Ailing stocks lower boom on dot-coms
By Matt Krantz, USA TODAY
Even the most die-hard fans of Internet stocks must be second-guessing themselves now.
The USA TODAY Internet 100:
Third quarter report
Just when many on Wall Street were hoping the tattered Internet sector would rebound, investors instead learned a tough lesson in the just-ended third quarter: There are no places to hide from the worsening dot-com massacre.
Betting on profitable Internet companies didn't even offer shelter. Look no further than Yahoo!, the very symbol of a profitable Internet company. Remember those who called it the Teflon Internet stock? It's not looking so tough now, after falling 27% during the third quarter, leaving it down 58% for the year.
Razorfish, a Web consulting firm, was also making money. But the firm still lost a third of its value in the third quarter as the dot-com blowup rippled.
What about Cisco Systems, which was supposed to win out no matter what happened to dot-coms, by selling Internet gear? Its shares fell 13% in the third quarter. And even Dell, hailed for its ability not only to get more than half its revenue over the Internet but to use it to shave costs, saw its stock slide 38% during the quarter.
Related stories and tables:
Changes to the Internet 100
Best and worst of the Internet 100
How the e-Consumer 50 did
How the e-Business 50 did
The USA TODAY Internet 100
"Blue chip Internet stocks took arrows in their backs" in the third quarter, says Andrea Williams Rice, managing director of Deutsche Banc Alex. Brown. "That's a big change from the past four years."
A big change indeed. Without bedrock Internet companies to support the sector, Internet stocks endured another dismal quarter. It's so bad, investors are wondering if the real lows are still to come.
There are no pockets of euphoria left, as investors are getting more cautious about companies building Internet infrastructure, which had been an unstoppable sector. And analysts agree that things are likely to get worse, as a drawn-out shakeout could soon whittle the number of business-to-consumer companies to less than a handful.
Thousands of dot-com worker bees have found themselves without jobs, as struggling companies announced layoffs. Even blue-chip Internet holding company CMGI just dismissed 175, or 13%, of workers in its Engage Internet ad division and a quarter of the workers at its AltaVista search-engine unit. Investors, such as Brian Head, 49, a print production manager for J.C. Penney in Dallas, can't stomach the swings anymore, even though he still thinks the Internet will revolutionize business. "I'm not going to buy directly into Internet stocks," he says. "I don't want to be out there on the cutting edge. I can't afford to lose."
Losing investor support for even the big names is another vote of no confidence for Internet stocks. While not as precipitous as the drop during the second quarter, the USA TODAY Internet 100 fell another 6.9% in the third quarter, leaving it down 10.5% for the year. In all, only two of the seven subindexes of the Internet 100, e-Services/Solutions and e-Financial, gained during the quarter. And e-Financial is up largely because of takeover rumors.
"We're seeing the unwinding of the excesses," says Cathy Baker, portfolio manager at RS Investment Management. Internet visionaries like to say falling stock prices within their industry don't harm their companies. Sky Dayton, the twentysomething founder of Internet service provider EarthLink, equates collapsing stock prices to bad weather: Neither can be controlled, but both make the survivors stronger. But in reality, the opposite has been true in the Internet economy, says Bob Hiler, analyst with Credit Suisse First Boston. Plummeting stock prices have already harmed the profitability and growth of surviving Internet companies.
"It's an interesting side of the Internet economy," Hiler says, "that the stock prices can (drag down) the fundamentals of the sector."
Consider the demise of Web consulting firms. For instance, iXL Enterprises said its third-quarter revenue would fall 20% below the second quarter's. Analysts say that shortfall was the direct result of the collapse of Internet companies that used to hire ixl Meanwhile, the dot-com bust also eased the urgency of some large companies to look for help to get online. Shares of ixl fell 70% during the quarter, parking them down 92% for the year. That soured investors on other Web consultants that haven't indicated any problems: Shares of Proxicom and Razorfish plummeted 59% and 36%, respectively, in the third quarter.
Better to get out than to risk being caught if things prove to be serious for more than just ixl, says Randal Chin, portfolio manager of Zero Gravity Internet Group, who disposed of shares of Web consultants Viant and Scient. "We had to face the music and sell."
Not even Yahoo! could escape the ripple effect caused by the crashing of Internet stocks. In fact, analysts are concerned Yahoo! won't live up to estimates for its third-quarter earnings because the easy money from free-spending dot-coms is drying up, Hiler says.
After all, Yahoo! gets 90% of its revenue from advertising, and much of that comes from Internet companies unlikely to get more funding from either venture capitalists or the stock market. Since banner ads on Web sites have proven ineffective, Doug Foreman, co-manager of TCW Galileo Aggressive Growth fund, wonders if large companies such as Gillette will ever pick up the spending where dot-coms left off.
"People at larger companies wear suits and go to meetings. It takes awhile for them to open purse strings," says Doug Foreman, co-portfolio manager of TCW Galileo Aggressive Growth fund. "We have to get past banner ads and have ads that can make you cry."
It may be no surprise, then, that the hardest hit subsector of the Internet during the quarter was Digital Madison Avenue. Already reeling over concerns about online privacy, fears about a slowdown in ad spending caused more suffering. The e-Advertising/marketing/media subindex of the Internet 100 fell 30.4% in the quarter, leaving it down 34.8% for the year. "We all knew dot-com spending would slow," Foreman says. But "the speed that (it) dried up surprised me," he says.
Investors also are no longer willing to pay any price for stocks of any company building Internet infrastructure. Investors started picking favorites in the third quarter, refusing to settle for second best.
Internet infrastructure "companies with questionable business plans are getting crushed," says Doug Hickey, CEO of infrastructure firm Critical Path, which saw its shares gain 4% in the third quarter.
Consider how shares of Juniper Networks have pulled ahead of Foundry Networks and Sycamore Networks. While they all came public last summer and soared in unison amid the same giddiness for infrastructure, Juniper rose 50% in the third quarter, as Sycamore fell 2% and Foundry dropped 39%.
Investors are even getting selective in the once-sizzling optical networking sector, where companies make gear that turns data into light that is fired through glass wires at high speeds. Both Juniper and Sycamore make optical gear, but Juniper's stock has been the runaway outperformer.
Even Cisco's shares have fallen, as Juniper's have skyrocketed, largely because Juniper is already selling high-speed routers needed to get full power from fiber-optic lines, says Martin Pyykkonen, analyst at CIBC World Markets. Cisco, on the other hand, won't have such products until year's end at the earliest.
Showing just how cruel Internet investing can be, many of the best stocks during the third quarter were in business-to-consumer sectors that had been left for dead: Half of the top 10 best performing Internet stocks were e-Consumer 50 stocks.
Despite the ad slowdowns, ZDNet was the fifth-best-performing Internet stock in the third quarter, thanks to its pending buyout by Cnet. And Homestore, thanks to a hot housing market and its exclusive rights to many real estate listings, was fourth, jumping 60% in the quarter |
