*** Financial Times Internet Stocks ***
FRIDAY JANUARY 22 1999
Equities
INTERNET: Stocks fall victim to an attack of vertigo
In the wake of the precipitous rises of recent weeks, investors are pausing for thought, write Philip Coggan and Susanna Voyle
Sharp falls in the shares of On-Line and Virtual.net yesterday were the first signs of a break in what had been a phenomenal rise in UK internet stocks in the first few weeks of 1999.
Before yesterday's 53 per cent decline, On-line, the games company, had risen more than twenty-fold in less than two weeks, while two other stocks, Zergo Holdings and Netcall, had trebled and doubled respectively since the start of January.
As yet, the UK industry - which will become a sub-sector of a new FTSE technology sector in April - remains a fraction of the size of its US counterpart, which has seen its own even more remarkable run-up in share prices through the likes of eBay and uBid.
While it is universally acknowledged that internet activity has grown at an astonishing rate, doubts remain about the ability of businesses to make a profit.
Barton Biggs, the chairman of Morgan Stanley Dean Witter Investments, said yesterday that the rapid appreciation of internet stocks was a bubble which had already lasted a long time, compared with other speculative market movements.
Last week Rupert Murdoch, the media baron, said that many internet stocks were heavily overvalued and would not produce the profits to justify the exuberance.
For some veteran market watchers, the rapid rise of the sector's stocks is reminiscent of the mining bubble of the late 1960s, when Poseidion, the Australian nickel group, was dubbed "the share of the century".
As with other speculative surges, the internet boom owes much to the enthusiasm of private investors who seize on any stock with a link, however tangential, to the chosen activity. "This has all been private investors doing business on an execution-only basis," commented one sceptical trader.
Rather like mining stocks, the attractions of internet companies are in the form of "hopes and dreams" concerning the profits that might be made several years down the line. Current profits, and even sometimes sales, are slight and conventional stock market valuation methods simply do not apply.
But when investors are in the right mood, shares start to rise because they have already gone up and people want to jump on the bandwagon, particularly if the supply of stock is limited because the companies are small and much of the equity is in the hands of the founders. On-Line, for example, has just 3.3m shares in issue, of which the vast majority are in the hands of directors.
"There is a liquidity problem [with the whole sector] that is going to benefit punting investors on the way up, but burn the hell out of those investors when they pop," said Graham Brown, technology analyst at Sutherlands.
Analysts say that the sharpest jumps had come in those stocks seen as "pure internet plays". These companies are thought likely to receive increased attention throughout this year as uncertainties persist about continued growth in more general IT companies that have ridden the wave of millennium bug and European single currency work.
The small group of UK stocks in the limelight include On-Line, Intelligent Environments, which specialises in intranets, NetCall, the call-centre group and the electronic trading concern, Voss Net.
Internet Technology and Easy Net, which are internet service providers, have also seen their shares rise, as has Gresham, the electronic commerce group.
One of the stocks that has attracted most attention is Zergo, where any news of alliances and new customers has pushed the shares up. Zergo provides encryption technology that holds out the promise of secure electronic commerce transactions.
Investor interest has also focused on larger groups that have an internet link or service. The success of Dixons' internet service, and the share price rise that has accompanied it, may encourage other retailers planning internet offerings.
Shares in WH Smith jumped last week after it announced the £5.6m acquisition of an educational publisher. Speculation mounted that it was about to launch a free internet service with on-line access to a free encyclopaedia.
"The lure of explosive growth may be hard to resist for some investors," said George O'Connor, an analyst with Granville. "The share price success of Dixons following its debut as an internet service provider shows the pent-up demand for internet exposure in the UK," he said.
But the most important factor for share prices is likely to be developments in the US, where in recent sessions some of the shine has come off internet share prices.
If momentum is lost, then investors may start to sort the internet wheat from the chaff. "Investors have got to start differentiating between companies' growth prospects and back the high-quality stocks in the technology sector," says Graham Brown of Sutherlands.
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