A Cold Blast on the Net Incubators
As analysts downgrade their stock and question their business model, CMGI,
Safeguard, and ICG are frantically shedding dead weight
Like Cinderella at a holiday ball, Internet incubator
CMGI (CMGI ) stole the spotlight in December a
year ago. Analysts fawned over the company's fiscal
first-quarter losses for 2000, which were 47% less
than expected, and praised its impressive 231%
sales growth. CMGI groupies chalked up the losses
to what they deemed a visionary buying spree by the firm's then-venerable fairy
godfather, CEO and Chairman David Wetherell.
Small wonder. In four months, Wetherell had inked deals worth more than $1
billion to acquire several online advertisers and direct marketers. His plan: Turn
a simple venture-capital unit into what he called "an online marketing
powerhouse." It was only a matter of days into the New Year before the
company's stock ascended to its 52-week high of $163.50 per share, adjusted
for a stock split later in January. The market for business-to-business (B2B)
Net incubators was red-hot, and CMGI was on fire.
PLUNGING SHARES. But midnight came all too soon, turning the Net princess
back into a handmaiden. Today, CMGI bears the brunt of being a virtual
outcast. Its share price has plunged from its 52-week high of about $163 to
about $10 per share.
CMGI's Furniture.com recently ceased operation, and publicly traded
MotherNature.com has announced plans to liquidate. Then, on Nov. 13,
CMGI said it will shed two of its own fledgling startups, free Net-access
provider 1stUp.com and entertainment site iCast, at the end of January, 2001,
if no buyer steps forward.
All this has spurred analysts to question CMGI's $4.6 billion market cap and
what value remains in Wetherell's empire. In fact, Wall Street is starting to take
a good, hard look at the cottage industry of firms that nurture gaggles of Net
ideas into stand-alone companies ready to take on the equity markets.
Incubators, holding companies, operating networks -- call them what you will
-- the business models of these modern-day Net conglomerates may not be
any better than those of their extinct Old Economy forefathers.
TWOFOLD BURDEN. The idea behind these companies is to increase the value of
individual startups by uniting them in a network of shared resources and
funding. Just as each of the companies in the network has value, so does the
network as a whole. But the burden of publicly held incubators is twofold: They
must prove their worth and answer to their shareholders while at the same time
showing value in their portfolio companies.
This means taking companies public to help raise cash for nurturing other
private holdings. In effect, outfits such as CMGI, Safeguard Scientifics (SFE ),
and Internet Capital Group (ICGE ) are created to feed on themselves. A
brilliant idea at the height of Internet mania, where ideas could become public
companies almost overnight. But the reverse of such a virtuous cycle is vicious,
as these companies are learning the hard way. Wetherell says the move to put
1stUp and iCast in front of the firing squad is part of CMGI's strategy to attain
profitability by the end of its current fiscal year, on July 31, 2001. But many
analysts see it as a desperate attempt to reverse a market nosedive and cloak
portfolio weakness. Nearly half the brokers covering the company rushed to
downgrade their stock ratings from buy to hold after CMGI's announcement,
including Credit Suisse First Boston, U.S. Bancorp Piper Jaffray, and ING
Barings.
"I COULD KICK MYSELF." Even the notoriously bullish Merrill Lynch stepped on
the brakes. "I could kick myself for not downgrading [CMGI] sooner," says
Adams Harkness analyst Steven Frankel, who lowered his stock rating to a
buy from a strong buy on the heels of the news. "We haven't seen their rock
bottom yet, although we're getting close."
Of course, the Andover (Mass.) CMGI isn't the only one under Wall Street's
magnifying glass. The stock values of its competitors, such as Safeguard and
ICG, also have shriveled following April's market turmoil, and the poor
performance and uncertain prospects of many of their portfolio companies.
Safeguard shares have dropped from their 52-week high of $99 to around $10
per share. ICG's stats are no better: Its stock has collapsed to about $6 per
share, from a high of $212.
Third-quarter-earnings report cards have only exacerbated the slump. On Nov.
9, Safeguard, which directly controls 50 Net infrastructure companies and has
holdings in about 300 others, reported a third-quarter loss of $25.2 million.
Revenue for its 350 partner companies rose an underwhelming $100 million, to
$1.34 billion, compared to the same period a year ago. Meanwhile, ICG
reported losses totaling $263.9 million and slashed its staff by 35%. Analyst
downgrades quickly followed suit, only to be repeated for CMGI a few days
later.
TAKING CONTROL? In an effort to bolster their stock prices and win Wall
Street's favor, CMGI and ICG are cleaning house. Wetherell says he'll reduce
CMGI's majority-owned and -operated companies to between 5 and 10 from
13. ICG says it will pare its U.S. holdings to 15 from 65. Those that can't
substantially improve operations will presumably go by the wayside. One
criterion, says ICG CEO Walter Buckley, is to show a profit within 18 months.
"We've taken control of our destiny," Buckley says. "We're realizing our
identity and moving from the land grab to focusing on growing big businesses."
One thing working in these companies' favor is cash flow. CMGI says it has
$940 million cash on hand and $210 million in for-sale securities. Safeguard
claims $240 million in cash reserves and $300 million in credit. ICG says it has
cash and credit reserves of $515 million, will "significantly slow the rate of
investments" in its current holdings, and won't be funding new ventures,
according to Buckley.
Plus, CMGI maintains it will decrease its so-called cash-burn rate to $45
million per quarter by the end of its fiscal year next July, including a reduction of
$30 million in new investments, from about $190 million per quarter at the end
of fiscal year 2000. ICG says it expects to reduce its quarterly cash outflow
about 26% annually, to $33 million per quarter.
"OLD AND BROKE." Frank Biondi, senior managing director of Waterview
Partners, says many incubators have overinvested in startups and risk being
scorched to death by their burn rates. "If you can't get to breakeven, then the
challenge becomes raising more money," Biondi says. "And if you're depending
on third-party investors today, you're going to grow old and broke real fast."
Factor in the sharp contraction of venture-capital investment expected in 2001,
and you can see why the market is so wary of the incubators. That could mean
CMGI, ICG, and Safeguard will need to sell securities or draw on their credit
lines in the second half of 2001. "Safeguard will most likely have to dip into
cash reserves in order to tread water next year," says Merrill's Henry Blodget
in his November ratings report.
As evidence, CMGI's cash and equities total has fallen $45 million since
August, although the company says it still expects to have $700 million at the
end of its fiscal year 2001. But cutting costs isn't necessarily a stock savior. "As
much as they would argue to the contrary, ICG and Safeguard are holding
companies, not operating companies," says Adams Harkness' Frankel. "They
build companies, not products, and their business is determined by the
[individual] value of their children."
Safeguard -- a 47-year-old firm, based in Wayne, Pa., which owns 13% of
ICG -- has 15 public companies in its portfolio. ICG, also based in Wayne,
controls six public companies, in which Buckley says he has invested about $3
billion, slightly more than the value of the company's $2.5 billion market
capitalization.
LIQUIDITY IS KEY. Many analysts believe the value of ICG and Safeguard,
which have, in a move that seems smart, invested in Net-infrastructure
companies rather than online-content or e-commerce ventures, hinges not on
their ability to cut costs and eliminate dead weight but to deliver a return on
their investments. "At the end of the day, the point is to create a liquidity event
out of a company, isn't it?" says Sangam Pant, executive vice-president and
general manager of eCompanies, the incubator started by venture capitalists
Jake Winebaum and Sky Dayton in June, 1999.
To be sure, incubators have had their share of successes. "Dogs are built into
the model," Frankel says. "So there's always a built-in cushion for the winners
to fall back on." Safeguard's Nextron, a Web-content management company,
filed for a $57.5 million initial public offering on Oct. 9. The company's other
IPO hopefuls include Atlas Commerce, Persona, Mi8, Redleaf,
WirelessOnline, and ThinAirApps.
ICG hasn't had a public offering since March, but its star performer,
industrial-trading portal VerticalNet (VERT ), is slated for profitability next
year. VerticalNet's revenues have doubled quarter over quarter, up 30% to
$73.7 million in its last earnings report. Still, the portal's share price has
dropped 85% this year from its 52-week high of $148.38 and has sunk to a
new low of around $9 per share, thanks to its parent's market performance as
well as the depression of its sector.
AD-DEPENDENT. CMGI, which in spring 2001 hopes to launch CMGion -- an
$80 million network-services venture funded by CMGI, Sun Microsystems,
Compaq, and Novell -- might be in more dire straits. Although Wetherell says
CMGI's revenues for fiscal 2001 will climb to $1.65 billion, up more than 90%
from last year's $898 million, and will offset $1.4 billion in losses, its two public
companies, Engage and Navisite, aren't profitable. The majority of its portfolio
companies, such as portal AltaVista, rely on advertising revenue -- a business
model that hasn't proved to be as lucrative as entrepreneurs had once hoped.
CMGI delayed an AltaVista IPO in spring and finally pulled it in fall 2000. On
Nov. 9, advertising-delivery service Engage (ENGA ), which analysts say
accounts for 8.3% of CMGI's market value, warned its first fiscal quarter 2001
revenue would fall 22% below the consensus, to $40 million, from $42 million.
Engage also announced the resignation of its CEO. Analysts had predicted
revenues of $63 million, compared to $66.7 million for fourth quarter 2000.
Engage's share price has dropped 92% in the past year, hitting a 52-week low
of $1.50 per share from a high of $94.50 and is currently trading at around
$1.80 per share.
Overall, Frankel says CMGI had a track record for getting in early on
companies such as Lycos and GeoCities. But in the end, its guidance wasn't
structured enough to provide a good operating model. "I'm not sure CMGI has
made enough hard decisions," Frankel says. "If they want to be a true operating
company, they need to be more focused." It could take 12 months to restore
investor confidence, he says, since there are few buyers for advertising-based
businesses like AltaVista. In such a hostile market environment, it could be the
longest 12 months of Wetherell's career.
By Stefani Eads in New York
Edited by Beth Belton |
