THE NET'S NEXT ERA: Shaky Legs for the Net's Heavy Lifters
NOVEMBER 14, 2001
The big names that keep the Web spinning got tangled in the tech downturn -- and tight IT budgets may keep them from springing back soon
In the short-lived but legendary dot-com era, when venture capital grew on trees and the Internet held the promise of amazing riches, no companies benefited more than the Big Four that keep the Web running. The Net revolved around Sun Microsystems, whose servers host Web sites. Dot-com investors worshiped Cisco, whose routers direct traffic to all those servers. Oracle's business blossomed, as Web companies used its database software for everything from managing e-commerce to delivering dynamically generated pages. And as the need to store megawads of Web info grew by leaps and bounds, so did storage provider EMC.
The glitzy growth these companies enjoyed is gone for now, and what remains are questions: How long and deep will the post-dot-com letdown be for such former pillars of the New Economy? Will they bounce back quickly or remain stunted for years?
Fortunately for these and other companies that cashed in on the Web -- and grew to depend on it -- the dot-com bust is probably bottoming out. Even so, prospects for suppliers of most things Web-related may remain muted for some time to come. Sales of all of the Big Four except Oracle are down 25% to 50% this year vs. last. Thus, based on projections from a number of analysts, it could be half a decade before even the major Web infrastructure players are again as big and prosperous as they were in 2000.
SLEEPY MARKET. A major problem for the Big Four is the same one that afflicts the entire tech sector: Forecasts of near-term corporate information technology (IT) spending range from disappointing to dismal. According to a recent Merrill Lynch survey of 50 U.S. and 15 European businesses, IT budgets may grow only 2% in nominal terms next year, vs. the 5% the same companies projected in July.
Stamford (Conn.) IT consultancy META Group is even more pessimistic -- it expects total IT spending in the U.S. to actually decline next year, by 2% to 5%. Either forecast is sobering when compared with the dot-com heyday: Compared with 11.1% growth in 2000, market researcher IDC expects a 3% rise in tech capital spending in 2001.
Those tight purse strings will translate into a relatively somnolent market for companies that supply the Net. Web-related hardware sales might grow 10% annually over the next few years -- a healthy pace but well short of the high double-digit rates during the dot-com buildup, says Andrew Bartels, an expert in e-business strategy at IT advisory Giga Information Group. Eventually, "we'll see revenues come back, but we won't see the growth [of the 1990s] come back," he says.
DARWIN RETURNS. The market for Web hosting -- also called data-center management -- is also facing a letdown. It's projected to grow from a $1 billion business last year to $20 billion by 2005 -- far short of the previously anticipated $100 billion by then, says Ford Cavallari, an analyst at Boston-based tech consultancy Adventis. More and more, adds Bartels, the dot-com era is starting to look like "a once-in-a-generation phenomenon."
In fact, says Brian Turner, chief financial officer of RealNetworks, a supplier of software that delivers sound and video via the Web, the Net "has moved from a phenomenon to a viable business." While that's good, it also means that success on the Web has been redefined from survival of the fastest (as in, fastest to market) to survival of the fittest.
Fierce competitors in the right markets may do fine, while ones that merely participated in the indiscriminate prosperity of the dot-com buildup won't. Companies that supply big corporations with Net technology are anticipating a slight rebound reasonably soon, reflecting the minor uptick many analysts expect for next year.
That's great news compared with what's happening at phone carriers that provide access to the Web for consumers and businesses. Their spending on technology initiatives could decline as much as 20% this year -- and then fall again in 2002, according to investment bank TD Securities. Most analysts estimate that next year's decline will be in the single digits.
RELATIVE STRENGTH. In the corporate environment, the beneficiaries could include Cisco, which relies on business customers for as much as 70% of its revenues, and IBM, whose corporate clients "continue to move important business processes to the Web," says Jim Gant, Big Blue's vice-president for e-business hosting. Still, on Nov. 5, Cisco reported net sales for the first quarter of fiscal 2002 of $4.4 billion, a decrease of 32% from the same period last year, and predicted that sales in its current quarter will be flat to up slightly. And IBM's net income dropped 19% in the third quarter ended Sept. 30. But compare those companies to optical-gear maker Nortel Networks (NT ), which, on Oct. 18, reported third-quarter revenues of $3.69 billion, a 45% drop from the same period the year before.
One sector positioned for strong growth next year, says A.G. Edwards analyst Shebly Seyrafi, is services, a high-margin category that includes such businesses as outsourcing, or managing all of a client's technical operations. Services are certainly contributing to IBM's bottom line at the moment.
Also in high demand are so-called convergence applications -- software that connects a company's PCs with cell phones and personal digital assistants (PDAs), says Cavallari. Bell Canada Enterprises offers a service that lets customers log into their company's network using a variety of methods, from desktop PCs to wireless devices. The thinking behind such products, says Cavallari, is that "if you tie it all together, you can sell more of everything."
DIZZYING FALL. Another key to success, of course, is staying power. In the Web hosting sector, industry leader Exodus Communications (EXDSQ ) filed for Chapter 11 bankruptcy protection in September and is trading around 12 cents a share, a dizzying fall from its 52-week high of $37 a share. By contrast, IBM recently announced that it has attracted $1.7 billion in new Web-hosting business so far this year, about double the amount it won through the same date last year. IBM attributes its success to going after solid, traditional business clients instead of Internet companies -- many of which have disappeared anyway.
One group of Net suppliers that won't be bouncing back any time soon, says Bartels, are the companies that help support e-commerce, such as software makers BroadVision (BVSN ), Commerce One (CMRC ), and Ariba (ARBA ). They help customers put catalogs of products on the Web. Although researcher Jupiter Media Metrix projects retail sales via the Net to rise more than 180% in 2001, to $34 billion, and then reach $130 billion by 2006, turning a profit on those revenues has proven difficult.
Consequently, new players with busloads of money are unlikely to start new industry exchanges and marketplaces in the near future, says Pacific Crest Securities analyst Brent Bracelin. This has left Ariba trading near $2.83 a share, down from its 52-week high of $141 a share.
SEEING BEYOND GLOOM. For now, companies that power the Web have to take solace in the notion that though meteoric growth may be a thing of the past, solid growth is still reasonable to expect -- and it could happen when the economy improves. Already, the number of broadband subscribers in North America exceeds 9.3 million users -- vs. 6 million a year ago, according to broadband consultancy Kinetic Strategies. And that number will double for the next few years, predicts Gary Schultz, president of MRG Multimedia Research Group. Chances are, consumers who are buying fast access plan to use enhanced Web capabilities, such as multimedia, that will benefit Net infrastructure companies.
Some analysts worry that Web suppliers may face six to nine months more of shrinking demand before this rosier scenario takes hold. "Most [corporate customers] are sitting with servers that are idle and storage that has a lot of room," Bartels explains. "They'll wait for those to fill up." Even so, a consensus is growing that the worst is nearly over for Net infrastructure companies -- and that in 2002 they'll walk the first few steps along the path to renewed growth.
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By Olga Kharif in New York
Copyright 2000-2001, by The McGraw-Hill Companies Inc. All rights reserved.
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