Harmon: Pick Net stocks that defy gravity
Internet analyst and author Steve Harmon looks for 'zero
gravity' investments -- pure digital companies. Among his favorites: eBay,
Commerce One, Ariba, MatrixOne and FreeMarkets.
By Eneida Guzman
In an industry that seems to spawn hot-and-cold running experts with the same
frequency as new trends, Steve Harmon has managed to build a cultlike
following that has stood the test of Internet time.
He gained a following as a senior investment analyst for Jupiter
Communications, and built on his growing reputation with "Zero Gravity," a
book published last year in which he wrote about how companies go from
ideas to mega-million dollar IPOs (initial public offerings). Most recently, he
founded e-harmon.com, which he calls the "world's first full-spectrum Internet
investment firm."
The four-month-old venture, for which Harmon also
serves as chief executive officer, invests in Internet
companies at all stages of their business growth, from
startup "wannabes" through IPO to publicly traded
Internet maturity. The venture also includes a private investment fund, and Harmon
plans to open two Internet mutual funds in the near future.
In an interview with MSN MoneyCentral, the energetic, fast-talking Internet guru
offered his "fundamental truisms" on how to become a successful Internet investor.
The Internet space has changed drastically since you left Jupiter Communications
five years ago -- a lifetime in Internet years. What would you consider to be the
highlights in that time?
What I've seen since then has been a very interesting roller-coaster ride. From the
period of 1994 through 1998, the roller coaster didn't have too many highs or too
many lows; it was mostly flatline. In July of 1998, the Internet sector began taking off,
as retail investors began buying these stocks based on the fact that they were using
these Internet services themselves. And since July of 1998, it has been really a wild
mood swing. You know, one minute it's Viagra, the next minute it's Prozac.
How sector soared from fad to trend
Prior to 1998, there weren't really very many Internet issues. The sector was so
small at that point that many investors were still under the impression that the
Internet might be a fad.
That's true. The surge in Internet stock prices was more about people realizing that
we're four years into this commercial phase of the Internet. And I think Microsoft
(MSFT, news, msgs) was a big part of that. In late December of 1995, it embraced the
Internet and started showing products to the world. Investors thought: "Hey, if
Microsoft thinks it's important, it probably is." That lent a lot of credibility to the
Internet on a commercial level. (Editor's note: Microsoft owns and publishes MSN
MoneyCentral.)
Critics of Microsoft would argue that
the company was late to the game and
is still playing catch-up.
It was. But being late doesn't
necessarily mean that you miss out on
the action. And, being first doesn't
necessarily mean you win.
Four months ago you started
e-harmon.com, which you call the
world's first full-spectrum Internet
investment firm. Tell us more about what you're trying to do and how it's going so
far.
It's too early for hard-core return figures, but it's going well. The reason we call
e-harmon.com the world's first full-spectrum Internet investment firm is because no
one company in the world is investing in startups and in privately held companies, as
well as companies that are already publicly traded in the Internet space, and opening
funds to investors.
The reason why we are end-to-end investors is because the core of what we do is
focus on knowledge, on Internet intelligence and due diligence. This allows us to
apply our knowledge in any stage of a company. Knowledge is the most important
piece of understanding the different technologies, iterations and services that are
being thrown into the marketplace.
You are a hybrid between a venture capitalist and money manager. Those two
professions are distinct from one another, in that VCs look to make anywhere from
12 to 20 times their money in five years, and money managers typically look to
outperform either their sector or the market. How do you marry those two
disciplines?
We're taking our Internet intelligence and maximizing it via venture or public markets
to get a maximum return on our knowledge. That's our benchmark. There's no
comparing that to the Nasdaq ($COMPX) or the Dow ($INDU). Sure, you can
compare any product or a fund to those benchmarks, and on the venture side, you
can look to your return. But ultimately, the most accountable benchmark we have is
whether we are getting an appropriate return on our knowledge. That's the key.
How do you measure something like that? What type of returns should your
investors expect on your knowledge over time?
Our goal is to translate knowledge into return and measure it over the long term, in
percentages and in the quality of investments and companies created. So it is tough
to quantify that this early on.
The changing Internet model
The Internet business climate has shifted focus from business-to-consumer (B2C)
companies to business-to-business (B2B) e-commerce. What does that tell you about
the sector?
Well, it tells me first that the industrial applications of the Internet are far greater than
the consumer applications. That, to me, is a fundamental truism. Most of the action
actually happens on the industrial side of things, so the Internet is no exception. For
example, we see that in the telecommunications business -- most of the phone traffic
in the world is done between businesses, not consumers. Most of AT&T's (T, news,
msgs) revenues are derived from businesses using the network, not from consumers.
The fact that investors and investment firms are moving to that area is logical. The
first wave of the Internet was more consumer oriented, which was to be expected
because the investors that were driving the stocks were individuals, not institutions.
Individual investors were using services like eBay (EBAY, news, msgs), Amazon.com
(AMZN, news, msgs), Yahoo! (YHOO, news, msgs) and America Online (AOL, news,
msgs). So the shift is totally logical, but it doesn't mean that the B2C space is dead. It
just means that investors' appetite for the Internet is expanding.
Some contend that the B2B space is also cooling off rapidly. Is that how you see it?
Many casual investors or speculators began buying B2B stocks as if anything with
that acronym was worthwhile. So, a lot of it was overheated due to hot air. Also,
many venture capitalists invested in a lot of deals that were chasing the wind. We
expect to see a shakeout in the B2B space, which has for all intents and purposes
already started.
Last year, you wrote a book called "Zero Gravity." As you define it, zero gravity is
essentially the ability for a company to operate purely in a digital environment. Can
you illustrate the idea for us?
The beauty of the Internet is that it enables digital communication and digital
commerce. But most companies in the world do not use it for that function. Most
companies are using the Internet as "brochure ware" -- as a pretty face to their offline
business. To me, that's like having a birthday gift with nothing inside. Just a pretty
wrapper. It's not using the box to house the real value, which is the gift inside.
The gift inside the Internet is distribution. It is computing power. It is instantaneous
global awareness. It is a flow of commerce and communications and community,
things that never have to touch ground. For the past 200 years, our economic growth
relied on the notion of burning petroleum products, coal, oil, gasoline or natural gas
to produce things that consumers and businesses buy and use. What's going to fuel
the next 200 years is information.
So what is the fuel of information, and what is the conduit? The Internet is its own
digital platform, its own digital world. It requires electricity. It requires information to
be created and disseminated. It requires software to be coded. It requires soft assets.
In space, zero gravity means that astronauts can move up and down, sideways,
anyway they want, and get things done in an entirely different way than they can on
Earth. In the digital world, things move the same way. It's about being hyperlinked --
hypermovement, hypercommerce. It's no longer based on shipping goods and parts
around the world via trains, planes or automobiles.
Stocks with zero gravity
What are your favorite "zero gravity" companies at the moment?
Companies I like that have a great zero-gravity model are eBay, Commerce One
(CMRC, news, msgs), Ariba (ARBA, news, msgs), MatrixOne (MONE, news, msgs)
and FreeMarkets (FMKT, news, msgs). Some underlying fiber firms, like JDS
Uniphase (JDSU, news, msgs), also could qualify. Spyglass (SPYG, news, msgs), Net
Perceptions (NETP, news, msgs), U.S. Interactive (USIT, news, msgs), Redback
Networks (RBAK, news, msgs), Terra Networks (TRRA, news, msgs) and Pacific
Internet (PCNTF, news, msgs) are companies involved in enabling and building
bridges from offline to online, from hardware or software to the network.
Couldn't you classify these as Internet infrastructure companies in some sense? Is
that a useful way to think about "zero gravity" companies?
Yes, infrastructure, in the sense that some of them represent core technologies that
are part of the Internet.
Unless a company
cannot exist without
the Internet, or at a
minimum derive
51% or greater
revenues because
of the Internet, then
to me it's not an
Internet company.
Just using the
Internet to take
orders doesn't
mean you're an
Internet company.
In the "zero gravity" space, which types of companies would you
avoid?
I avoid companies that are trying to throw a lot of assets into space.
Companies to avoid would be barnesandnoble.com (BNBN, news, msgs),
Wal-Mart.com, part of Wal-Mart Stores (WMT, news, msgs) -- those types of
click-and-mortar retailers.
Are you saying that Old Economy businesses that are moving
aggressively to adopt the Internet are bad investments? Or just that
they're not the pure plays that you think will offer the greatest returns?
Some Old Economy companies that can accelerate themselves by becoming
more Internet-centric are the ones I look at. Old Economy companies
launching Web sites to play catch-up with upstarts are not following the
approach I favor.
Amazon.com continues to invest in bricks-and-mortar distribution
infrastructure. So, would you include Amazon in this group?
I would. Amazon is becoming more gravity-bound with its warehouse notions.
I'd also put many of the online delivery services, like HomeGrocer.com
(HOMG, news, msgs), Webvan Group (WBVN, news, msgs) and
Kozmo.com, which is going public soon, in that category. Unless a company
cannot exist without the Internet, or at a minimum derive 51% or greater
revenues because of the Internet, then to me it's not an Internet company. Just
using the Internet to take orders doesn't mean you're an Internet company. You
can order a pizza from Domino's with a telephone, but that doesn't make it a
telephone company.
Looking for new stocks
Are there new stocks on the market that we should be looking out for?
The vice president of investment research for e-harmon.com likes a new one
called I3 Mobile (IIIM, news, msgs). The company distributes information to
Web devices, such as phones and PDAs (personal digital assistants). It
aggregates for about 50 different information providers, like ESPN, Dow Jones,
etc. It also has agreements with AT&T, Vodafone AirTouch (VOD, news,
msgs) and several others. The company's been around for almost ten years.
So it's not a "newbie," and it has some depth in the space. The public offering
was done last week by Deutsche Banc Alex. Brown.
What else do you like?
There's a deal that just came public last week from Goldman Sachs (GS,
news, msgs) that I like, called Saba Software (SABA, news, msgs). It's a
distance-learning business for employees in the big, Fortune 500-type tech
companies. The company services about two million employees in the tech
business. Its client list includes Cisco Systems (CSCO, news, msgs), IBM
(IBM, news, msgs), 3Com (COMS, news, msgs) and General Electric (GE,
news, msgs).
Much of what you write about in your book has to do with the fine
points of VC funding. Should investors pay more attention to who and
how companies are funded?
Absolutely. Pedigree matters. If I tell you Michael Dell is making a computer,
and Michael Snell is making a computer, whose are you going to buy? When
you look at the sheer volume of deals getting funded, and the number of
startups out there, one way of cutting through the noise is by looking at who is
investing in these companies. Obviously, the better VC firms usually invest in
the better deals. The pedigree VCs do their due diligence. Again, it's not a hard
and fast rule, but investors should look at who the venture or notable investors
are in general, because it does have some bearing on the company.
Interviews
Recent Interviews:
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for value, 4/6/00
? A secret weapon for
spying hot stocks, 3/30/00
? How to spot trends and
ride their momentum,
3/23/00
More?
Do you limit your investments to deals funded by the usual suspects,
like Kleiner Perkins Caufield & Byers and Sequoia Capital?
Mainly, yes. We also look at the deals funded by one of our own investors,
Hummer Winblad Venture Partners, as well as Benchmark Capital and Accel
Partners. We also look at some of the corporate venture firms. For example we
follow the corporate venture capital arms of folks like Intel (INTC, news, msgs),
GE Equity, CMGI Inc. (CMGI, news, msgs) and SoftBank. Basically, I look for
groups of investors who have a good track record and credibility in the Internet
space.
Many Internet stocks in all segments of the sector have been badly
bruised during the current Nasdaq correction. Ultimately, what will
differentiate the successful Internet investors from the not so successful
ones?
Those investors who understand and can differentiate which companies are
enabled by the Internet, as opposed to those that rely on the medium for their
livelihood, will be successful. If you can spot and buy companies that can
successfully scale and grow exponentially, and spread virally without having to
box software or place their wares on a store shelf, you will be rewarded in the
long run. A company like eBay, for example, scaled so rapidly because it
wasn't responsible for warehousing. It wasn't responsible for shipping. It wasn't
responsible for all the heavy-lifting elements of buying and selling. It's only
responsible for putting people together in a marketplace and then taking a cut
of the deal. It's a pure digital notion. And those types of companies will
continue to make their investors very happy over time.
At the time of publication, Eneida Guzman owned or controlled shares in the
following equities mentioned in this column: Amazon.com.
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