Here is an interesting article from Barron's that should put a smile on you CFON shorts..
May 18, 1998
Detroit's Past Could Hold Lessons For the
Internet's Future
By Eric J. Savitz
That the Internet sector has become one big hot-air balloon, badly in need
of a sharp pin, has become so obvious to so many on Wall Street that people
have almost stopped talking about it. The Internet stocks look like an accident
waiting to happen? Well, of course. Yawn. Ancient history.
Ancient history, as it happens, provides some sobering insights on what might
happen to the group's current darlings over the next few years. Edward
Kirschner, chief investment strategist at PaineWebber, tackled the subject last
week in an insightful commentary headlined "Net for Naught?" His
observations bear repeating.
Granted, Kirschner says, the Internet "is unquestionably a tremendous source
of growth." However, he warns that the early leaders in high-growth industries
often fall by the wayside much sooner than anyone thinks. Consider, for
instance, the auto industry. "For sheer size, pace of growth and
money-making potential," Kirschner writes, "no growth industry in American
history has rivaled auto manufacturing." Between 1900 and 1908, Kirschner
notes, 485 U.S. companies entered the automobile business. By the end of
that period, 262 had shut down -- and almost all of the others eventually
disappeared, as well. Bad business? No. But long-term success eluded most
of the early entrants.
For a more contemporary example, consider the 1982-83 personal computer
boom, which was followed by the infamous 1984 computer bust. By
February 1984, Kirschner reports, a group of 24 major PC companies had
plunged on average 50% from their 52-week highs. Very few of the
companies survived; fewer still have prospered. In 1982, Kirschner recalls,
the leading personal computer makers included Apple, IBM, Atari,
Commodore, Tandy and Texas Instruments. Of that group, only Apple and
IBM still play a role in the PC industry.
IBM hit an earnings peak in 1984 which it couldn't top for 12 years. "Only
Apple was a good long-term vehicle for playing the personal computer
business, depending on one's entry price," Kirschner writes. And for the
patient investor, there were better alternatives: the 1983 IPO of Compaq
Computer -- or five years later, the 1988 debut of Dell Computer.
Alternatively, recall the 1991 biotechnology boom. That year, PaineWebber's
biotech index rose a cool 157%. What happened next, of course, was
seriously ugly. In the first half of 1992, biotech stocks skidded, on average,
30%. In fact, of the 35 largest-cap biotech stocks in 1991, Kirschner reports,
only 10 now have prices higher than their year-end 1991 close.
Of the other 25, six were acquired, mostly at prices well below their 1991
year-end close, 13 never again reached their 1991 year-end level, and six at
some point topped that level, but subsequently fell back.
Kirschner fears that the Internet boom shares many of the characteristics of
previous high-growth manias. As in previous booms, demand for shares has
spurred a rise in supply "of distinctly varying quality." For the moment, both
economic forces and internal market dynamics remain favorable-low interest
rates, a growing economy, healthy demand for advertising, ever-cheaper
personal computers.
Media coverage of the Internet phenomenon has been glowing. Investors
have been less-than-discerning buyers. And not least, Kirschner observes, "in
an environment of slowing earnings growth, stocks with no earnings appear
attractive." The beauty of having no earnings: no earnings disappointments.
So, how will it play out?
Survival rates for the current Internet players, Kirschner asserts, will be low.
The business environment, he says, eventually will become less favorable. At
some point, the flood of funding to the industry will dry up. For many, Web
page "hits" will fail to turn into consistent profits. Many industry leaders will fail
to thrive for long; some Wall Street favorites will blow up. Too much will be
paid even for the industry's best companies. And many of the long-term
survivors will be companies that don't yet exist.
Of course, investors at the moment continue to scramble, looking for the
next great Internet stock. On Friday, shares of a little company called Pivot
Rules, which sells golf clothing, announced plans to hawk discounted apparel
over the Internet -- and the stock promptly soared 81%, to close at 3 5/8 .
Another bit of Internet insanity last week involved a Wilmington, North
Carolina, company called C-Phone. In a press release, it announced "the
introduction" of C-Phone ITV, a set-top box for providing Internet access
using a TV and a regular phone line. That's essentially the same service
offered by both WebTV, now a division of Microsoft, and NetChannel,
recently acquired by America Online, shortly after shutting down service
because of weak demand.
One difference is that the C-Phone box is supposed to be compatible with
any Internet service provider; most WebTV users sign up with their own
access service, though they do offer the option of keeping an existing ISP,
and then paying a reduced monthly fee to WebTV.
The news created a trading frenzy. The stock, which until the middle of last
week had been trading just south of $3, more than tripled on Wednesday, to
9 3/4, topped 10 in a hugely volatile session Thursday (during which it got as
high as 15 1/2 ), and then, with investors getting slightly more cautious, on
Friday closed at 9 3/8, for a weekly gain of 6 9/16, or 233%.
Trading volume reached insane proportions: more than 23 million shares
Wednesday, close to 29 million Thursday, and a "modest" 7.5 million Friday.
This for a company that has 5.3 million shares outstanding, about a fifth of
which are held by the company's husband-and-wife management team, CEO
Dan Flohr and COO Tina Jacobs. Toss in various warrants and a convertible
preferred issue outstanding, and C-Phone has the equivalent of 7.8 million
shares out, giving it a market cap of about $73 million.
Before you jump on the C-Phone bandwagon, consider a few facts:
For starters, it isn't exactly a corporate titan. For the nine months ended
November 30, 1997, C-Phone reported revenues of $1.2 million, down from
$1.5 million a year earlier. Losses totaled $4.4 million for the '97 period.
C-Phone sells a range of video-conferencing products, for both homes and
businesses -- but they apparently haven't been a big success. It's also worth
nothing that this is at least the fourth attempt C-Phone has made to find a
business model.
Founded in 1986 as Target Tuning, the company originally made
single-station radios, as promotional items for radio stations. In 1990, it
entered the modem business and became Target Technologies, the monicker
under which it went public in 1994. The company shifted its sights to
video-conferencing in 1993, however, and renamed itself C-Phone in 1996.
Now it's discovered the Internet. Annoyingly, there are an awful lot of things
that C-Phone isn't saying about its new box. Like what it will cost. And where
you can buy it. And how the company will finance development,
manufacturing and marketing of the device. At November 30, C-Phone had
$1.4 million in cash; it subsequently raised $4.1 million in a private placement.
Especially given C-Phone's mounting losses, that's not much of a war chest to
compete with Microsoft and AOL.
The company's pedigree doesn't inspire confidence, either. C-Phone was
taken public by Josephthal Lyon & Ross, a firm that has had repeated
brushes with regulators, including a $575,000 fine in 1996 for overcharging
investors. Just last week, C-Phone agreed to cut the exercise price on
200,000 warrants owned by Josephthal from $8.40 a share to $6.
And then there's this bit of oddness: We called Bill Karr, the company's
investor-relations contact, whom C-Phone designated to take calls about its
new gizmo, to ask him a few questions. Like what the thing looked like. Karr
responded that he couldn't do that. "The secrecy has been so great around
this," he said, "that I've not seen the product and not seen it demonstrated."
Karr had a little more to say about the run-up in C-Phone's stock price.
"Obviously, we're very pleased with the reaction," he observed. "As to why
it's happened, you really can't say. The market is driven by fear and greed,
and why a stock appreciates that much in value overnight, who knows?"
Finally, there's this bit of weirdness: Among the participants in C-Phone's
April 1997 private placement was an Indonesian banker named Made Oka
Masagung. In December, the Jakarta Post reported that a person by that
name had been indicted for his part in a scheme to forge promissory notes
worth $56.3 million. An outside spokesman for C-Phone said the company
was introduced to the banker by Josephthal, and knew nothing about him
beyond the fact that he was an investor.
A few weeks back, we noted a warning from the newsletter
Microprocessor Report that a glut of capacity seemed on the horizon in the
microprocessor industry. On Friday, concerns about that possibility stepped
up a notch after Thomas Kurlak, the Street's biggest Intel bear, issued a
similar warning.
Kurlak observes that Intel already has enough capacity to make more chips
than the market requires, and that the company's transition this year to chips
with thinner line widths will boost its potential capacity about 50%. Include
new capacity from Advanced Micro Devices and other clone makers, Kurlak
adds, and the total goes even higher.
Intel, he concludes, faces the prospect of either laying off workers or starting
a price war. As the Intel situation demonstrates, the pressure on PC
manufacturers to sell cheaper and cheaper personal computers creates some
interesting dynamics for the semiconductor industry. On the one hand,
providers of historically high-margin parts, most obviously Intel, must reduce
pricing. On the other hand, higher unit demand should soften the blow for
parts makers enduring narrowed margins, and provide a lift to makers of
commodity parts.
So, what's an investor to do? At a recent Silicon Valley dinner meeting, a
group of Wall Street analysts gathered to ponder that question. The event,
hosted by the Churchill Club, featured prognostications from four Wall Street
chip analysts: Dan Niles, of BancAmerica Robertson Stephens; Erika Klauer,
of BT Alex. Brown; Doug Van Dorsten of Hambrecht & Quist; and Drew
Peck, of Cowen & Co.
For the upbeat view, Dan Niles is your man. While noting that we're currently
mired in the worst three-year stretch in the history of the semiconductor
industry, he fell into the raging bull camp. The chip industry, he says, should
benefit from a need for more PCs -- and more powerful ones -- the coming
of both Windows 98 and Windows NT 5.0 from Microsoft, the
near-completion of an inventory correction in the PC industry, and some
promising efforts to solve the "bandwidth problem" -- the thirst for faster
connections to the Internet.
While Niles warned that the sector could soon see a 10%-15% correction, he
forecasts that the SOX, the Philadelphia Stock Exchange's semiconductor
index, will hit 400 by the end of the year -- 25% above its current level.
Bullish on PC demand, he names Intel as his top pick.
Peck, in contrast, sees reason for caution on chips in general and Intel in
particular. The Cowen analyst argues that Intel's X86 microprocessor
architecture, including the top-of-the-line Pentium II chip, is "running out of
steam."
Intel's response, he notes, has been to cut prices, boost advertising and
segment its market. Like Niles, Peck sees robust unit growth ahead for the
PC industry, better than 20% a year. He sees that growth, though, driven by
lower and lower prices, leaving Intel with higher sales growth, but reduced
margins. "It becomes a different type of business," Peck says. Other investors
are wary, too. Friday, Intel shares fell 4 1/4 points, to 80 5/16.
Trying to avoid the unsettled PC business, Peck has been searching for
opportunities in chip makers catering to other end markets, like cellular
phones, digital cameras, DVD players and XDSL modems. Thus, he's
focused on makers of analog chips, analog-to-digital converters and DSPs
(digital signal processors). His top choice: Analog Devices. (He's not the only
analyst who admires those companies, of course. Look out three to five
years, advises Niles, and no company looks better-positioned than Texas
Instruments, which has refocused its business on DSPs.)
Klauer, of BT Alex. Brown, sees chip industry growth returning to
15%-20%, starting next year and going through 2003, driven by robust
demand for both computers and a range of communications and networking
gear.
Chip supplies, now in excess, should become considerably tighter by the
middle of next year, she asserts. For that reason, Klauer sees some
investment opportunities in an increasingly fragmented semiconductor
production industry. While many investors are familiar with
semiconductor-equipment stocks, like Applied Materials, she sees promise in
two other pieces of the process-packaging and testing. Both segments,
Klauer says, should grow at better than 20% annually for the next five years.
Her top pick: Amkor Technology, a newly public Korean semiconductor
packaging company.
Van Dorsten, of H&Q, made a case for "intellectual property" plays,
companies that can provide reusable software parts to speed up the process
of developing new chips. While Van Dorsten notes that most semiconductor
intellectual property is held inside companies that design chips or provide
electronic design automation tools, he sees a real market available for
independent players. His favorite: newly public Aspec Technology.
All four analysts, by the way, gave not only their top picks for the next 12
months, but also their top shorts.
Niles went for the obvious choice, and named K-tel International, which has
had a monstrous run since announcing its online music store. Klauer advised
shorting Amazon.com, the online booksellers. Van Dorsten chose At Home,
operator of a cable-based Internet access service. The gutsiest pick came
from Peck, who chose Dell Computer, theorizing that the company won't be
able to avoid the fallout of the personal computer price crunch.
E-mail: savitz@barronsmag.com |
