(OT)ANALYST UPDATE: WALL
STREET PLAYS HEAD
GAMES
By Peter D. Henig
May 7, 1998
Wall Street may need shock therapy as it hugs
Internet stocks tighter, while offering a support group
for Netscape investors. The market seems to be in
heavy denial of signs that the speculative bubble is due
to deflate, if not burst.
Netscape's fragile ego
Netscape (NSCP) could be a case study in market
psychology. While the company played head games
with investors and search partners during recent
Netcenter negotiations, BT Alex. Brown, Volpe
Brown Whelan, and Hambrecht & Quist all bumped
up recommendations on the browser-cum-AOL
wannabe. That's good news for the browser king, but
investors shouldn't cancel their own therapy sessions
just yet.
While Netscape chose to ink a 50 percent partnership
deal with Excite, it still has to renegotiate the other 50
percent of its search revenue-sharing deals -- which
means a whole lot of future revenue is up for grabs.
So why would Wall Street pump the stock when it
knows full well Netscape's comeback, both in servers
and its Web site strategy, is less than sure? One
analyst says Netscape's turnaround is "perhaps two
years too late."
Mary McCaffrey of BT Alex. Brown was one Wall
Streeter willing to give it a chance; she recently raised
her recommendation from Market Perform to Buy. "I
had reservations that the quarter would get completely
blown, but it didn't," she says. "Since I'd been pretty
vocal throughout the process of Netscape choosing a
partner [the $70 million deal with Excite], and because
I felt there would be more positive announcements
coming out, I just said what the hell."
While Ms. McCaffrey thinks there's a good chance
that enhanced content services can keep people at
Netscape's site, she says there are still some rough
edges to it. Volpe Brown Whelan more than shares
her hesitations; while it previously had the guts to put
out that rare Underperform rating (read: Sell) on
Netscape on its way down, it has now only upgraded
its recommendation to Neutral.
Internet stocks in denial
Here's a question for you. What do Yahoo (YHOO),
Infoseek (SEEK), Excite (XCIT), DoubleClick
(DCLK), Amazon.com (AMZN), America Online
(AOL), CMG Information Services (CMGI), and
OzEmail (OZEMY) have in common -- besides all
being Internet stocks setting new records for stock
appreciation against negative earnings?
Give up? They are now all the proud owners of Buy
or Strong Buy recommendations from Wall Street's
top Internet analysts. To boot, each stock enjoys a
rating of Buy or better from more than half of the
analysts.
Taken as a group, the eight Internet stocks listed
above have 46 Buy recommendations and 11 Strong
Buy recommendations out of a total of 78 ratings on
the group as a whole. How do you spell "bullish"
again? B-u-b-b-l-e.
While we know the party line on most of these stocks
by now, that Wall Street loves them not for earnings
but rather for branding, market identity, dynamic
growth rates, and mind share, we couldn't help but
quiz David Levy, Internet analyst with Furman Selz,
on just what the attraction is.
"We are using a 30 times multiple on year 2003
earnings to predict our target price," he says.
Earnings? In the year 2003? "What, you think that's
too far out?" says Mr. Levy of on his recent initiation
of coverage of OzEmail with a Strong Buy, a
company he refers to as 'Australia's own AOL."
"Let me tell you something, 2003 is nothing," he
continues. "Just take a look at some other industries."
All right, let's. "Competitive local exchange carriers
(CLEC)? They don't even have earnings. And
biotech? Biotech doesn't even have revenues. And
besides, we're discounting OzEmail 30 percent
compared to comparable valuations we placed on
Earthlink or Mindspring. We've got a 40 target, and
unlike the others, OzEmail is even profitable." Oh,
whatever.
For another version of this new Internet reality, we
turned to Paul Noglows, technology analyst with
Hambrecht & Quist who recently picked up coverage
of CMG Information Services with a Buy
recommendation. While CMG's received such honors
before, this is the first high-profile technology
investment bank to recommend CMG.
"The key to valuing CMG is to view it as an Internet
mutual fund," says Mr. Noglows in his research report
-- a very successful fund, at that. CMG's return on its
venture investments to date tops 2000 percent, and it
is now starting its third venture capital fund,
@Ventures III, to raise even more money for its
Internet marketing keiretsu.
The only challenge to investors, notes Mr. Noglows, is
that CMG's "quarterly operating performance will not
be highly predictable nor particularly relevant ... with
the key to CMG being its ability to benefit from
companies it helps start that are either sold for a profit,
or taken public via high-profile IPOs."
Hambrecht & Quist has a price target of 120 a share
over the next twelve months, which Mr. Noglows
feels should prove conservative. Normally we'd say
he's crazy, but since Wall Street is playing with all of
our heads at the moment, maybe Mr. Noglows knows
something the rest of us don't.
Channel-speak
Ask any analyst about Intel (INTC) or Compaq
(CPQ), and all they want to talk about is the channel
(as in "inventory," not "Spice"). "We did a channel
check and feel that the run rate will return to more
normal levels in the second half of the year," said
Ashok Kumar, analyst with Piper Jaffray. See what
we mean?
Mr. Kumar, along with his counterparts at Brown
Brothers Harriman and Salomon Smith Barney, all
upgraded Compaq to a Buy citing strong flows of
Compaq's inventory out of the channel and strong
moves by the company to incorporate the acquisition
of Digital Equipment Corporation into its operations.
(Reportedly Compaq plans to lay off 15,000
ex-Digital employees when the deal closes.)
This is good news for investors who have taken a thrill
ride with the stock since February when the stock
sank from 35 to 25, and has been on a rocky course
higher ever since. The overloaded channel, which
reached a glutted peak in Q1 1998, is now emptying
at a faster pace than analysts had anticipated, with
numbers out of Compaq, IBM (IBM), and Intel
indicating that current PC demand remains strong and
will likely continue at a steady clip through the second
half of the year.
"Order rates have picked up for delivery in the third
quarter when we hope to see a 3 million unit run rate
and a complete refresh of Compaq's product line,"
says Mr. Kumar. Compaq's higher unit volume,
according to Mr. Kumar, should return the company
to a more normalized 25 percent year-over-year
growth rate, as opposed to a nearly flat growth rate in
the first half of this year.
Piper Jaffray has a price target of 40 on the stock,
based on a 20x multiple of 1999 earnings. This price
target includes estimates that the Digital acquisition will
add 0.20 to 0.25 to Compaq's bottom-line earnings
for next year. Bad news for all of those unemployed
Digital workers, but great news for investors given
Wall Street's sick and twisted ways of rewarding the
companies which make the humanly difficult decisions
to fire significant portions of a workforce.
Like we said, Wall Street could use some help.
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