Field guide to the new Net stock universe:
For those who think they missed out on big Internet plays like Yahoo! and AOL, there are still plenty of Net subsector stocks to put your money in, such as EMC and Verio. Here's an overview of the top players.
By Nancy Gondo
Yahoo! co-founders David Filo and Jerry Yang knew what they were doing when they named their company. Investors who got in early, late or just two months ago are screaming with happy abandon as they watch it and other Web stocks launch from cyberspace to outer space.
But what about those who've been standing on the sidelines, watching the show from afar? Many perhaps don't realize the Internet space is made up of many different types of companies, from makers of infrastructure building blocks to innovative retailers to creators of entirely new software and services that might be appropriate for investors without money to burn.
Indeed, the blanket term "Internet stocks" doesn't do these companies justice. The industry is so busy consolidating that whole subsectors are being wiped out by the voracious predations of giants such as America Online (AOL) and Yahoo! (YHOO).
It's hard to know how to value companies in this new industry because many are not yet profitable. We'll have more on that Wednesday. But for now, just realize that in the New Paradigm, earnings don't matter. Don't laugh. It's true, at least for now. What matters is brand development, revenue growth, customer service and gross margin expansion. With those concepts in mind, here's a field guide to the key Internet stock sectors, and a cheat sheet to help you understand the top players in each and their risk profiles. (Web giants like America Online, Amazon.com (AMZN) and Microsoft (MSFT), now tower over multiple sectors -- but in this article, we'll only let them dominate one.)
Consider that Yahoo! has gained the kind of traffic that television networks took decades to acquire, and you realize the company is only at the start of its growth curve.
Portal: the starting point
Once you get to the Internet, this is often the first page you face. Increasingly, the object of portals is to bring so much into one place that you'll never go elsewhere. Yahoo! is our top pick in this space -- a Web blue chip. Here, customers can search the Web, go online shopping, check and send e-mail, enter chat rooms, research a new car and set up a new store -- all from the same site.
Though they make it look easy, Yahoo! has been a real innovator -- the first portal to offer users free e-mail, calendars, Web-based pagers, games and other services. This isn't just about fun and games, though: A portal needs to make money via multiple revenue streams, and Yahoo! has paved the way with advertising, e-commerce, referral fees and more en route to impressive 36% operating margins.
The company got out of the red in 1998, sending the stock 615% higher over the year. The firm earlier this month reported first-quarter 1999 operating earnings of 11 cents a share, beating estimates. Traffic growth also rose to an average of 235 million page views per day from 167 million in December.
"Yahoo! happens to be the best example of Internet wheat out there, all the more so since some of the veritable sea of chaff remains as highly valued as this Internet Blue Chip," SG Cowen analyst Scott Reamer wrote last week in his biweekly report, the Internet Capitalist.
What's next? Yahoo! content will be formatted by Online Anywhere for hand-held devices and WebTV. And Yahoo! bought broadcast.com (BCST), which will let it display TV-like videos on PC screens.
Yahoo! was second only to America Online for total number of unique visitors in February, says research firm Media Metrix, attracting a whopping 31.1 million visitors, vs. America Online's 38.1 million. Consider that it's gained the kind of traffic that television networks -- the old mass medium -- took decades to acquire, and you realize the company is only at the start of its growth curve.
Strong challengers: Go2Net (GNET), Lycos (LCOS), CNET (CNET), America Online (AOL), Microsoft (MSFT)
Strange challengers: theGlobe.com (TGLO), Infoseek (SEEK), Walt Disney (DIS)
"The company is so large it's the gorilla, but it moves like a chimpanzee."
-- Steve Harmon, Internet.com
ISPs: providing access to the Internet
These guys allow you to use the functions on the portal. It doesn't take a genius to choose America Online as a top pick. The company started as an Internet service provider (ISP) but has also become a portal, software maker and e-commerce hub. Besides hooking users to the Web with the click of a button, it manages online communities, offers e-mail, provides an electronic newsstand, will get your store hooked up to customers and appeals to all age groups.
"AOL is the leader," said Steve Harmon, senior investment analyst at Internet.com. "The company is so large it's the gorilla, but it moves like a chimpanzee. That's powerful -- and dangerous for the competition."
America Online stock rallied 592% last year and hit a new high earlier this month. Web-heads often consider America Online to be for beginners, but its recent buyout of Netscape Communications and alliance with Sun Microsystems (SUNW) could change that image.
MindSpring Enterprises (MSPG), another top pick, provides Internet access in most major markets across the United States. It turned its first profit of 30 cents a share last year. That's expected to surge to 93 cents this year. The stock saw a 483% run in 1998 and had been consolidating for three months before breaking out last week.
Strong challengers: AtHome (ATHM), EarthLink Networks (ELNK), PSINet (PSIX), Verio (VRIO)
Strange challengers: Internet America (GEEK), Cable & Wireless (CWP)
Harmon doesn't even consider Barnes & Noble a rival. Instead, he says, the company's rivals are big retailers like K-Mart, Wal-Mart Stores and Costco.
Retailer: selling or auctioning goods over the Internet
Web e-tailers don't have to shell out money for salespeople or real estate, so prices are generally lower than in stores. Shipping costs can raise the price back to store price, but for large purchases, the lack of a sales tax gives e-tailing the advantage. A drawback could be the wait.
Still, if you bought Amazon.com (AMZN) stock last year along with a John Grisham paperback or the Starr Report, you're styling. And the company is still a top pick in this space. The online bookseller was 1998's stock leader among big caps, with a stellar 980% gain. It's now trading just below its Jan. 8 peak near 200.
Despite triple-digit sales gains the past two years, Amazon.com has yet to post a profit. The good news: Amazon.com topped book chain Barnes & Noble (BKS) in Media Metrix's February ranking, as it has done for months. Harmon doesn't even consider Barnes & Noble a rival. Instead, he says, the company's rivals are big retailers like K-Mart (KM), Wal-Mart Stores (WMT) and Costco (COST).
And Amazon.com is now going after eBay (EBAY) with its own auction site. "We believe Amazon's brand allows the company to sell anything and everything on the Web, becoming e-tailing's leading franchise," said analyst Lauren Cooks Levitan of BancBoston Robertson Stephens.
eBay, another top pick, went public in September at a split-adjusted $6 a share and is now trading around $170. It runs an online auction site where users can buy and sell their wares. eBay has made small profits the past three years, but that's better than most Internet companies. Its market capitalization now is larger than Sears, Roebuck (S) and Federated Stores (FD) -- owner of Bloomingdale's, Macy's and other heavyweights -- combined. One problem is maintaining credibility in the interaction between buyers and sellers, but new anti-fraud initiatives appear to be abating that fear.
"eBay is probably the most efficient model out there in terms of operating," Harmon said. "They never touch the merchandise."
Strong challengers: Egghead.com (EGGS), Cyberian Outpost (COOL), Beyond.com (BYND)
Strange challengers: Cybershop (CYSP), uBid (UBID)
Its positioning in almost every aspect of Internet use -- from Web servers to Web database software to Web browsers to Web commerce solutions.
Software: products that tell the hardware what to do
Microsoft (MSFT), the world's largest software developer, makes operating, application and database software used both by PCs accessing the Web and companies displaying their wares on the Web. (Editor's note: Microsoft is also the publisher of MSN MoneyCentral).
The stock went public in 1986 and started fast out of the gate, but went flat before really taking off in 1990. Since then, it's seldom looked back. Last year, it gained 111% even under the cloud of a U.S. Justice Department lawsuit. Its positioning in almost every aspect of Internet use -- from Web servers to Web database software to Web browsers to Web commerce solutions via wireless, wireline, cable and television -- makes it a top pick by most analysts.
Oracle (ORCL), another top pick, makes Web database and business software, and provides consulting and support services. It had a rough 1997. Worries about its slowing applications business were compounded by concerns that Microsoft was stealing some of its database sales. But Oracle beat fiscal third-quarter profit forecasts by a penny. The stock's now trading around 24, slightly more than half its 52-week high of 41.17.
Strong challengers: America Online (AOL) (due to its Netscape acquisition), IBM Corp. (IBM), Sun Microsystems (SUNW)
Networkers: make hardware and software products that link computer network systems
Cisco Systems (CSCO), a top pick, makes networking equipment and software. Two-thirds of the market for routers, which direct information on data networks, belongs to Cisco. The stock's been consolidating for about 10 weeks. After rallying 139% in 1998, it's gained about 23% in 1999. Earnings are expected to rise 24% for July, the end of fiscal 1999.
Because Cisco's the leader at moving data, it wants to use its know-how to move voice with Internet technology. Cisco now makes it possible for customers to make phone calls, surf the Web and send faxes over an Internet connection.
Strong challengers: 3Com (COMS), Lucent Technologies (LU), Intel (INTC)
Semiconductor makers: sell chips that speed up connection to the Internet
Semiconductors control computing equipment by interpreting the software's instructions.
PMC-Sierra (PMCS), which saw a price gain of 103% last year, makes chips for the PC and communications industries. The stock has trended sideways much of this year and has been profitable since 1997.
In 1996, the company turned its focus from PC chips to networking, helping it gain revenues from the Internet business. Now, 96% of its sales come from networking cards.
Analyst Hans Mosesmann of Prudential Securities thinks PMC-Sierra "is one of the best broadband integrated circuit vehicles for investors wishing to play Internet-driven demand for more bandwidth."
Strong challengers: Broadcom (BRCM), Galileo Technology (GALT), Intel (INTC)
Strange challengers: Analog Devices (ADI)
Storage devices: needed to store and remember any data on a PC
EMC Corp. (EMC) is benefiting from the Internet and e-commerce boom because more information now must be stored. The stock -- and its earnings -- have shown no signs of a slowdown.
Last year, EMC shot up 189%. It's up about 54% this year. Lehman Brothers analyst George Elling recently gave an "outperform" rating to the stock. "With ever-increasing needs for storage, we believe EMC is uniquely positioned to exploit opportunities in the open systems and mainframe area," he said.
Strong challengers: IBM (IBM), Seagate Technology (SEG), Network Appliance (NTAP)
Bandwidth: the pipes that connect the user's home to the Internet
Most people connect with a modem through a phone line, which is like trying to suck data through a straw. The higher the bandwidth, the bigger the pipe. You'll get better, richer sound and graphics.
Metromedia Fiber Network (MFNX) provides high-bandwidth fiber-optic networks to local phone companies. It's now operating in the East Coast. Chicago, Seattle and Los Angeles soon will follow. It also plans to build a network in Germany.
Just about every month, Metromedia announces another deal to lease its fiber-optic lines in the U.S. to another ISP. The stock vaulted 737% last year and is near new-high ground. Year-to-date, shares have surged 138%.
Another key player is Qwest Communications International (QWST), which is building a 18,500-mile nationwide network.
Qwest technology lets customers place calls automatically from the Internet on Switchboard's Web site. Acquisitions are shaping Qwest into a commerce service provider. This year, it bought Icon CMT, a provider of Web hosting services, and EUnet International, an ISP in Amsterdam. After a volatile 1998 in which Qwest rose 65%, the stock already has gained 89% this year.
Strong challengers: Level 3 Communications (LVLT), IXC Communications (IIXC), Global Crossing (GBLX), Williams Companies (WMB)
Digital delivery: software purchases are sent directly to buyer's computer
Why buy software at CompUSA if you can download it from home?
Digital River (DRIV) uses electronic software delivery to send software via the Internet to customers' PCs. It stores programs on a server, takes and sends the orders and keeps a cut of each sale.
The stock has grown more than fivefold since its Aug. 11 debut, from $9 a share to about $47. Digital River is not expected to make money this year or next.
"That's the future of software," Harmon said. "The inefficiency (with software stores) is having to drive to the store to pick up your software."
Commerce service providers: provide Internet connection, Web site hosting and application services
When accessing a company's Web site, most don't wonder who makes it possible. Commerce service providers (CSPs) such as Exodus Communications (EXDS) and PSINet are behind the scenes.
Sectors and Trends
Exodus has more than 800 customers across many industries, including Yahoo!, Microsoft and many Fortune 500 companies. With eight Internet data centers in the states, it's now looking overseas. Three Internet sites in Europe and Asia are planned for 1999.
Exodus stock went public in mid-March 1998 at $15 and is now trading around $70, a 367% jump. Though sales have grown at triple-digit rates since 1996, analysts don't expect Exodus to make money until 2001.
PSINet already does business in Canada, Europe and Asia. It has teamed with Covad Communications (COVD) to launch PSINet digital subscriber line services, making high-speed Internet access available over existing phone lines. The stock, which rallied 288% last year, has tripled this year.
Web-hosting services from CSPs will grow to more than $10.5 billion by 2002, Forrester Research predicts.
Strong challengers: AboveNet Communications (ABOV), Verio (VRIO), Concentric Network (CNCX)
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