Heard on the Street
Web-Gear Firms Show Signs
Of Drawing 'Internuts' Mania
By SUSAN PULLIAM and TERZAH EWING
Staff Reporters of THE WALL STREET JOURNAL
Sure, at least some of the air has been let out of the Internet bubble. But a mini-bubble has emerged in recent weeks to take its place.
The new mania? Companies that provide the hardware and software to Internet concerns themselves. And the craze to buy the equipment companies that provide the switches and networks for the Web is beginning to show some of the hallmarks of the mania that led the bigger, and more familiar, Internet stocks into the stratosphere this spring.
Consider the explosive rise in the shares of Juniper Networks, which provides Internet infrastructure systems. Its shares have rocketed to 206.8125 from 138 on July 20. At Wednesday's close, Juniper is trading at a multiple of more than 136 times projections for this year's sales. It is anyone's guess when it will turn a profit. From its IPO, the stock has sextupled.
Meantime, many new issues have zoomed, even as the overall market for IPOs has hit the skids. Red Hat Inc. climbed from its IPO price of $14 last week to a high of $90.6875. Wednesday it closed at 71.50, up 4.25. SilverStream Software Inc., which nearly doubled on its first trading day Tuesday, fell back 20% Wednesday, or 6.3125, to 25.1875. Since its late July offering, Gadzoox Networks, a computer-networking company, has soared to 78.50 from its offering price of $44.375.
Redback Networks traded at 150 late last month; Wednesday, its shares closed at 212.25. Redback's valuations are the variety that are possible only in dot-com land: It is trading at 88 times this year's projected sales and has seen a ninefold run-up since its offering. Its market value at Wednesday's closing price is $4.5 billion.
Here is the theory behind the Internet-infrastructure craze. Net service providers are being forced to upgrade their technology to accommodate the huge growth in the number of Internet users. "The Internet needs to get to a level of scale that it didn't need before. Right now there are a couple of hundred million users on the Internet, and traffic is doubling every 100 days [meaning the number of people using the Internet at any one time]. The Internet was designed for one level of usage, and we've gone way beyond that," says Credit Suisse First Boston analyst Paul Weinstein.
The upshot: a need for more of the chips, wires and software that Internet so-called infrastructure companies provide.
But along with these red-hot valuations on equipment and software stocks have come red flags. Says Kenneth Heebner, portfolio manager at Capital Growth Management: "There are two things investors are ignoring here: There is no way they can grow into this valuation. And there is going to be competition." That's particularly so, he says, with access to capital so freely available from venture capitalists and the public markets.
Even if Juniper were (by some miracle) able to begin earning $30 million this year, for instance, it still would trade at 300 times earnings at its current valuation. "Work the arithmetic," Mr. Heebner says. "There is no way the earnings can get high enough to support this valuation."
Still, flashbacks to the earlier, heady days of Net stocks abound. Remember when analysts would set price targets for Internet favorites, like Amazon.com, that would be surpassed within days? They are having the same problem again. On July 27, Mr. Weinstein initiated coverage of Juniper Networks with a one-to-two-year price target of 200.
Instead of two years, it took only two weeks for Juniper to blow through that target. That is what is called "Internet time."
Mind you, Mr. Weinstein doesn't plan to downgrade Juniper from a strong buy anytime soon. To the contrary, he says: "As long as they keep beating expectations, I'll keep raising my price target. People want to own infrastructure stocks because we are at the front end of the cycle, and it's a multiyear, durable cycle."
Yet the popularity of Net infrastructure companies could turn on a dime. Indeed, e-commerce stocks got a sudden boost Wednesday after Merrill Lynch analyst Henry Blodget told clients in a conference call that he believes sentiment is turning back toward those issues. That could be bad news for infrastructure.
"We are throwing our hat into the ring," Mr. Blodget said. He advised buying some down-and-out Internet retailers, including Amazon.com, Barnesandnoble.com and eToys, along with service providers such as America Online and Yahoo!, on the theory that they will benefit from a strong back-to-school and holiday season.
"This has been a rocky summer for this sector. But if you are committed to holding until December and you buy them at this level, you'll probably make significant money," Mr. Blodget said. He even put together a "holiday basket" with eight Internet stocks he thinks will "benefit disproportionately from strength" in the sector later this year. His list included not only Yahoo, Amazon.com, America Online and Barnesandnoble.com, but also eToys, Lycos, Excite At Home and Inktomi.
Mr. Blodget's picks got a lift Wednesday amid an overall rally in Internet stocks. Yahoo closed at 145.0625, up 6.1875; Inktomi closed at 119, up 3; Amazon.com closed at 113.125, up 3.875.
But some investors insist not all e-commerce stocks will bounce back from their fall this summer. One big manager, for instance, says he believes certain Internet retailers -- such as OnSale, which has slid to 16.25 from a peak of 108 -- are unlikely to come anywhere near their old highs.
So far this year, IPOs of Net infrastructure companies have outperformed their e-commerce counterparts. The 94 nonretail Net IPOs this year are up an average of 71% through Tuesday from their offering prices, according to Thomson Financial Securities Data. The 40 Net retailers, meanwhile, have seen their shares rise by only 28.3%.
The argument for Internet infrastructure companies nevertheless has struck a chord among some institutional investors. Jay Tracey, a small-capitalization mutual-fund manager at OppenheimerFunds and an avowed believer in the future of the Internet, says he favors equipment and software concerns over e-commerce companies because they represent a more general bet on the Net.
If a company leads the market in network-oriented equipment or software that performs an e-business function more efficiently, he notes, that company will have as customers "not only dot-coms flush with cash but also Fortune 500 companies eager to compete on the Net."
Write to Susan Pulliam at susan.pulliam@wsj.com and Terzah Ewing at terzah.ewing@wsj.com
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