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Internet stocks may snap back by the third quarter of this year, says Chris Nerney, senior analyst for Internet.com's Internet Stock Report, but at the moment the market "is still trying to find a bottom."
Nerney is a member of the committee that reviews Internet stocks for inclusion in the ISDEX, an index established in 1996 that lists the 50 top names in a dozen sectors. He was the guest at a May 11 investment chat presented on America Online by Business Week Online.
In response to questions from the audience and from BW Online's Jack Dierdorff, the moderator, he observed among many other things that Cisco is the "preeminent" Internet company, that many, if not most, B2B and B2C companies may not rebound, and that it may not be too early for long-term investors to get back into those Net stocks that are "heading toward profitability." The following are edited excerpts from the chat. A complete transcript is available from Business Week Online AOL at keyword: BW Talk.
Q. Have the Internet stocks regained much ground? What does the ISDEX show? A. Well, right now we are still right in the middle of a period of volatility. Last week every single sector of Internet stocks (we track 12 different sectors) was up. This week it has reversed, and every single sector is down.... I think the market is still trying to find the bottom.
Q. Of the dozen sectors ISDEX tracks, which have been best recently? And the worst? A. The best recently would be the security stocks. They have held their own better in the recent downturn, although they did not benefit from the "Love Bug" as they did following the hacker attack in February on major Web sites. The sector that has done the worst has been the e-commerce software companies. That's because many of them were tremendously overvalued and had the furthest to fall.
Q. Let me ask how ISDEX defines "Internet" -- it covers so much these days. How do you decide a company belongs in the index?
A. It does cover so much, and the lines blur so much that sometimes it is hard to say what is an Internet company and what isn't. When we choose companies for our Internet stock list and the ISDEX, we want companies deriving the majority of their revenues from Internet-related activities. That is why you won't see a company like 1-800-flowers.com [FLWS], which still makes most of its sales through the telephone.
Q. How often does ISDEX change its components? Any recent additions or subtractions?
A. We review the ISDEX every quarter. There is usually at least one change. A lot of times it is because two companies merge. We are going to have to replace Network Solutions [NSOL] after its merger with VeriSign [VRSN] in June. At the end of March we added i2 Technologies [ITWO] and Vignette [VIGN]. We put them in to replace two companies whose market caps had fallen so low -- iVillage [IVIL] and Beyond.com [BYND].
Q. What do you think of Cisco [CSCO]? A. Cisco is probably the preeminent Internet company. It just posted a quarterly report with $4.9 billion in revenues, and it showed a 55% revenue-growth rate, which is actually accelerating from 53% in the quarter before. For a company with that kind of revenue to show that kind of growth is pretty astounding. If it is true that infrastructure is one of the hot places to bet on in the Internet, then Cisco is one of the best-positioned companies.
Q. What is your view on EXDS [Exodus Communications]? It's been beaten down badly recently. A. It has been, but it is still a market leader as far as Web hosting and related Internet services. I think it is a good company, and I think it is going to bounce back.
Q. What do you think of Internet giant Softbank [STFBF] and its future potential?
A. I think Softbank is one of the most powerful players in the Internet. They are investing more money than nearly anyone...
Q. How about Broadcom [BRCM]?
A. I think they are in a unique position doing semiconductors for the Internet. They have competition certainly, but they've targeted a great market in high-speed broadband, and they are aggressively introducing new products into the market...
Q. Which stocks in the downtrodden B2C (business-to-consumer) sector do you think are best positioned to recover when tech stocks rebound?
A. The one good thing I can say about the B2C sector is it appears to have bottomed out. Most of the companies aren't going to rebound...I think Priceline.com [PCLN] might, because it is big, has a unique niche, and is growing revenues. I would love to say eToys [ETYS], but I think I've about given up on them. They seem to be doing everything right, but the market is not responding...
Q. What do you think of B2B [business-to-business] stocks?
A. I think B2B is a great sector. It was highly overvalued. I think right now investors are sorting out who the winners and losers will be.
Q. Do you think B2B stocks will recover to previous levels?
A. The answer is no. I think most of them won't...The ones I think will are companies like i2 Technologies. Another one to watch is Art Technology Group [ARTG]. They are growing revenues and narrowing their losses rapidly. A lot of people like Commerce One [CMRC] and Ariba [ARBA]...but they were just so highly overvalued before that, even after coming down, they are still overvalued.
Q. What do you think about CFLO [CacheFlow]?
A. I like the company. They make Internet caching appliances and content management services, which help sites and companies manage their Web traffic. They just announced a partnership with RealNetworks [RNWK]. So they are making the right friends.
Q. What's your opinion on EBAY [eBay]? A. I'm really bullish on eBay...its financial performance has been stellar. It has a commanding lead in the online auction market. I don't see it relinquishing that lead any time soon.
Q. What about Yahoo! [Yahoo]? A. Yahoo! is one of the four or five strongest Web properties out there, but it is still overvalued relative to some of the other major players...if I were an investor, I'd look for a little bit better entry point.
Q. And, inevitably, from Yahoo! to AOL and the merger [with Time Warner] we all talk about. A. The market didn't react well to the merger. I think it is a good merger. People are concerned that it will slow AOL's revenue growth, but the outcome of the merger will be the largest Internet/entertainment company in the world and a company that is profitable. Growth is great, but in the end profitability is what matters.
Q. Chris, are any of the online brokers in your index, and where do they stand?
A. There are two: Ameritrade [AMTD] and E*Trade [EGRP]. I'm higher on E*Trade. It has a larger share of the online trading market. In terms of quarterly revenues, E*Trade has the fourth highest amount of any Internet company...
Q. Is it too early for Internet banking and SONE [S1 Corp.]? A. I think it might be a little early for Internet banking, at least in terms of figuring out who the winners will be. S1 delivered a mixed earnings report last week. And I think the company was overly punished. Apparently they are the defendant in a lawsuit, which worries me. I wouldn't make a big commitment to S1 right now.
Q. What about DCLK [DoubleClick]?
A. I think it is a great company. They are the leader in online ad services, although CMGI is mounting a strong challenge. To be a top player in the online advertising infrastructure is a good place to be because they get a piece of all the transactions...
Q. Do you have any thoughts on INSP [InfoSpace]?
A. InfoSpace was one of the top performers last year. This year it has not done as well, although it is only down 11% this year. It has positioned itself shrewdly as a provider of wireless content, and that puts it a little ahead of the curve...
Q. Any insights on foreign Net companies -- and specifically on Latin America? A. I think the Latin market is still up for grabs. A number of players have entered in the last year, including AOL. StarMedia [STRM] is the one most people think about. They are trying to position themselves as the Latin portal. To me, the market is a little too early to call. I'd say the same about Asia.
Q. Chris, is this a good time to buy some of the depressed Net stocks -- or is it too early?
A. A lot of it depends on your investing goals. If you are looking for a quick return, it might be too early. But if you're looking to invest for the long haul, it is worth anyone's time to do a little research on companies, figure out who the market leaders are, who is heading toward profitablity.
Q. Do you have any personal favorites you can name -- say, perhaps five stocks? A. Sure. If I had to pick five stocks to bet on right now, they would be AOL, Inktomi [INKT], RealNetworks, i2 Technologies, and eBay.
Q. Many think Internet and new tech stocks won't come back until the fourth quarter -- what do you think about such timing? A. I think they are going to come back sooner than that. It is really a guess, but I don't think it will take that long. I'd be looking for the third quarter at the latest.
EDITED BY JACK DIERDORFF
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