Herr is another article from the red herring...
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.
We were wondering if Compaq, DEC and Tandem would make a happy fit. Apparently not.
Wall Street fell in love with CMG's story not more than a month ago.
Any analyst recommendations take you to a happy place? Share your joy.
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