This article has some interesting things to say about the carnage taking place in the Internet stocks.
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 incubatorCMGI (CMGI ) stole the spotlight in December ayear ago. Analysts fawned over the company's fiscalfirst-quarter losses for 2000, which were 47% lessthan expected, and praised its impressive 231%sales growth. CMGI groupies chalked up the lossesto what they deemed a visionary buying spree by the firm's then-venerable fairygodfather, CEO and Chairman David Wetherell. Small wonder. In four months, Wetherell had inked deals worth more than $1billion to acquire several online advertisers and direct marketers. His plan: Turna simple venture-capital unit into what he called "an online marketingpowerhouse." It was only a matter of days into the New Year before thecompany's stock ascended to its 52-week high of $163.50 per share, adjustedfor 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 princessback into a handmaiden. Today, CMGI bears the brunt of being a virtualoutcast. Its share price has plunged from its 52-week high of about $163 toabout $10 per share. CMGI's Furniture.com recently ceased operation, and publicly tradedMotherNature.com has announced plans to liquidate. Then, on Nov. 13,CMGI said it will shed two of its own fledgling startups, free Net-accessprovider 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 andwhat value remains in Wetherell's empire. In fact, Wall Street is starting to takea good, hard look at the cottage industry of firms that nurture gaggles of Netideas 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 beany better than those of their extinct Old Economy forefathers. TWOFOLD BURDEN. The idea behind these companies is to increase the value ofindividual startups by uniting them in a network of shared resources andfunding. Just as each of the companies in the network has value, so does thenetwork as a whole. But the burden of publicly held incubators is twofold: Theymust prove their worth and answer to their shareholders while at the same timeshowing value in their portfolio companies. This means taking companies public to help raise cash for nurturing otherprivate holdings. In effect, outfits such as CMGI, Safeguard Scientifics (SFE ),and Internet Capital Group (ICGE ) are created to feed on themselves. Abrilliant idea at the height of Internet mania, where ideas could become publiccompanies 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 put1stUp and iCast in front of the firing squad is part of CMGI's strategy to attainprofitability by the end of its current fiscal year, on July 31, 2001. But manyanalysts see it as a desperate attempt to reverse a market nosedive and cloakportfolio weakness. Nearly half the brokers covering the company rushed todowngrade their stock ratings from buy to hold after CMGI's announcement,including Credit Suisse First Boston, U.S. Bancorp Piper Jaffray, and INGBarings. "I COULD KICK MYSELF." Even the notoriously bullish Merrill Lynch stepped onthe brakes. "I could kick myself for not downgrading [CMGI] sooner," saysAdams Harkness analyst Steven Frankel, who lowered his stock rating to abuy from a strong buy on the heels of the news. "We haven't seen their rockbottom yet, although we're getting close." Of course, the Andover (Mass.) CMGI isn't the only one under Wall Street'smagnifying glass. The stock values of its competitors, such as Safeguard andICG, also have shriveled following April's market turmoil, and the poorperformance and uncertain prospects of many of their portfolio companies.Safeguard shares have dropped from their 52-week high of $99 to around $10per share. ICG's stats are no better: Its stock has collapsed to about $6 pershare, 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 hasholdings 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, ICGreported losses totaling $263.9 million and slashed its staff by 35%. Analystdowngrades quickly followed suit, only to be repeated for CMGI a few dayslater. TAKING CONTROL? In an effort to bolster their stock prices and win WallStreet's favor, CMGI and ICG are cleaning house. Wetherell says he'll reduceCMGI's majority-owned and -operated companies to between 5 and 10 from13. ICG says it will pare its U.S. holdings to 15 from 65. Those that can'tsubstantially improve operations will presumably go by the wayside. Onecriterion, 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 ouridentity 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. Safeguardclaims $240 million in cash reserves and $300 million in credit. ICG says it hascash and credit reserves of $515 million, will "significantly slow the rate ofinvestments" 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 $45million 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 endof fiscal year 2000. ICG says it expects to reduce its quarterly cash outflowabout 26% annually, to $33 million per quarter. "OLD AND BROKE." Frank Biondi, senior managing director of WaterviewPartners, says many incubators have overinvested in startups and risk beingscorched to death by their burn rates. "If you can't get to breakeven, then thechallenge becomes raising more money," Biondi says. "And if you're dependingon 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 meanCMGI, ICG, and Safeguard will need to sell securities or draw on their creditlines in the second half of 2001. "Safeguard will most likely have to dip intocash reserves in order to tread water next year," says Merrill's Henry Blodgetin his November ratings report. As evidence, CMGI's cash and equities total has fallen $45 million sinceAugust, although the company says it still expects to have $700 million at theend of its fiscal year 2001. But cutting costs isn't necessarily a stock savior. "Asmuch as they would argue to the contrary, ICG and Safeguard are holdingcompanies, not operating companies," says Adams Harkness' Frankel. "Theybuild 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% ofICG -- has 15 public companies in its portfolio. ICG, also based in Wayne,controls six public companies, in which Buckley says he has invested about $3billion, slightly more than the value of the company's $2.5 billion marketcapitalization. LIQUIDITY IS KEY. Many analysts believe the value of ICG and Safeguard,which have, in a move that seems smart, invested in Net-infrastructurecompanies rather than online-content or e-commerce ventures, hinges not ontheir ability to cut costs and eliminate dead weight but to deliver a return ontheir investments. "At the end of the day, the point is to create a liquidity eventout of a company, isn't it?" says Sangam Pant, executive vice-president andgeneral manager of eCompanies, the incubator started by venture capitalistsJake Winebaum and Sky Dayton in June, 1999. To be sure, incubators have had their share of successes. "Dogs are built intothe model," Frankel says. "So there's always a built-in cushion for the winnersto 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 otherIPO 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 nextyear. 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 hasdropped 85% this year from its 52-week high of $148.38 and has sunk to anew low of around $9 per share, thanks to its parent's market performance aswell 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 saysCMGI'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 publiccompanies, Engage and Navisite, aren't profitable. The majority of its portfoliocompanies, such as portal AltaVista, rely on advertising revenue -- a businessmodel 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. OnNov. 9, advertising-delivery service Engage (ENGA ), which analysts sayaccounts for 8.3% of CMGI's market value, warned its first fiscal quarter 2001revenue would fall 22% below the consensus, to $40 million, from $42 million.Engage also announced the resignation of its CEO. Analysts had predictedrevenues 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 lowof $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 oncompanies such as Lycos and GeoCities. But in the end, its guidance wasn'tstructured enough to provide a good operating model. "I'm not sure CMGI hasmade enough hard decisions," Frankel says. "If they want to be a true operatingcompany, they need to be more focused." It could take 12 months to restoreinvestor confidence, he says, since there are few buyers for advertising-basedbusinesses like AltaVista. In such a hostile market environment, it could be thelongest 12 months of Wetherell's career. By Stefani Eads in New YorkEdited by Beth Belton |
