05:34 -0800

"it's more valuable than United, Continental, and Northwest combined."

Jim and I have been having long arguments about 'sure it's gonna crash,
but how could you ever tell?" Well, this is how...

This is a company that completes 6% of its bids, and only 24% of
"within 35% of lowest APEX" for airline tickets. It's only a matter of
time before airlines do it in-house: who needs priceline to do your
yield management for you? That's what killed Pan Am, in the end.

Fine, so the company expects to make money selling hotels (same
objection) and mortgages (the brokers make the points anyway).

You can't be a 'meta-middleman' for long. Ebay is an example of a primary
middleware broker -- but outsourcing that?

Of course, the real indicator of doom (tm) isn't the analysis of their
S-1 business risks at all -- it's that rational pricing has gone out
the window.

You have a boom here driven almost exclusively by large-cap stocks --
so you say Priceline's eventual collapse isn't going to affect the
"real" market? Well, it *is* part of the problem: it went from
small-cap to large-cap in a single day.

Sure there isn't "Real Money" at stake here -- wipe out the entire
Internet sector and who'd care? After all, submerging markets didn't
sink the boom -- after all, that was only 3% of global valuation
anyway. 3rd world bond sales cratered from 100 billion to 25 billion
from 97 to 98 -- but who cares about such trifling rounding errors in
an age where AT&T can register to sell $6bn (and actually clear $8bn)
on its own?

And yet... if you move only a tiny fraction of money out of the US
equity market, the whole house can tumble down real damn fast. Only a
tiny fraction of money has to move back abroad, or back to safety.

A P/E of 26 on the S&P500 -- up from 15 a decade ago -- means that in
the current environment of .6% profit increases and 2.75% inflation, that
a share of SPY represent over two decades of future earnings.

The only economic fundamental that's changed is long-run productivity
growth is 2% instead of 1%. That means the US GDP will double in 35
years. So fine -- that'll be $18 trillion in GDP (barring a
nanotechnological breakthrough). The current equity market is $6
trillion -- 2/3 of current GDP.

These are big numbers, and they're soon going to be smaller numbers.
at 40% of households in the market, you're at the saturation point
(for a country with 100+% personal debt loads). There is not enough
money on the sidelines to stop the next 3,000 point slide.

I sat down and reread Mackay's "Popular Delusions and the Madness of
Crowds" on the tulip, south sea, and mississipi bubbles. There's only
one common thread: every observer with common sense knew it couldn't
work at the time -- newspapers widely debunked them -- but *no one*
predicted when it would end. It was always sudden, and free-fall.

There will be no warning.

And with Internet day-traders, there will be the biggest rush for the
exits in history (yes, I know it's a vacuously true prediction -- it's
the biggest market in history).

Look around and ask who *isn't* fully invested in the market now.
Where's the money left for "buying on a dip"?

Adam believes there will be no crash because Greenspan cares for his
own ass too much -- he's up for reappointment and will just keep on
inflating the balloon. Maybe.

Me? I'm thinking 1982.

How many of today's traders and journalists even were *alive* in 82?
No one under 38 has a clue what's going to hit. At most, they're
thinking 1987. And they'll retort, '82 was a short recession'. But it
destroyed considerable value, and most of all, destroyed optimism,
Reagan or no.

Of course, that gloom shrouded the birth of the IT boom we're
currently riding. Perhaps the Internet will be the same way.


But I don't believe there's all this meta-money to be had. Amazon
could sell every book on the planet, and the profits wouldn't justify
its cap. So they'll sell something else, and something else, and just
be the veritable Sears, Roebuck of the new age. Bullshit.

Brands have to deliver value, not eyeballs. I have never "discovered"
a book at Amazon. In fact, I've never even ordered one. So maybe I don't
count. But cross this with the graying of America: the richest, oldest
segment of the population is the least likely to buy on-line.

Brands have to deliver value.

What does Priceline bring to airlines, mortgages, or socks?

I say all this as one who's fully vested in the market, almost all of
it on the indices. I'm shopping around to pull back -- and yes, there
just aren't that many attractive places to stash it for now. But I
intend to have that money around. A few hundred grand in the
depression venture capital market of 2003 when I graduate is going to
be a hell of a lot more powerful than $14 million in VC today.

Europe is no answer. They're too correlated to US movement, and
there's no sign that the recent wave of left-center "third way"
governments have anywhere close to the gumption to make real reform
happen. Same with Japan. India, maybe -- but what to invest in? The
markets are so underdeveloped.

Cal munis make a difference. At 6% tax-free, that's effectively 8.5, 9%.
If no one pulls an Orange County bankruptcy, that is.

Now, Krugerrands...



Big Ticket

By James Surowiecki

So Priceline.com, which last year lost $114 million on $35 million in
revenue, goes public yesterday and, in the space of one day, watches
its market capitalization rocket to $9.8 billion, which means, as
the New York Times pointed out, it's more valuable than United,
Continental, and Northwest combined.

There is only one possible response to this: GIVE ME A BREAK!

On the other hand, while Priceline.com is just the latest beneficiary
of the Internet feeding frenzy (which is back in full effect, as a
glance at AOL's or Amazon.com's stock chart for the past two weeks
will tell you), the comparison to the actual airlines is a telling
one, but not for the reasons that you might expect. After all, the
airlines do the actual flying for which Priceline merely sells the
tickets at a cut-rate price. The airlines own real planes, real
landing slots, and established brand names. Priceline has a neat
idea--though one that presumably could be duplicated by anyone--and
William Shatner (the company's ubiquitous shill). That Priceline
should be more valuable than the airlines seems, therefore, absurd.

And it is absurd, because the barriers to entry in Priceline's
business are so low. (If Amazon announced tomorrow that it would be
selling cheap airline tickets, would anyone be surprised?) But it's
not absurd because the airlines have real assets and Priceline
doesn't. It is the fact that the airline business is so
capital-intensive that makes it such a sketchy business to be in,
especially when on top of having to spend tons of money to operate
you have to worry about oil prices, cyclical demand, and very little
pricing power.

As many people (including Bill Gates just last week) are fond of
pointing out, in its entire history the airline industry has
probably created zero economic value, which is to say that its
return on invested capital has never equaled the cost of that
capital. So it's not surprising that airline stocks are cheaper
than, well, just about every other sector out there. If you invest
in airlines, you're investing in a business that is, almost by
definition, inefficient, and that is going to put your money to less
productive use than hundreds of other companies.

The odd thing is that we're all glad that someone wants to run the
airlines, and even that someone wants to invest in them (which keeps
them afloat). But the experience of the airlines points up a crucial
truism (much-reiterated here) about capitalism, which is that in a
perfectly competitive market, there is zero economic profit to be
made. As it happens, the airline industry is a long way from being
perfectly competitive, mainly because the majors have a stranglehold
on landing slots at the big airports. But it's close enough, and
it's capital-intensive and cyclical enough, to erode competitive
advantages very quickly. And since investors look for competitive
advantage as a source of earnings growth, they sensibly have tended
to avoid airline stocks (relative to other sectors).

The irony is that the Internet promises to be a market with as close
to perfect competition as can be imagined, which means that most of
these companies that are currently losing money are never going to
get close to profitability. A business like Priceline has the great
virtue of requiring almost no capital to run it, which gives it a
better chance of earning a reasonable return on the capital that is
invested in the business. But how it will keep competitors at bay is
completely unclear. So the comparison with the airlines is a
valuable one. Just not for reasons that either Priceline or the
airlines would like