Caught up in the Net
Keith Benjamin isn't wary of the Web. As Robertson Stephens' Internet analyst, he's bullish on the sector. His favorites: America Online, CNET and E*Trade.
By Eneida Guzman
Those high-flying Internet stocks have seen more than their share of downdrafts during Wall Street's recent, volatile weeks. But "to give up on the group at this point would be extremely premature," contends Robertson Stephens' Internet analyst Keith Benjamin.
Benjamin, whose stock picks are up about 35% so far this year, uses a top-down approach to select among leading Internet brands. Then he goes for a "second tier" of stocks, surfing for opportunities among the Internet's emerging brands.
Investor caught up with Benjamin during a hectic week in which Internet stocks were down more than 15%. Surprisingly, we found the analyst's confidence intact.
With the exception of the past few weeks, your job has been pretty easy this year. Internet stocks are up more than 30% year-to-date.
The group has been marked by extraordinary volatility and it's been incredibly difficult to figure out when to get in and out of these stocks. If you take a look at the overall performance of Internet stocks over the last 18 months, or since the beginning of 1997, the group is actually up less than the S&P. Yes, Internet stocks are up 30% so far this year, but that's after correcting 20% a couple of weeks ago. So I wouldn't necessarily characterize this as an easy year.
50% growth rate
Tell us how you see Internet business trends evolving.
The most exciting, surprising trend that continues to evolve in this field is that more people on the Web are buying more things. Fifty million people bought something on the Web since the beginning of 1998, which, by most measures, represents a mass market. Advertising revenues have come in roughly in line with expectations, but e-commerce revenues -- we actually like to use the word e-tailing -- have come in well above expectations. If you had asked me a year ago, I would have expected 1997 e-tailing revenues to have been about $1 billion. They came in somewhere over $3 billion. So what we've been seeing since late 1997 or early 1998 is that more people are on the Web and more companies are generating more revenue from commerce. I expect that similar trends will continue. I estimate that we'll see 50%-plus growth in the Internet audience on a calendar-year-over-year basis over the next few years, more than a doubling of advertising revenues and possibly a tripling of commerce revenues.
If you had asked me a year ago, I would have expected 1997 e-tailing revenues to have been about $1 billion. They came in somewhere over $3 billion.
Will stocks continue to respond accordingly?
The stocks have been pretty consistent -- they tend to react very favorably to news. There are two categories of news -- news of quarterly reports, and then strategic news in between quarterly reports. The challenge is that institutional investors have been participating in this space, but retail investors on the margins have been the ones really driving the stock prices. They tend to buy when they see a news release and they tend to sell at the first signs of stock weakening. So it's been actually a pretty consistent pattern that after the stocks report and there's no more news, the retail investors sell and stocks tend to go down. The institutional investors buy when we start to get back into the quarterly reporting season.
So will Internet stocks go up or down next earnings' season?
Sometime in late September I think we'll start to see the stocks move up in anticipation of the quarterly reports for October. I think that the stocks will move up not just because they'll recover from the recent weakness, but also because I think that the group will see reasonably strong, positive surprises in terms of traffic and revenue growth for the September and December quarters.
Some market experts believe the exact opposite -- that Internet stocks currently have a lot more downside than upside, simply because they've had such significant gains and several of the stocks are not even close to reporting profits.
Sometime in late September I think we'll start to see the stocks move up in anticipation of the quarterly reports for October.
This is no different than any other new media business. Looking back to say that these companies haven't been earning money is just about as short-sighted as having said the same thing at the beginning of the cable industry. I think you'll see that as we get to the end of 1998 and 1999, there will be a host of companies ramping towards profitability. But investors do have to make informed and, hopefully, conservative judgments about how these business models will evolve. To come up with a rational way to value these companies, you have to judge how much money these companies can make based on audience sizes that are being built. If all you had done at the beginning of cable were to say, "Well, of course these stocks are worthless because they're not making money," you would have missed a huge opportunity.
Survival of the fittest
You have a pretty long list of buys on your recommended list. There have been a lot of strong performers in the sector -- how do you separate the wheat from the chaff?
Well, as you can tell, I'm reasonably positive on the group. I take a top-down approach and make a decision whether or not I believe there's enough money out there to support multiple companies. Then I look at the different segments. I've focused primarily on the networks, those companies trying to aggregate content and commerce, like the America Onlines (AOL), the Yahoo!s (YHOO) and the Amazon.coms (AMZN) -- those companies trying to provide stores for you on the Internet, the e-tailers. We try to start with the leading brands. They're the ones that we have been consistently recommending. The challenge with these stocks is that they tend to reflect higher levels of expectations than some of the emerging brands. And our second-tier effort has been to try to find the emerging brands.
Excite, Sportsline, CNET, E*Trade and Preview Travel all have strong competitive positioning, and I believe they will prove to be leaders in their space.
Which emerging brands stand out?
There are several in that category that stand out. Excite (XCIT), SportsLine (SPLN), CNET (CNWK), E*Trade (EGRP) and Preview Travel (PTVL) all have strong competitive positioning, and I believe they will prove to be leaders in their space. These stocks tend to sell at lower multiples relative to potential future earnings. I use the year 2001 as my benchmark for evaluation. So I'd give these companies at least another two to three years to demonstrate brand leadership.
You also cover a third business category within the sector that you call the Internet-enabled business category. What do you like in that space?
The Internet-enabled business category is fundamental to the growth of the Internet. These are businesses where the Internet can help improve distribution methods. Dell Computer (DELL), for example, is a direct seller of computers. And now they are selling several million dollars' worth of product every day from their Internet e-business site. Does that make them an Internet company? No. Does that make them an Internet-enabled or an Internet-enhanced company? Yes. One of the companies that's doing a terrific job in the e-business space is Getty Images (GETY).
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Tell us more.
Getty happens to own the largest library of stock photography in the world. They own the type of photos that you might see in a magazine advertisement or that might accompany a newspaper article or a feature in a book. They have amassed more than 30 million images, and it has been a pretty good business. The Internet has enabled them to do two things with those pictures. One, digitize them, so it's easier for you to find the picture that you might want; and two, actually deliver that picture to you over the Web. This allows Getty to reach a broader audience at a much lower cost of goods sold. I expect the company to see a pretty dramatic acceleration in revenue growth and profit margins from 1998 to 1999. The stock sells at approximately $19 a share and trades at less than 20 times current cash flow per share.
Best of the best
Of all the 17 stocks that you follow, which would you rate your top picks?
AOL, CNET and E*Trade.
The reasons for picking AOL are quite obvious, but why CNET and E*Trade?
I like CNET because it offers a lot in terms of value. The content and service is very good. Their business model started from a strong base of advertising revenues. They actually get higher prices and sell a higher percentage of their advertising than almost any other site on the Web. They're moving into a commerce model. They're actually helping to direct you to places on the Web to buy computers and software, which I believe will provide a pretty significant upside to earnings estimates and to the stock.
And E*Trade?
E*Trade is the pure play on the shifting of discount brokerage business from telephone-based sales people to the Web-based transactions. E*Trade has two very valuable assets in my view. One, they have the technology to enable online trading, and two, an impressive, well-recognized brand. And that's something that will prove very valuable to those investment banks and institutional brokers who need to reach the emerging class of retail investors that have pretty much decided to give up on their Merrill Lynch (MER) brokers. E*Trade is actually working with Robertson Stephens to package our research in order to help us reach this new emerging class of retail investors.
The stock has languished here.
The stock has languished because of fear of competition and debate as to whether or not they could build brand momentum and end up becoming a leader in the midst of a confusing competitive landscape. The company is currently trading near cost. In other words, their current market cap is about $1.5 billion. They have $600 million in cash, and by my estimates, it would cost somebody at least $500 million to $750 million to duplicate what E*Trade has done. So the stock is trading as if nobody values their ability to grow their business.
They have had some growth problems, and competition is fierce in that business. These days, everyone wants to execute your stock trades for practically pennies.
They started out with a nice growth path and then they've slowed down a bit as they've tried new competitive strategies. But they're just rolling out a new strategy called Destination E*Trade, where they're trying to promote additional content to their customers as the principal selling point, as opposed to just cheaper transaction costs. So I think that over the next couple of months we'll see a lot of promotion regarding Destination E*Trade that will promote awareness and conviction in the service and the stock.
The portal battle
The current buzzword on the content side of the Internet business is "portal." Will this shift to a one-stop shop destination prove to be meaningful?
For years we have had established patterns of going to the same local newspaper, the same television network or the same cable network where somebody has bundled content for us. So on the Web, it just turns out that the places where we get bundled content are called portals. The debate previously was whether everybody would be just poking around the Web creating their own list of sites that they liked, or whether they would depend on somebody else's editorial skills to pick and choose for them. Evidence supports that people don't want to poke around on their own. They'd like somebody to package it for them. So everybody's fighting to be the package that you choose.
I'm not going to be surprised if the stocks are down 5% in a day or 20% in a week. I still believe that if you maintain a two-year outlook, the stock group and the individual stocks that I recommend can double.
Brand matters. So what you really have here is a branding battle where people are trying to get you to start there first. Microsoft (MSFT) and Netscape (NSCP) have advantages because you happen to choose their browser. That means that you're starting at their site first, and the question for both Microsoft and Netscape is, can they build enough things in their initial gateway to keep you there longer? [Editor's note: Microsoft publishes Investor.]
There is growing concern about Asia's economic troubles impacting our corporate profits and trade. Are you concerned about this as well?
Despite all of the concerns about Asia, I still think that the United States economy is strong enough that we can muddle through this. When I look at the fastest-growing areas of the economy, particularly technology and the Internet, I believe that there continue to be substantial business opportunities and opportunities to make money in these stocks. So I have not let my recommendations on these stocks become tainted by the volatility in the overall market. I just watch for opportunities to accumulate more of the stocks I like.
I'm not going to be surprised if the stocks are down 5% in a day or 20% in a week. I still believe that if you maintain a two-year outlook, the stock group and the individual stocks that I recommend can double. But individual investors should be prepared to see prices fall 20%-30% over short periods of time in this group, which can represent purchase opportunities.
What's your favorite Web site?
Dilbert. I read it every day.
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