Net Losses

By Daniel Kadlec

In the world of Internet investing, few things are clear. But here's one: after last week's rout, dot.com stocks are 40% to 60% off their peaks, and investors are finding there is no safety net in Netland. For those with faith and a long investment horizon, discounted prices today are compelling. That's why the bloodbath didn't turn into a bigger catastrophe. Early last Thursday, Net stocks were in free fall and touching their lowest levels of the year. Enough investors suddenly viewed them as bargains so that prices turned up.

But for many, Net stocks remain the epitome of pure speculation. On an earnings basis, after all, a company with no profit is as expensive at $20 a share as it is at $40. That's what makes Net stocks so confounding. Most lose money, and predicting when they'll turn a profit and how big that profit will be is sheer guesswork.

Since mid-April, the pessimists have been winning the valuation squabble. Amazon.com once boasting a market value twice that of Sears, is now about as big as the Sears tool department. Founder Jeff Bezos has seen $8 billion of his net worth evaporate in four months. Sure, he's still worth $5 billion, but the roller-coaster ride is taking a toll on less well-heeled entrepreneurs and investors.

"It's been quite an experience," says Jack Marshall, founder of Photoloft.com which moves pictures across the Net. His stock, traded on the NASDAQ bulletin board, is down 66%, to less than $3 a share. All 32 of his employees have stock options. The collapse "hasn't really hurt morale because business is so good, we all know we're here for the long term," he says. Still, at many Net firms, the early-year euphoria of optioned employees is gone. Net investors, many of them day-trading online, have had a comeuppance as well. Losses have driven thousands out of the market.

A couple of points bear mentioning. First, Internet stocks are still up for the year--again of 24%, as measured by TheStreet.com Internet index. Second, Net investors who have been at the game longer than six months may still have sizable profits. The carnage has been largely confined to pure Internet stocks--such retailers as Amazon.com and eBay; communities like iVillage.com and TheGlobe.com media companies Marketwatch.com and TheStreet. com; and portals such as Yahoo and America Online. Many stocks that benefit from the Internet but don't depend on it to sell their goods have held up well. IBM is up 35% since Internet stocks peaked in April.

Why did Net stocks tumble? In retrospect, it seems clear that as they were hitting their highs, speculation had taken over. The average Net stock had risen 475% in the previous six months. Internet initial public offerings were routinely doubling and tripling on the first trade. A pullback was in order.

Rising interest rates helped bring that about. In Wall Street's perverse logic, higher rates, reflecting a robust economy--employment figures last Friday were strong--and the threat of inflation, are seen as negative because they threaten to slow the economy longer term and put off Internet profits further into the future.

Also, there is too much merchandise for sale. A flood of new Internet shares is hitting the market via IPOs this summer. Supply and demand are so out of balance that some of the new issues, such as flower seller FTD.com were postponed.

Is the selling over? No one knows. "On a valuation basis, there's still plenty of downside left," warns Henry Blodgett, a Merrill Lynch analyst. His main concern is that the explosive growth in the numbers of people going online for the first time is reaching an end. Roughly half the U.S. population is already there, so new users can't keep doubling each year. In fact, the Net selling began just as April data showed month-to-month new users and hours logged on flattening.

Michael Graham, analyst at BankBoston Robertson Stephens, believes the recent carnage has created some no-brainer bargains. He sees Amazon.com as one of those. The 35 biggest traditional retailers have a market value of $630 billion, he says, while the 32 biggest online retailers have a market value of just $53 billion. Graham says that in time those numbers must converge because the online companies are taking business from their bricks-and-mortar competition.

Lacking earnings or some template for a profitable Internet business, that's the kind of analysis Net investors rely on. As a result, "these stocks trade on emotion, not fundamentals," says Lise Buyer, an analyst at CS First Boston. "Right now there is a significant amount of emotional fatigue."

It will pass. And as promised, the Internet will develop into a grand global facilitator, making us more efficient at work and at play. Some Internet companies--maybe one in 20--will survive to see it, so their stock prices today are bargains. We just don't know which ones they are.