From Barrons this week:
Down, Not Out
Strategist on Internet investments picks stocks for a rebound
An Interview With David Readerman ~ As director of Internet strategy for Thomas Weisel Partners and with nearly 20 years of experience tracking technology companies, Readerman's weekly insights into the trends and dynamics of the New Economy have proven indispensable to investors seeking to profit from the next new thing. His DIRT report -- that is, Dreaderman's Internet Research Trends (available at www.tweisel.com), is more than on time; it has also been on target in its appraisal of a sector known more for the ballyhoo surrounding it than for any balanced coverage. Readerman's research is exhaustive, all-encompassing and richly informative. Despite all that, he's the first to admit there have been few places to hide as we go through the "bust" phase of the Internet era. To learn w confident there'll be a return to boom times, please read on.
-Sandra Ward
Barron's: You're known as the "DIRT" guy. Are you feeling pretty dirty these days?
Readerman: Yeah, my whole universe is dirt.
Q: And your tailwinds have turned to headwinds, it seems.
A: Some have turned into headwinds and some have almost disappeared; the e-commerce ones have pretty much vaporized. But the infrastructure tailwind has actually been quite strong and broadening to include not only server software, but hardware, too. Communication equipment has been an important dimension to the infrastructure tailwind and with the DSL [digital subscriber line] guys and the CLECs [competitive local exchange carriers] imploding, that has been a tough place. There haven't been a lot of places to hide in technology this year.
Q: Your reports in July showed you to be pretty sanguine, overall. Five months later, you've declared the music has died. What made all the difference?
A: We hosted an Internet forum at the end of June, modeled after Herb Allen's Sun Valley media conference. By then we'd had the March 10 peak and the selloff in April and had crawled our way back by the end of June so that the Nasdaq was more or less net-flat. This was all pre-Regulation Fair Disclosure, and the comments from the CEOs were generally very positive in terms of their outlook. We had identified 18 names we thought were interesting and compelling stories, split between the software part of Internet, the infrastructure segment and the equipment side. Two weeks ago, when we evaluated how our picks had done, only five stocks actually beat the Nasdaq since we published the list in July -- Seibe Systems, Cisco Systems, Extreme Networks, Juniper Networks and Sun Microsystems. Equipment names held up reasonably well, but even they had pulled in. I concluded that 2000 was a wipeout, and it struck me that the lyrics of the Don McLean song "American Pie" typified what had happened to a big segment of the Internet. To some extent, the Internet in general died. There was and is no more special treatment for Internet companies in terms of valuations. There was no more waiting for that off-in-the-future profitability crossover point, and as such the invisible hand of the market began to radically take down valuations. Through the course of the year, we had seen this in those companies that were dependent on an advertising-driven model and had been under a lot of pressure. But the bottom fell out of the entire group coming off third-quarter earnings reports.
Q: How bad has it been?
A: ...........
Q: Did that class share something in common?
A: The class of '99 had some successful stories in it: Juniper Networks, Aether Systems, Ariba -- and like it or not, Martha Stewart Living Omnimedia has somehow held up relatively well. But the bulk of the class has suffered. It cuts across virtually every area: information technology services, e-tail, e-media, e-health, e-finance, communication services, business services, B2B. VerticalNet is down 90%; ......
Q: What changed sentiment?
A: ....
Q: Since more so-called survivor deals haven't happened, should we perhaps have seen more bricks-and-mortar companies stepping in to pick through the rubble?
A: ....
Q: But isn't there a lot less urgency for businesses to spend on e-business solutions?
A: That's a fair point. In 1999, if you picked an industry -- say, finance -- where Charles Schwab traded at the same market cap as Merrill Lynch though it is a tenth of its size or, say, AOL exceeded the market cap of all the major networks and notably Walt Disney, and all it had was its online presence, not even any theme parks, the market was pricing the valuation gap between New Economy and Old Economy and creating a frenzy to get online. The stock prices and euphoria for the Internet were guiding corporate policy on spending. Now there is less urgency to get online because the bricks-and-mortar guys are still standing and they still have customers. But any complacency and inertia are misplaced. It's like a retail bank in that putting in ATM machines is a cost of doing business and if you don't do it and the bank across the street does, over time you will lose customers. There has been a steady increase in investment in information technology as a percentage of U.S. GDP, and that is very much embedded in the spending cycle. Look at the telecom industry. Long-distance rates are cratering and they've got structural problems, but they still recognize they have to make investments in optical equipment in order to remain competitive long-term. The Internet -- by that I mean a communications-based technology that allows you to operate a storefront 24/7 -- isn't going away. Evidence of that is seen in the auto industry and many large industrial sectors. That's where the enduring growth of the Internet is going to prove out.
Q: Which Internet companies will benefit from this?
A: In managing data traffic you have companies like Akamai Technologies, which are involved with the business of streaming content and graphics over the Internet. Inktomi, which manages data over networks. Exodus, which hosts access to the Internet almost on an outsourcing basis. Software companies, such webMethods, which helps facilitate integration of B2B exchanges. There is BEA Systems and its Web-logic product that helps facilitate transactions. On the hardware side, the plays are tied to the move to a post-PC-centric world, and they are Sun Microsystems, EMC and Storage Networks, and Cisco Systems. On the security side there is VeriSign.
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