On the Net, Who Will Survive the Race to Profitability?
By Katherine Hobson
Staff Reporter
6/5/00 9:59 AM ET
Profitability rules!
The Race to Profitability
Until recently, the market for Internet stocks was so appalling that all investors could do was watch, agape, as valuations plummeted. Now that things appear to be getting better -- at least temporarily -- analysts and investors are in the "what have we learned from the crash, Daddy?" phase. What we've learned: Internet companies need to someday be profitable, and moreover, they need enough cash on hand to get them to that point.
First, the profitability thing. The difference between companies that are simply riding a new wave of optimism in the Nasdaq and those that have a chance of paying off long-term for shareholders is all about how far off profitablility looms. To demonstrate that they fall closer to Microsoft (MSFT:Nasdaq - news - boards) than toysmart on the continuum of long-term investing, a lot of these Internet concerns are now peppering earnings releases with phrases like "clear path to profitability." The not-so-subtle subtext: We actually do have a business plan, and it's one that will make money for you, the shareholder -- and sooner rather than later. But a business plan calling for profitability in 2003 doesn't do much good if cash runs out in 2001. That's where cash comes in: Companies with enough cash to fulfill their business plans are in a nicer spot than those that don't.
In theory, a company with a shorter path to profitability and enough cash to get there should be more highly valued than a comparable company with a longer road ahead. After all, a company that can finance its own operations is less of an investment risk than one that must depend on the kindness of the market to stay in business. It's one thing for a well-established, already profitable business to sell more shares to fund expansion, says Andrew Johns, CFO of 24/7 Media (TFSM:Nasdaq - news - boards). It's another thing entirely to have to sell more shares simply to raise enough money to survive. "That second scenario is obviously what would have investors very nervous," he says.
Chasing Their E-tails?
E-tailers.
Illustration: Helaine Tishberg/TheStreet.com
To help investors get a sense of the race to profitability, we've put together graphics showing when various Internet companies -- running the gamut from content to e-marketers to B2B -- plan to make money.
NOTE: the cute illustration shows racecars on a track - labeled with company names. Back to front: Netcentives, 24/7 Media, Engage, Goto, Ask Jeeves, Lifeminders, About and Look and only one car is shown crossing the finish line - Go2net. In the etailer section the Winner was EBAY, and B2B was a tie between Ariba and ITWO.
We're using positive cash flow from operations as a proxy for profitability, because when a company has more cash coming in than flowing out, at least it will be able to finance day-to-day operations. True bottom-line earnings might not come for a while, if the company is investing in technology or other equipment that will be written off over a number of years. (Cash flow, measured by EBITDA, or earnings before interest, taxes, depreciation and amortization, is the yardstick of choice for media and cable companies with big fixed costs. And cash flow from operations is how sell-side Internet analysts have chosen to judge the industry -- they subtract out miscellany such as noncash compensation expense and goodwill amortization, then call the results "pro forma earnings.")
Ad It Up
Net ad firms and portals.
Illustration: Helaine Tishberg/TheStreet.com
We've also included separate tables for each broad sector of the Internet market to give a little more detail. These tables show how much cash these companies have, as they've reported in their most recent filings with the Securities and Exchange Commission. And we've extrapolated from that how many quarters they can operate with their existing cash, and whether they have enough cash to make it to positive cash flow. Warning: Just because a company doesn't have enough cash to make it to profitability now doesn't mean it won't ever get there. Even e-tailers that had been all but left for dead, like online grocer Peapod (PPOD:Nasdaq - news - boards), have gotten infusions to keep them going a while longer. But companies that may have to return to the capital markets face more uncertainty, and uncertainty, to misquote Gordon Gekko, is bad.
Finally, we show the price-to-sales ratio for each company. A quick scan shows that B2C companies aren't getting much Street cred -- with the exception of eBay (EBAY:Nasdaq - news - boards), all the B2C companies we looked at trade at below ten times sales. B2B wunderkind Ariba (ARBA:Nasdaq - news - boards), by contrast, trades at about 84 times sales, even after the months-long slide in former momentum favorites, which has reduced sector share prices by two-thirds and more.
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