You're Only as Good as Your Choices Surprise! Some dot-coms are worthless! But then again, so are some companies with physical stuff. It's not what you have that matters; it's what you can do with it.
By Geoffrey Colvin

(FORTUNE Magazine) – What makes a company worthless?

It's an old question with a new twist as the inevitable wave of dot-com failures rolls on, most recently DEN (Digital Entertainment Network), a provider of online television, and Boo.com, an online retailer of clothing. Meanwhile, in the middle-aged economy, Chris-Craft recently sold its half interest in the UPN television network to Viacom for $5 million, which is the Hollywood version of zero. And in the old economy, BMW just sold the Rover car business to a group of British investors for 10[pounds].

This intrigues because so many new-economy companies have become so stunningly valuable with few or no physical assets. The greatest example--even at today's price--is Microsoft, worth $335 billion though producing nothing but pure thought from human brains. Plenty of dot-coms are working the same magic; even after the April crash, Yahoo is worth $68 billion. As we're always reminded, that's more than General Motors is worth.

Physical assets were beginning to look so awfully 20th century. Then the dot-com debacles started happening, and it was tempting to conclude that the worm had turned. Easy come, easy go, eh, DEN? No physical assets to absorb capital on the way up, but not a blessed thing to sell off for the investors on the way down.

The Rover story reminds us that it's more complicated than that. For here was a business with plenty of good old-fashioned assets--a factory, machinery, parts, and quite a few cars--and it still wasn't worth a thing. So though the new economy tempts us to think about these issues in terms of hard assets, there's actually a better way.

Try thinking instead about obligations and options. Those are all any company has, no matter what economy it's in. Obligations are pretty easy to think about; they tend to be contractual, and if their dollar value isn't precise, it can usually be estimated quite closely. Options--and we're not talking about the kind you buy and sell on Wall Street or get from your employer as part of your pay package--are another matter entirely, and they're where things get interesting.

A motley band of deep thinkers, mostly academics and consultants, have been working up a theory about options during the past few years. They call it real option theory. They're talking about the real-life options that companies face running a business: to expand into this or that business, to encroach on suppliers or customers, to raise or lower prices, and so on. Their innovation has been to analyze these options using the option-pricing theory developed at MIT in the '70s by megaquants Fisher Black and Myron Scholes.

What some of the theorists found, they said, was that many highflying dot-coms were worth every cent of their price because the companies had so many real options. Amazon, for example, could move easily into a vast number of new businesses cheaply, with a high chance of success, since it was already doing low-cost e-business with millions of customers. But it didn't have to move into those businesses; it could pick and choose entirely at will.

The dot-coms that have failed didn't face many obligations--leases, employment contracts--but their options were even fewer because they hadn't built robust relationships with paying customers. The balance tilted the wrong way, resulting in zero value. Same deal at UPN, which has more substantial obligations--contracts with affiliated stations and with program producers--and meager options for getting into new businesses.

Now use this model to think about Rover. As a company employing close to 20,000 unionized British workers, its obligations are enormous. And the key fact about its considerable physical assets is that, while they may have some value if sold, they powerfully limit the company's options as a going concern. What are you going to do with a rather small car factory? Not much, except make cars.

Physical assets aren't necessarily albatrosses, but by their nature they often limit their owners' options. Being in e-business doesn't guarantee you'll create wealth, as newly poor dot-com entrepreneurs realize, but it does tend to give you a shot at many low-cost options with few obligations attached. I don't recommend the options-and-obligations model for deciding whether a business is worth $60 a share rather than $50, but in sizing up whether it's worth a lot or a little--or nothing--it can reveal a great deal.