Bold:
Dow Jones News Service
(Copyright (c) 1999, Dow Jones & Company, Inc.)
(This story was originally published Tuesday.)
NEW YORK (Dow Jones)--Up until August, Internet stocks were like
lemonade. They weren't especially good for you, and there wasn't a whole
lot of science to putting them together, but they sure tasted sweet.
Well, all but a few of the Internet IPOs that rocketed this spring
fizzled while "springtime turned slowly into autumn," as the Bard of
Minnesota put it. Sobered investors and analysts are looking at Internet
stocks with sharper attention as we usher in fall.
Nobody's come down from the mountaintop and declared the Internet to
be over. And nobody will. With big manufacturers embracing it as a sales
tool and big media companies investing in it as a consumer service, the
Net itself will grow no matter what happens to stocks of companies
trying to ride it. But listen closely to analysts, both in Wall Street
brokerages and market-research companies, and you'll hear a more
weathered edge to their voices. For fall, if you're an Internet stock
investor, you'd better know what you're buying.
"The metrics that have been used for many of these stocks have been
quite simplistic, pure revenue multiples," says Jim Preissler, who
covers consumer Internet stocks for PaineWebber. "[With] momentum
stocks, it worked great." Now, says Preissler, a concept from retailing
known as seasonality may take the zing out of revenue growth. For
e-tailers, just as for their brick-and-mortar counterparts, and for
advertising-supported Web sites, just as for magazines and TV stations,
business is strongest around the holidays and weakest in the first
quarter. The upshot of this seasonality, which Merrill Lynch's Henry
Blodget has also discussed, may lead investors to lose faith in momentum
and seek more traditional signs of growth. Odd, isn't it, that the
Internet, which was supposed to act as the spaceship of our new-consumer
lives, should fall victim to the same calendar pressures as barnacled
barges like Kmart (KM) and Wal-Mart (WMT)?
Something else about that spaceship that's starting to look
increasingly dubious: It was supposed to be fueled by advertising. The
ignition sequence was simple. Have an IPO; use the proceeds to fund a
lavish brand-building ad campaign; let the "eyeballs" roll in; and then
maybe eventually actually have a working business. Bill Frezza of Adams
Capital Management looked at the stampeding IPOs this summer and came
away shaken. "The businesses that are most suspicious are the ones with
negative gross margins, putting all their capital into building brand,"
he says.
Dubious advertising is shaping up as the social disease of the
Internet orgy. On the one hand, new Internet sites have to advertise in
order to draw significant traffic. On the other hand, investors no
longer seem content with the idea of buying stock in order to fund
cheeky media blitzes for just another me-too site. As we discussed
earlier, even the once-profitable CNET (CNET) got flayed by investors
for plowing money into a multimedia ad campaign. Internet companies' ad
spending can fail spectacularly, especially if the economy cools off, by
boring consumers and annoying investors at the same time. "Part of brand
spending is about attracting consumers, but the other part is shameless
hyping of stock," Frezza says.
The real winner here, ironically, may turn out to be the old media
that was supposedly going to be devastated by the Internet. "This is a
great opportunity for [ad] agencies," says Marissa Gluck, an advertising
analyst with market-research outfit Jupiter Communications. And as CBS
(CBS) honcho Mel Karmazin pointed out at his nuptials with Viacom (VIA
VIAB), it's also a great opportunity for media companies that sell a lot
of ad time on TV and radio stations.
There are long-term Internet plays to be played, though - especially
in the unglamorous world of infrastructure. Stocks in this area involve
hard-core science, which can be harder to understand than those sexy
"content" stories, but they also involve big contracts for equipment and
service, which makes their growth easier to track. The IPO pipeline,
which was clogged with now-humbled content stocks such as iVillage
(IVIL) and TheStreet.com (TSCM) this past spring, now contains several
companies that focus on making the Internet run faster. Some expected
Cerent to pace this market, but Cisco Systems (CSCO) took it out of play
by bidding $6.85 billion for it at the end of August. Now Sycamore
Networks, which makes gizmos to help phone carriers allocate space on
their lines, expects to raise $115 million in an IPO this fall.
Here, too, though, investors need to show a lot of faith. Covad
Communications (COVD) illustrates the case nicely. The company, which
makes technology to make the Internet run faster over ordinary phone
lines, announced an expanded business plan after the close last
Thursday. Its stock gained 6% the next day. Covad now plans to offer
service in the country's 100 biggest metropolitan areas by the end of
next year. Sounds strong, but you still have to use the business model
rather than the business itself to value this stock and its peers.
According underwriters Bear Stearns, Covad distinguishes itself by
posting positive gross margins - the percentage of sales it keeps after
paying for goods sold but before paying overhead. But those margins are
a paltry 2.5% - not much enticement for the show-me investor.
For the risk-averse, the conviction that the Net will grow as a medium
could produce some relatively cheap plays. Merger speculation will
continue to nip at 3Com (COMS), Cabletron Systems (CS), Newbridge
Networks (NN) and the other networking equipment companies that have
sluggish growth but strong sales forces and brand names. And the stocks
of big behemoths like AT&T (T) and MCI WorldCom (WCOM) could have room
to climb. MCI WorldCom got stung after an embarrassing data outage; AT&T
got caught in a crossfire of doubts about its cable upgrades and
confusion over its willingness to give AOL access to its cable systems.
Of course, everything depends on how many punches investors are
willing to take. Adams Capital's Frezza is waiting it out, unable to
predict whether a series of small corrections will produce a "soft
landing" for Internet investors. He's putting his clients' money only
into businesses with growth models he is able to measure. Investors
who've had a summer of fun with Internet stocks might do well to store
up some tried-and-true equipment businesses for a harsh and sudden
winter.
For more information and analysis of companies and mutual funds, visit
SmartMoney.com at smartmoney.com
|
