"These stocks are immune to news of competition..."
NEW YORK (Dow Jones)--If one part of the technology industry benefited from the steep stock price losses in the computer hardware group over the past week, it was undoubtedly the Internet sector.
Shares of most of the big, widely recognized names in the Internet business - as well some of the smaller, less well-known names - soared over the preceding three trading sessions as technology investors fled hardware.
Still hoping to put their money in high-tech companies, investors sought out a business that they hope won't suffer as much from the pricing trends that have caused the likes of Intel Corp. (INTC) and Compaq Computer Corp. (CPQ) to guide earnings estimates down sharply.
As a result, "we are seeing a broadening of investors in these stocks," said BancAmerica Robertson Stephens analyst Keith Benjamin.
Yet even as many sell-side analysts continue to lift their price targets on the big Web players, some observers are warning that risks still abound in the Internet sector. After all, they point out, the business is still establishing itself, and many companies in the group have yet to turn a profit.
"The potential is limitless, but the pitfalls are bottomless," said David Simons, managing director of Digital Video Investments.
Many traders are in fact expecting many Internet names to lose steam later in the session as they give back some of the sharp momentum gains they have recorded in recent days - particularly since there is no immediate news to boost the sector and since short interest in the group has been building.
Intel and Compaq both surprised the market last week with disappointing first-quarter outlooks and warned that prices for PCs and the components that go in them - including microprocessors - continue to fall.
But many believe that the growing popularity of "sub-zero" machines - PCs that cost $1000 or less - could be an incredible boon for the emerging Internet industry.
Falling computer prices, the argument goes, should spur demand for PCs and ultimately increase PC penetration - particularly in lower-income homes that until now could not afford a computer.
And as more households buy computers, according to this line of reasoning, more people will go online and drive the growth of online services, Web-based advertising and electronic commerce.
"We are seeing lower price points with very high (unit) volumes," said Dean Frost of Frost and Berman, an investment bank that focuses largely on the Internet sector. "This opens a whole new category of consumer. ... It has sucked the margins out of the hardware players, but it's God's gift to Internet and software companies."
Frost added that the Internet industry should also benefit from another trend resulting from falling prices. "At traditional price points, customers expect much higher performance," he said.
Despite the optimism surrounding the Internet sector right now, Simons, of Digital Video Investments, still sees a number of important risks.
For one, he pointed out that even though many industry observers expect falling PC prices to enable people in lower-income homes to afford machines, it appears that it is mainly repeat customers - who may already be online - rather than new buyers who are purchasing the sub-$1,000 PCs.
Moreover, in their earnings warnings last week, Intel and Compaq also raised concerns that PC sales could be slowing - which, CIBC Oppenheimer Corp. analyst Henry Blodget acknowledged, is "without a doubt a negative" for the Internet companies.
Still, Blodget noted, the Internet sector is much more insulated from slowing PC sales than many other technology sectors because the industry still has a major growth opportunity in households that own a computer but aren't yet online. "They can grow for years on the installed base," he said.
Blodget added that the emerging market for Web devices that deliver Web access without a computer - like TV set-top boxes - should also drive growth, even if PC sales slow.
And, of course, he noted, there is plenty of potential to mine in people who are already online by showing them more advertising and selling them more things on the Internet.
"There appears (to be) an opportunity for significant growth in revenue on the existing audience base," Benjamin of Robertson Stephens wrote in a report last week.
Yet Simons has other concerns as well. For one, he said, even if falling PC prices do prompt lower-income households to purchase machines, these households may still be reluctant to spend another $20 a month for Internet access.
"At least as much an obstacle to going online as the cost of the box is the $20 a month to feed it," Simons said, since this cost competes with other entertainment expenditures like video rentals and premium cable service.
Simons also believes many Internet investors are ignoring - at their own peril - the competition that companies in this industry face.
Online-bookseller Amazon.com Inc. (AMZN), one of the recent high-fliers, already has to contend with Barnes & Noble Inc.'s (BKS) online operations and will soon face competition from Borders Group Inc. (BGP) and Bertelsmann A.G., for instance.
And America Online Inc. (AOL), which just raised its monthly subscription rate by $2 to $21.95 a month, is facing an onslaught from MCI Communications and Internet service providers like Earthlink Network Inc. (ELNK). Both MCI, which is teaming with Yahoo Inc. (YHOO) to create an online service that will compete with AOL, and Earthlink offer cheaper Internet access.
"These stocks are immune to news of competition," Simons said. "These stocks are trading as if the Internet is an infinite-sum game."
(MORE) DOW JONES NEWS 03-10-98
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