DECEMBER 19, 2000
SPECIAL REPORT--AFTER THE MELTDOWN
Crawling from the Dot-Com Wreckage | Yes, the carnage will get worse. But survivors -- and a healthier overall climate -- will ultimately emerge. Here's what's next
| How serious is the shakeout in dot-com stocks? Take a look at Chemdex, one of the first online marketplaces to facilitate business-to-business e-commerce. It took $50 million and 18 months to build Chemdex. But on Dec. 6, parent company Ventro (VNTR
) announced it was pulling the plug, not just on Chemdex but on its sister site Promedix as well.
Ventro won't sell the sites. Nor does it have any plans to dismantle them and sell off the parts. It's just closing them down to stem the losses from a business model that didn't work. "Lessons learned the hard way," is how Chief Operating Officer Robin Abrams sums up the company's history. A $244 stock only nine months ago, Ventro now trades at $1.09 a share.
If that short tale of Web gold disintegrating into dust doesn't sound familiar, it soon will. It has been about nine months since the Internet stock market bubble burst and the capital that fueled the Net boom dried up. But we're just now getting to the stage where Web companies are running out of steam. Hundreds, if not thousands, of dot-com startups that operate at a loss are simply spending their remaining cash, hoping for a last-minute reprieve, or in the case of online retailers, a strong holiday shopping period that can lift them out of the red.
IT STILL SMARTS. The nation's Silicon Alleys and Valleys are already inured to the carnage. After all, even the most bullish Internet stock analysts have long predicted that the great majority of dot-com startups would eventually disappear. "People have learned to live within this environment," says Michael Sherrick, an analyst at Morgan Stanley Dean Witter. "They've generated a thick skin, sort of as if it was expected all along."
But knowing the diagnosis doesn't ease the pain. The stock market is signaling the eventual demise of hundreds of public companies. Out of about 400 publicly traded Web companies tracked by Pegasus Research, 35% are trading below $2 a share -- a benchmark value that usually means investors expect the company to disappear, says Greg Kyle, the company's president. More than half of the Internet companies in his database trade below $5 a share, and the average stock price has gone from $40 in the beginning of the year to just under $10. Major Web brands that soared on their initial public offerings are now basically penny stocks. Webvan (WBVN
) trades at 50 cents, iVillage (IVIL
) at 75 cents, and Priceline.com (PCLN
) is at $1.56.
So far, consulting firm Webmergers.com has counted only 135 dot-com names that have shut down out of an estimated 7,000 to 10,000 private and public dot-coms. Many will eventually get bought, but at fire-sale prices. "The people with cash can run out the clock," says Peter Cohan, whose Marlborough (Mass.) company consults on Web strategy.
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The meltdown coincided with -- and also played a role in -- the overall economic downturn
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That also means a lot more dot-com employees will be looking for work in the coming months. By the end of November, Chicago outplacement company Challenger, Gray & Christmas had counted more than 31,000 dot-com workers that had been laid off this year, with monthly totals on a steep rise -- from 5,677 in October to 8,789 in November. Those cuts came from only 383 companies, 75 of which have actually gone out of business.
While Web cynics have long anticipated the eventual demise of so many money-losing Web startups, the surprise has been that the meltdown coincided with, and in some ways played a role in, a sudden and sharp overall economic slowdown. The repercussions of that one-two punch are just beginning to be felt across many other industries. W. Shannon Reid, who heads a growth-stock investing team at Evergreen Funds, never got caught up in the dot-com stock bubble, but he says now he has to worry about how the meltdown will affect other major names that bought into Internet startups.
"That's a real big worry," he says. In recent weeks, Compaq Computer, Intel, and Chase have all warned investors that they wouldn't meet quarterly earnings targets in part because of hits they've taken on their venture capital investments. Compaq, in particular, cited its stake in CMGI, a holding company for Web startups that has fallen in price from $163 to $8.28, as a cause of its shortfall.
BUBBLE, BUBBLE. Morgan Stanley's Sherrick believes the dot-com meltdown continues to play a bigger role in the broader economic slowdown than anyone expected. "There was a bubble on top of the bubble," he says, which was the spending traditional companies were doing to try to keep up with the dot-com startups. In many cases they're now halting or delaying their Web projects, which is causing a drop-off in business for the Web consulting companies he covers.
A lot of stimulus has been removed from the economy now that Web business is in decline, he says. Think about all the money spent on hiring, computers, consulting, and branding, combined with increased consumer demand created by below-market pricing on the Web. While not a big part of the economy, "when you look at the incremental growth in the economy, it's a much bigger percentage," says Sherrick.
On the bright side, while there is a more pain to come, we may have reached the nadir of dot-com pessimism. "The market has [factored in] that the whole Internet industry is basically finished, and that's not the case," says Kyle.
OMINOUS SIGNS. As Ryan Jacob, president of Jacob Asset Management, sees it, each segment of the dot-com world has its own business dynamics. Worst off is e-commerce, he says. Many companies were hoping for a strong holiday season, but signs are pointing to a weaker year than last year. The biggest harbinger of bad news is eToys, which announced on Dec. 15 that sales are coming in at about half of what was expected. UPS' Dec. 13 announcement that domestic shipping volume in the first two weeks of the month was flat compared to 1999 is ominous. "Most of them are just trying to hang on by their fingernails," says Jacob.
Amazon.com (AMZN
), the bellwether of the group, is now trading for only $19.88 a share. "The ultimate end of this thing would be if Amazon.com got acquired or folded," says Cohan. So far, the e-tailing giant seems to be holding its own this season as shoppers stick with the strongest brand.
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Web-ad rates have fallen so far that some sites barely recoup the cost of running ads
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For Web companies that hope to make the bulk of their profits from advertising, the near-term prospects are bleak, but there's light at the end of the tunnel. Content sites have suffered as struggling dot-coms cut their ad budgets and mainstream advertisers largely remain on the sidelines, unconvinced that Web advertising works.
Result: Ad rates on the Web are falling through the floor. Wit Soundview media analyst Jordan Rohan says some second-tier sites that used to charge $2.50 for each 1,000 page views generated by a banner ad, are now charging only 50 cents -- which is getting close to a site's actual marginal cost of running the ad. He believes the pricing environment will probably deteriorate more in the first quarter of next year as more inventory at Web sites goes unsold.
A YEAR OR MORE. So the Web as a place of business is finished, right? Not by a long shot. In a December report, research company Forrester predicts that content sites' revenues will grow from $7 billion this year to $40 billion by 2005. "Which sites will be the best? Niche sites with devoted audiences but little targeting that will sustain traffic and see ad revenues soar," the report predicts. While some analysts look to the second half of 2001 for improvement, Rohan believes it will take 12 to 18 months for online media companies -- so heavily laden with content -- to tweak their business models and return to favor.
Most analysts still believe advertising will ultimately work on the Web. "Is the potential for online advertising as low as people seem to think it is today?" asks Derek Brown, an analyst with W.R. Hambrecht & Co. "The answer is clearly no." He thinks the ability to target consumers directly will eventually win the favor of traditional companies. "Advertisers follow audiences, and if audiences are moving online, then advertisers will follow them," he says.
Indeed, business-to-business is what most analysts believe will work best on the Web. The trick will be in getting the right mix of clicks and bricks. Here the models are companies like Dell and Cisco, which are rooted in the bricks-and-mortar world, yet have automated systems for working with customers and suppliers. As far as dot-coms go, that leaves room for only a few companies that can provide the software and services needed to set up these systems, despite the billions in transactions that will be done on the Web.
TRADITIONAL WINNERS. "I don't think the Internet is dead as a tool for business," says Cohan. "But there is going to be a virtual elimination of companies that are pure-play dot-coms." He thinks traditional companies will reap most of the benefit of the Web, and Reid of Evergreen Funds agrees. "The Internet is a very important innovation and technology," he says. "But when you look back on history, the net result will be that it really benefited the established businesses rather than the startups."
In a Dec. 4 note, Merrill Lynch analyst Henry Blodget predicted "only a handful of strong global companies" will emerge from the wreckage. Time and time again, the same names come up as survivors: Yahoo! (YHOO
), eBay (EBAY
), and CNET Networks (CNET
). America Online, which is merging with Time Warner, is no longer considered a dot-com since the bulk of its revenues will come from old-media businesses.
Of course, new technology is leading to new startups that may ultimately have a better chance at making it on the Web, in part because they're starting out in tougher times. "There will be pockets of technical innovation that lead to pockets of value creation that are very bright spots for investors," says John Corcoran, an analyst with CIBC World Markets. "No one wants to talk about that right now." He believes that new technologies will improve the functionality of the Web and lead to services that people will be willing to pay for. For example, he recently initiated coverage on two speech-recognition companies, Nuance (NUAN
) and SpeechWorks (SPWX
), which are helping to build a "voice" Internet.
ABOVE THE NOISE. And less money chasing fewer deals will improve business dynamics on the Web. Less competition will make it easier for innovative companies to be heard above the noise. As many of the "free" models -- for such things as phone and Internet service -- die out, pricing won't be as predatory, which will allow some dot-coms to actually eke out a profit. Most encouraging, early Web leaders like America Online and Yahoo! have already proved that dot-coms can change business models midstream. The big surprise of the dot-com bust may ultimately be how many companies can make the transition.
Remember Ventro? It plans to continue as a "marketplace service provider," helping other companies set up their own online exchanges. It's a model Morgan Stanley's Sherrick believes may work. But first Ventro has to get through the tough times. Eliminating the Chemdex and Promedix sites will staunch its cash burn rate by 50%. The company still has $240 million in cash that it hopes will be enough to last until it can shift to a profitable business model. In the meantime, it's laying off 235 employees and taking about a $400 million restructuring charge. "This is really painful," says Abrams. But such lessons learned in today's dot-com world will blaze new paths in tomorrow's.
By Amey Stone in New York
Edited by Douglas Harbrecht
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Copyright 2000, by The McGraw-Hill Companies Inc. All rights reserved.
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