AO entry to the market

As we close in on the end of the month equity markets, at present, seem to be trying to put on a quarter-end rally. Tensions between East and West appear to have cooled once again, and news desks continue to focus on the possibility of increased monetary stimulus from various parts of the world. Equities were also boosted by the continued improvement in the data coming out of the US; one particular report of note was the increase in new durable goods for February. The report showed a split as transportation orders were strong while orders for machinery and electrical equipment were slightly weaker.

I know that much has been written on the topic of the recent valuations put on some internet-based businesses, either by public flotation or through acquisition. The one that struck me the most was AO World Plc, not a company I had even heard of until it was taken to the public market. It does make a profit, but on a valuation multiple of 175x P/E and 4.5x times its sales, investors must consider AO has a great deal of potential to grow. I am not judging that view, but I did reflect on Dixons (probably not the first person to do so), a company that appears to offering a similar service, with a market valuation at 30% of sales and a multiple of 15x its earnings (P/E). There may be good reasons for the anomaly and I am not recommending one should be investing in one company based on the valuation of another or vice versa. 

What I was reminded of though is how even the massed brains of the investment world can lose a sense of value every now and again. In 1998, Dixons formed a company called Freeserve, which offered free internet access to customers buying goods from Dixons. Freeserve listed on the stock market in 1999, with 1.5 million subscribers and it was valued at £1.5 billion; if I have my maths right, valuing each subscriber at £1,000. Freeserve was eventually sold to France telecom in 2000. 

The reason I raise the point is that once Freeserve was floated, I believe Dixons were left with about 30% of the company. There was a moment in time that the stock market valued Dixons' 30% of Freeserve at a greater value than Dixons as a whole. The market effectively attributed, at the time, a negative value to the rest of Dixons retail business. Something was wrong, either Freeserve was overvalued or Dixons as a group undervalued. All it goes to prove is that sometimes logic and the stock market, despite the combined wit of many, can get out of kilter. 

One thing you cannot take away from Mr. Roberts, who apparently founded the AO business on the back of a pub dare, when a friend bet him £1 that the then-26-year-old would not follow through on his plan to quit his job as head of sales at a kitchen company, has done very well Rodney. 

N.B. for those investors who like to value businesses on EBITDA: at the IPO price, AO was valued at 72x 2015 estimated EBITDA. Similar online businesses Ocado trades at 35x and Asos at 49x (source Bloomberg).

Posted on March 27, 2014 .