BUSINESSWEEK ONLINE : APRIL 17, 2000 ISSUE
COVER STORY The Dot-Coms Are Falling to Earth Investors are fleeing consumer companies On Mar. 31, when investors discovered that drkoop.com's auditors had expressed doubts about the health site's ability to continue as an ongoing business, the reaction was swift. Drkoop (KOOP) shares, already down to 6 1/4 from a high of 36 7/8 last July, dropped to 2 1/2 over the next three days. Yet the low opinion of PricewaterhouseCoopers, drkoop's auditors, was hardly startling news. They'd given the exact same analysis last summer at the time of drkoop's initial public offering. No matter. Enthusiastic investors ignored the warnings and pushed the stock up 300% in its first month of trading. But that, as they say, was then. And this is now. As the tech market's highest fliers have come crashing down, few have been harder hit than unproven, unprofitable Net companies. From its high on Mar. 10, the Hambrecht & Quist Internet Index is down 33%. Raging cash burn rates, weak business models, and a growing supply of publicly traded shares have dramatically tempered what was once unquestioned optimism in the Net sector. 'DARWINIAN CHANGE.' Nothing underscores this more than the state of deflated consumer-oriented Net companies. The stocks of many have been in freefall. After throwing money around willy-nilly, public and private investors now understand just how hard it will be for most of them to make money. ''We had a mania that is completely history,'' says James W. Breyer, general partner at venture capital firm Accel Partners. ''Many companies were receiving venture-capital funding from the public market, and in most of those cases, the public made the wrong bet.'' While analysts differ on their estimates, they all agree that the inevitable shakeout will be bloody. Up to three-fourths of all Net companies will be eliminated, either through consolidation or bankruptcy, estimates Henry M. Blodget, an analyst at Merrill Lynch & Co. ''It's a Darwinian change, and entire species will disappear,'' says Gary Rieschel, managing general partner at venture-capital firm Softbank Technology Ventures. The worst damage today is in sites that offer up goods or services to consumers. But anxieties have also begun to hit business-to-business stocks, as investors fear that too many unproven companies are competing in that crowded market. Highfliers including Ventro Corp. (VNTR), Ariba (ARBA), and VerticalNet (VERT), which all operate online exchanges, have seen their stocks drop, in some cases by more than half from highs in mid-March. ''What's happening in the market is challenging everyone's assumptions,'' says Mark F. Santacrose, CEO of Entrade Inc., a Northfield (Ill.) company that helps form B2B marketplaces. ''Six months ago, two or three guys in a garage could come out with an idea and say they're worth $20 million to $30 million. That just changed in a big way.'' The shakeout threatening consumer companies is hardly surprising, given last year's investment free-for-all. In many e-commerce sectors--pets, consumer electronics, and beauty products, to name a few--10 to 20 heavily funded companies were set up to compete. A slew of content companies, including news, health, and women's sites, had over-the-top IPOs last year. Now, of the 272 Internet IPOs during the past year, 88 are trading below their offering price--and most of them are consumer Net companies, according to Thomson Financial Securities Data. Among content sites, women's site iVillage.com (IVIL), online magazine Salon.com (SALN), and wedding service The Knot are all below their IPO prices. TheStreet.com (TSCM), a financial news site that skyrocketed to 71 1/2 on its first day of trading last May, has plummeted to 6 1/2 and gone as far as hiring an investment banker. The investor flight has led to a frighteningly new situation for consumer companies: lack of access to cash. Already, the IPO market is coming in for a reassessment. There are currently $60 billion worth of public stock offerings in registration, says Michael Halloran, head of technology investment banking at Deutsche Bank Alex. Brown. If the stock market's correction is sustained, many will have to delay or cancel offerings and seek capital elsewhere, he reasons. During the last week in March alone, five Net companies delayed IPOs. BANKRUPTCY BOOM? Nor can new start-ups turn to venture capitalists. The word at many VCs is that investing in consumer companies is out. When they do take stakes, it's at drastically reduced valuations. New York venture fund Altcapital LLC in early April invested in a new e-commerce and service company--but for 50% less than it would have spent six months ago. ''It's a return to reasonable investing,'' says Geoffrey Smith, an Altcapital general manager. Softbank's Rieschel tells a similar story. The VC firm recently made a $3 million investment for a 10% stake in a consumer company--a price two-thirds lower than it would have paid eight months ago. A spate of auditors' warnings about the sector has also heightened trepidation. Since January, seven more e-businesses have filed annual reports in which their auditors raise new questions about their ability to continue doing business. The Securities & Exchange Commission says at least eight out of the 200 opinions filed this year on going concerns implicate Net companies, including CDnow (CDNW), Peapod (PPOD), drkoop, Value America, and Bingo.com. Such opinions indicate ''the auditors think the probability of bankruptcy is pretty high,'' says Rebecca Todd, an accounting professor at Boston University. With cash dwindling, the long awaited consolidation is expected to hit consumer companies during the second half of the year. Surprisingly, after two years of being dismissed as stuck-in-the-past ''brickheads'' by money-losing Net upstarts, cash-flush traditional retailers could well be among the big beneficiaries of the Net consolidation. Many analysts expect them to take advantage of the drop in Net stock prices to snatch up struggling online companies. ''Now, all these offline brands can get into this game, whereas they couldn't in the past because of the valuations,'' says Javier Rojas, managing director at Broadview International, an investment bank. That won't save everyone, though. Steve Frankel, an analyst at Adams, Harkness and Hill, questions whether grocery-delivery service Peapod will be bought even at its rock bottom price of $3 a share, or market valuation of $55.2 million. And of 200 consumer companies projected to run out of cash, Softbank's Rieschel estimates a third will go broke, a third will get bought by Net or brick-and-mortar rivals, and the rest will limp along. This revaluation isn't a passing trend--it's a reevaluation. Companies now have to prove themselves. In the e-tailing market, for instance, among the standouts will be those that can solve tricky distribution problems. Companies with unique models that are specific to the Web, like priceline.com and eBay (EBAY), are considered likely winners, while those with great customer service and new revenue streams like Amazon.com (AMZN) are also well-positioned. But across the board, companies will have to show a clear path to profitability and the ability to manage costs. Now that's a blast from the past. By Heather Green, with Nanette Byrnes, in New York, Norm Alster in Boston, and Arlene Weintraub in Los Angeles _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ BACK TO TOP					RELATED ITEMS Is the Party Over? COVER IMAGE: Wall Street: Is the Party Over? CHART: Tech Comes Back to Earth CHART: Internet Stocks Take a Dive TABLE: The Move to Quality Margin Calls: Not a Lot of Wiggle Room Time to Keep a Cool Head TABLE: Why You Shouldn't Sell in a Panic The Dot-Coms Are Falling to Earth TABLE: The Internet Shakeout Why Gates Is Rolling the Dice TABLE: Bill's Vision ONLINE ORIGINAL: "Ultimately, the Market Gets Priced on Fundamentals" ONLINE ORIGINAL: BW's Bill Wolman on the Stampede to Quality (Video) ONLINE ORIGINAL: Oppenheimer Funds' Marci Rossell on the Market in the New Economy (Video) INTERACT E-Mail to Business Week Online

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