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STREET WISE -- Some Faint Signs of Life at Net
Incubators
STREET WISE
By Amey Stone in New York
It might seem like a harbinger of a cold, snowy spring: Pasadena (Calif.) Internet
incubator idealab! (which backed eToys)
announced on Mar. 7 that it is shuttering its Silicon Valley operations. But hold on. The
truth is that the big, publicly traded
Web incubators, including Internet Capital Group (NasdaqNM:ICGE - news),
Safeguard Scientifics (NYSE:SFE - news), and
CMGI (NasdaqNM:CMGI - news), have all retrenched and seem ready to weather
the dot-com winter for at least another
year or two. That may not seem like much for investors to hang their hats on, but in the
current depressed environment for Web
startups, it's actually pretty good news.
ICG reported a dramatically reduced burn rate when it released fourth-quarter results
on Feb. 21 and seems to have enough
cash to get through three more years. In its Feb. 22 statement on fourth-quarter results,
Safeguard said it had the cash to last
through 2002. And CMGI, which is in the midst of a restructuring and has frustrated
Wall Street by being unable to say much
about its future burn rate, declared on Feb. 12 that it had $970 million in cash on hand.
It will say more when it releases
quarterly results on Mar. 13.
Only a few months ago, these publicly traded Web conglomerates didn't look half so
hardy. Comprised of dozens of
money-losing startups -- and with little opportunity to raise more money or take private
holdings public in a dead Net IPO
market -- they seemed all but doomed.
NOWHERE BUT UP? But bad news has a way of focusing the mind. With stock
prices in free fall, CMGI and ICG are in the
midst of plans to sell, shut down, or combine their most troubled units and stick with
the holdings that have the best shot at
making it. As ICG CEO Walter Buckley puts it, the goal is to become, ``a smaller but
stronger group of companies.''
``Right now they are in survival mode and hoping they can get through the downturn
before they run out of money,'' says Chris
Nerney, senior analyst for Internet.com. Can they? Well, says Nerney, ``that all
depends on how long the downturn lasts.''
At least one Wall Street analyst, Charles Grom of Salomon Smith Barney, was brave
enough to go out on a limb in
mid-February and initiate coverage of ICG and CMGI -- a positive in itself since it's a
sign the firm believes these stocks will be
around for a while. ``We did get some calls'' from skeptical clients, admits Grom, who
barely endorsed the companies. ICG
earned a ``venture accumulate'' rating and a $7 price target, which translates roughly
into a recommendation to maybe start
thinking about buying the stock at some point in the future -- if you're brave enough to
try venture-capital-style investing in the
current market. He rated CMGI only ``venture neutral'' and gave it a $6 price target,
which essentially means: Don't even think
of buying this one right now.
``It's just our gut that these things have reached a floor,'' says Grom. ``All the bad
news has been priced into them.'' Both
CMGI and ICG traded around $150 a year ago and now are around $4. Safeguard, a
company with a much longer history,
has fallen at a slightly less precipitous rate, from $100 to $8 in the past year.
Given how high investors' expectations were for CMGI, its fall is remarkable even
among Internet companies right now, says
Nerney: One of the Web's darlings in 1999, CMGI's 96% drop in 2000 sharply
exceeds the 58% decline for Internet.com's
index of Internet stocks.
PREMIUM ON PATIENCE. Grom doesn't expect these stocks to bounce back until
the market for Internet initial public
offerings comes back from the dead. ``If you're looking for a turnaround in two to six
months, you're not going to get it here,''
he warns. In 9 to 12 months, however, Grom thinks there could be some upside.
But with reduced burn rates and lots of cash, these companies seem to have a new
confidence that they can stay afloat until the
environment for Internet startups improves. ``We have a very strong group of
companies that are providing real value to
customers and are going to grow into very large substantial businesses,'' says ICG's
Buckley, pointing to 260% annual revenue
growth at the 16 strongest companies ICG has stakes in.
``We've made tremendous progress against our plan,'' says Bill White, executive
vice-president for marketing at CMGI. He
points out that the company has reduced its core holdings from 17 to 12. ``We've
made a lot of progress in a relatively short
period of time,'' he says.
FAULTY THEORY. And with $201.5 million in cash as of Dec. 31, 2000, Safeguard
Chief Financial Officer Gerald A.
Blitstein was able to point out, in the 2000 yearend statement, that ``throughout its
history, Safeguard has never begun a year
with more cash on its balance sheet as it has in 2001.'' Safeguard executives could not
be reached for comment.
Even if they can weather the hard times, the idea behind Internet incubators has taken a
severe hit. The theory was that startups
would benefit from being part of a large network of companies working together.
That's still the goal: ``We're providing a family
of companies with a backing that includes knowledge-sharing, financial resources, and
other effectiveness-generating
resources,'' says White. But as the incubators dump failed holdings and the stock
prices of their strongest fall through the floor,
there isn't much of a cushion. For example, ICG has VerticalNet (NasdaqNM:VERT -
news), now at $1 from a high of $95.
Investors, the 1999 theory also went, would benefit both from the holding company's
skill at selecting the most promising
companies and some measure of diversification, since the holding companies
comprised a basket of Web startups. Sorry, folks.
As it turns out, these companies are really just vehicles to take advantage of a hot
market for IPOs, which made them even
riskier than your average Net stock. It's unlikely they will return to their former highs
anytime soon.
Near-term catalysts for these stocks will be strong results for the companies the
incubators have stakes in, says Grom. As with
a venture-capital fund, for the entire company to benefit, ``all they really need is 1 out
of 10 to be a home run,'' he says.
SUM OF ITS PARTS. But that fact alone points to a major reason why most
investors may want to stay away from these
stocks. Getting a grip on the company's potential requires sorting through a lot of
holdings. ``Practically speaking, an incubator
is only as good as the sum of all its companies,'' says Pat O'Neil, portfolio manager of
the Loring Hedge Fund. That means all
the bad holdings can dilute the effectiveness of the one or two good ones. Says O'Neil:
``It adds more variables.''
And since most of their holdings are private companies, it makes it virtually impossible
for individual investors to see through the
veil. In an environment this difficult for all Internet companies, ``it's tough to say which
startup has long-term potential,'' Nerney
says.
For most investors, there's no mincing words: Internet incubators have been a
short-term disaster, and it would be better to
stay away. But for those who don't mind holding on until the market for Internet IPOs
comes back, some investors may find
encouragement knowing that these incubators aren't going quietly into the night. They'll
be around for a while, for those with a
taste for high risk and venture capital. |
