Monday, April 20, 1998
Tulip Time
A Momentary Lapse (Some Would Call It Sanity) For Internet Stocks, But Mostly They Defy Gravity
By Eric J. Savitz
For at least a moment, sanity has returned to the Internet stocks. After Wall Street spent most of last week frantically bidding them up, on Friday the 'Net stocks hit an air pocket. In the week's final session, Yahoo! backtracked 6 57/64, InfoSeek toppled 7 1/2, Excite slumped 15 13/16 and Lycos deflated 9 9/16. That seems pretty awful. Until you consider what happened the rest of the week.
For even given Friday's reversal, the stock market seems to have lost its collective common sense when it comes to the Internet. We will certainly not be the first to argue that the valuations of most cyberstocks have reached levels bearing little relationship to their underlying fundamentals, but the observation bears repeating. We're talking tulips here. Internet investing has reached the mania stage. And while no one knows if Friday's activity will mark the beginning of the end, there seems little doubt that when reality sets in, things will get seriously ugly.
Now, make no mistake, the Internet is a force of mammoth proportions. As a report last week from the Commerce Department observed, Internet use increased more than 150% in 1997 and Internet traffic doubles every 100 days. But the recent run-up shows every sign of investor hysteria. Even after the Friday swoon, Excite last week gained 21%, to 75 5/16, Yahoo! advanced 6.1%, to 121 1/2, Lycos improved 6.6%, to 68 7/8, and Infoseek jumped 66.8%, to 36 11/16. And the enthusiasm spread far beyond the Web navigation companies. Even stumbling Netscape improved 34.7%, to 23 1/16 for the week, while Spyglass gained 32.6%, to 11 15/16, and C Net tacked on 17.8%, to 36 3/8. Moreover, trading in these stocks has reached frantic proportions; on Thursday, volume in Infoseek totaled 33 million shares -- more shares than Intel and Microsoft traded that day combined, six million more shares than Infoseek has outstanding. There's been a flat-out buying panic. Every marketing agreement, every acquisition, every analyst comment, every new business venture provides an excuse to boost Internet stock prices, and by an astounding degree. With the year less than five months old, many of these stocks have enjoyed a lifetime's worth of gains.
Michael Murphy, the newsletter writer and fund manager, has just crawled out onto a long limb. In big, bold type on the front page of the April issue of his monthly Overpriced Stock Service newsletter, there's a headline advising investors to -- you guessed it -- "Short The Internet." And he's talking about the sector's biggest names. Like Amazon.com. On-line book sales, he contends, will be "a cutthroat business with razor-thin margins." He's also short Lycos, which he believes will get crowded out by larger competitors. "If they were a division of a Silicon Valley company they would be shut down as an also-ran not worth investing in," he writes. "As a Massachusetts company they get a billion-dollar market capitalization." Also on his hit list: OnSale. While the on-line auction site continues to build revenues, he notes, losses have been accelerating.
Murphy also advises shorting Infoseek, noting the company is "losing even more money per share than Lycos." He's short Excite, too. And in perhaps his boldest pronouncement, Murphy advises shorting Yahoo!. He contends advertising on Yahoo! doesn't accomplish very much. "Their effectiveness rate is near zero; that is, quality buyers are not being delivered to the advertisers," Murphy writes. "In a great media year like 1997 everyone makes money. Media budgets are high and there is cash to experiment with new outlets like the Internet. As the U.S. economy slows, advertising budgets get cut back and guess who gets cut first? You got it. Folks who cannot demonstrate cost-effective impact that sells products and services." The newsletter's list of "potential prey" includes an array of other Internet companies, including CDNow, Doubleclick, Go2Net, Network Solutions, Sportsline and VeriSign.
More than a few smart hedge-fund managers have been wounded in recent months trying to short these very stocks, so if you choose to take Murphy's advice, move cautiously. Last week's huge moves demonstrate the danger of being on the wrong side of one of these stocks. As noted in last week's Trader column, some institutions have been buying baskets of Internet stocks, bidding up prices seeking exposure, without paying a lot of attention to fundamentals. Until that changes, shorting Internet stocks will remain a highly dangerous activity.
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