BUSINESSWEEK ONLINE : DECEMBER 11, 2000 ISSUE
FINANCE The Fall of the Net Analyst Former oracles have been demoted, and a New Guard is rushing in after the fact to downgrade Internet stocks The Queen of the Internet was not amused. Under the glare of CNBC's television lights, Morgan Stanley Dean Witter's Mary G. Meeker appeared somewhat tentative on Oct. 23. Meeker, who among myriad other accolades has been called the third-most- powerful woman in business, usually exhibits a Zen-like calm. But on this day, Squawk Box host Mark Haines clearly put Meeker on the defensive, tersely grilling her on her willingness to talk up Internet stocks. At one point, Meeker responded: ''If we sound a little too optimistic, it's really a function of the fact that this is the kind of environment that creates buying opportunities.'' Haines retorted: ''You're telling us to start from this point and put our money in the right places. But following your advice, we put our money in the wrong places...now we don't have any money.'' In fact, since Meeker's appearance, the Nasdaq has dropped a further 22%. And so far this year, her picks are down 68%. It's life in the hot seat for big-time Internet analysts. The Goldman Sachs Internet Index is down 70% for the year. Layoffs at dot-coms hit record numbers in November. Both Merrill Lynch & Co. and Chase H&Q recently canceled their Internet conferences, with a Merrill spokesman saying the sector is ''more of a defensive story'' right now. So far this year, 130 dot-coms have shut down, according to Webmergers, a research firm that tracks Internet mergers and acquisitions. Still, most high-profile Internet analysts like Meeker and Merrill Lynch's Henry M. Blodget continue to stand by the stocks they cover. Clearly, big-name analysts from mega investment firms have caused investors untold pain. Rather than paying heed to the glitz, investors should be looking at humbler, lesser-known analysts at smaller firms that are not involved in investment banking. On a long-term basis, these are the best Internet stockpickers, according to Bulldog Research.com Inc., an analyst rating service. ''A huge part of an analyst's job is to bring in investment-banking business,'' says Michael Thompson, Bulldog's co-president. ''[But] these analysts are largely unencumbered.'' SPREAD TOO THIN? If investors had for an instance listened to Sean Jackson (who?), an Internet software analyst at Suntrust Equitable Securities (what?) in Nashville, they would have reaped a 236% gain over the past year through Oct. 31. ''As an analyst at a small firm, I get to choose the stocks I cover and focus on my niche, which is Internet security software. At big firms, analysts are often forced to cover too wide an array of companies because of investment-banking relationships,'' says Jackson. His winners include Checkpoint Software, and ISS Group. Matthew Barzowskas at First Albany Corp. in New York netted a 216% gain with recommendations like 3Com. Stephen Sigmond, a Net services analyst at Dain Rauscher in Minneapolis, has posted a 46% return over the last year with picks like Ariba and Netigrity. A study by Kent L. Womack, a finance professor at Dartmouth's Amos Tuck School of Business, and Roni Michaely, a Cornell University finance professor, found that the stock recommendations of brokerages without investment banking ties tend to be more accurate. Their stocks rose an average of 3.5% within a year, vs. a decline of 11.6% over the same period in stocks recommended by brokerages involved in investment banking with the companies they cover. Investors are so upset with the bullish forecasts that they're turning to analysts who are making splashy negative calls on Internet companies. Indeed, the trend is for analysts to make no-brainer ''momentum'' calls--that is, negative calls on already beaten-down stocks like Amazon.com, Priceline.com, eBay, and Yahoo!--and these analysts are riding the likely short-lived crest of Internet stardom. But the downgrades are a day late and a dollar short. On Nov. 20, Lehman Brothers Inc. analyst Holly Becker downgraded eBay from buy to hold and knocked it in a report, saying among other things that profits were wilting and margins would not live up to expectations. She may be right, but many say her call was hardly prescient. The stock was already down 50% since the beginning of November. ''It's enormously fashionable right now to beat up on Internet companies. But it doesn't take any courage or daring to do it in this environment,'' says Jonathan Cohen, a former Net analyst who soured on e-stocks in the mid-'90s. He is now head of European mergers and acquisitions at Wit Soundview Group. Says Becker: ''My job isn't to look through the rearview mirror, but to call it as it is today, and I think there's more downside.'' Still, Becker didn't become bearish on the Internet until after her colleague, bond analyst Ravi Suria, issued a groundbreaking report in July questioning the fate of Amazon (page 110). The scores of other analysts making negative calls include Thomas Courtney of Banc of America Securities. On Nov. 28, he issued a downbeat report on Amazon. And in September, Salomon Smith Barney analyst Tim Albright downgraded Priceline just a month after reiterating a $130 price target and recommended buying the stock--even as the stock fell to $25. Big underwriters, it seems, don't seem to give a hoot about stockpicking. ''Let's face it, someone like Henry Blodget is a real brand for a firm like Merrill. He has a following and sells stocks and gets underwriting business, and that's all the firms care about,'' says a venture capitalist who asked not to be identified. Since the beginning of 1998, Wall Street firms did $2.4 billion underwriting Internet initial public offerings, according to Thomson Financial Securities Data. Maybe Wall Street should start to care. ''Now that the underwriting business has dried up, the big firms are stuck with these white-elephant analysts who were so bullish and so much in the public eye. They may have been good branding, but they've caused investors to lose their shirts,'' says a hedge fund manager who asked not to be identified. Over the past two years, celebrity analysts have been heralded as oracles of the New Economy. ''We all got much more attention than analysts are used to getting, and perhaps much more than we deserved,'' says Lise J. Buyer, a former Internet analyst for Credit Suisse First Boston who is now a venture capitalist. The bullishness of Internet analysts is legendary. ''Because of the uncertainty when it comes to Internet valuations, it is easier for biased recommendations to hide more comfortably,'' Womack says. Merrill's Blodget, for instance, has never put a ''sell'' on a stock he covers. He downgraded Priceline in September, a day after the stock fell 43%, to $10.50 a share. And in August, he downgraded 11 stocks, dropping eToys Inc. and barnes-andnoble.com to ''holds,'' those stocks were already 95% and 84%, respectively, below their 52-week highs. Another who has never issued a ''sell'' is Meeker, who has downgraded only three stocks in three years. Meeker was not available for comment, and Blodget did not respond to phone calls. For the analysts' part, experts say their hands have been tied. ''Think about the impact they would have on a stock if they severely downgraded it,'' says Eric Von der Porten, a hedge-fund manager at Leeward Investments. ''It appears they're just quietly and slowly getting more negative in order to allow clients and brokers to get out of the stock.'' On Oct. 4, Lauren Cooks Levitan, senior e-tailing analyst at Robertson Stephens, said in a report that Amazon would never turn a profit without making ''fairly radical shifts'' in its business model. Yet Levitan kept her ''long-term accumulate'' rating on the stock. And Blodget has defended himself by saying his written comments on Internet stocks have been turning negative for more than a year, but that his ratings didn't reflect the trend. DECODING LINGO. But do investors pay attention to the fine print in analysts' reports? Moreover, what connotes a ''sell''? Part of understanding analysts is deciphering their codes, experts say, and this is especially true with Internet analysts. ''It's a world where even a downgrade to 'hold' from 'buy' can be a signal to sell,'' says Charles L. Hill, First Call Corp.'s director of research. And while more Internet analysts are moving to ''neutral'' ratings on stocks, the average recommendation is still a ''buy,'' according to First Call. Like the analysts themselves, the Internet valuation models used to justify high valuations have come under sharp scrutiny. Where amorphous things like ''hits metrics'' and ''annual run-rate sales'' used to matter, most experts now see them as mere valuation voodoo. One analyst, Credit Suisse First Boston's Jamie Kiggen, has been criticized over his ''lifetime value of a customer'' metrics used to justify his bullish Amazon calls. Kiggen's response: ''The probability of my most optimistic growth scenario is lower than it was a year ago, but that's all due to economic uncertainty and the near-term supply and demand in capital markets.'' Says Michael K. Parekh, an Internet analyst at Goldman, Sachs & Co., the leading e-commerce underwriter: ''Instead of using valuation criteria for mature industries, we ended up using filters that venture capitalists use.'' Fitting, then, that an extraordinary number of Internet analysts--including Buyer, Robertson Stephens' Keith Benjamin, Chase H&Q's Daniel H. Rimer, and CSFB's Bill Burnham--have jumped ship to venture capital firms, despite the recent downturn there, too. There has even been a persistent rumor that Meeker will leave for a VC. Buyer, who started covering the Internet in 1995 and secured a spot at a venture firm five years later--prior to the Internet crash--says of her decision to leave the dot-com world: ''It was one of my greatest calls as an Internet analyst.'' By Marcia Vickers in New York _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ BACK TO TOP					RELATED ITEMS The Fall of the Net Analyst TABLE: Some Got It Right Unconventional Wisdom from Lehman INTERACT E-Mail to Business Week Online

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