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Even though Internet stocks are generally way down, Standard & Poor's has some favorites worth buying or at least accumulating, according to Scott H. Kessler, Net-stock analyst for S&P. Adobe Systems is a "buy" on the S&P list, and so is MarchFirst, the Internet consulting company.
Among the Net search-engine rivals, he sees Yahoo! as the clear leader in what he views as a commodity business -- and probably the best-run Internet company. But interestingly, he thinks Yahoo stock is too richly valued to warrant more than a "hold" ranking.
Kessler made these comments in an America Online chat co-hosted by Business Week Online and S&P Personal Wealth on May 23, in response to questions from the audience and from BW Online's Jack Dierdorff, the moderator. Edited excerpts follow. For a full transcript on AOL, go to keyword: BW Talk.
Q: Internet stocks led the market up -- and now down. Will they lead us back up?
A: There's no doubt that much of the growth in the economy is being fueled by, as well as benefited by, Internet companies, and I am optimistic that the bellwether Internet stocks will at some point begin to perform favorably in comparison with the broader market.
Q: Scott, for purposes of your coverage at S&P, how do you define "Internet" stocks? The Net is so broad now. A: Generally, those companies characterized as Internet stocks are those that derive a significant percentage of revenues from Internet-based businesses. However, S&P does not maintain a formal definition of what constitutes an Internet company.
Q: How about an Internet service provider like PSINet [PSIX]? A: S&P does not cover PSINet. However, we do cover several ISPs, including EarthLink [ELNK], At Home [ATHM], and America Online [AOL]. We maintain "accumulate" ratings on all three of those stocks and see PSINet as similarly situated. The company is a market leader and recently moved to acquire Metamor Worldwide [MMWW], an Internet-consulting firm.... In general, we believe that the Internet-consulting area is one that contains many strong plays. Currently, we have "buy" recommendations on MarchFirst [MRCH], and we have "accumulate" recommendations on Sapient [SAPE] as well as AppNet [APNT].
Q: Scott, are any of your other Net stocks on S&P's "buy" list -- one step above "accumulate"? A: The only company that I cover currently that has a strong "buy" recommendation is Adobe Systems [ADBE]. Although Adobe is not a pure-play Internet company, it derives some 55% of its revenues via the Internet.... The stock has done quite well in this most recent downdraft -- only some 20% below its recent high....
Q: Has the recent price slide knocked any of the Net stocks down in the S&P rankings?
A: The only stock that I have downgraded of late is Lycos [LCOS]. As you may know, last week, Terra Networks of Spain [TRRA] made a bid for Lycos of $97.55 a share. The stock is trading at a significant discount to that price, but because shares of Lycos ran up in anticipation of this bid and Lycos will now trade according to shares of Terra -- and because we do not cover Terra -- we downgraded the stock and are waiting to initiate coverage of the combined company.
Today, we downgraded several "buy"-rated stocks to "accumulate" in light of weak near-term earnings power and rising interest rates, as well as exposure to dot-com customers. Such companies include Covad Communications [COVD], Organic [OGNC], Harbinger [HRBC], Peregrine Systems [PRGN], Copper Mountain Networks [CMTN], and AppNet.
Q: YHOO [Yahoo!] -- will it go up again? Keep or unload? A: We currently have a "hold" recommendation on shares of Yahoo. Even though this is probably the best-run Internet company, with great top-line growth as well as effective management of costs, the shares are still richly priced. In fact, some would say priced to perfection -- with a huge market cap, the stock is still in our estimation too highly valued to have a more favorable opinion at this time...
Q: Your feelings on Ask Jeeves [ASKJ]? A: ...This company, in terms of its shares, has suffered more than most Internet stocks, primarily as a result of the perception that the company is in a commodity-oriented space -- that being the search-engine business. However, the company has successfully made inroads into the B2B as well as the e-commerce arenas. So we see this company as likely to recover from current levels.
Q: What do you think of the incubators -- CMGI, ICGE [Internet Capital Group], SFE [Safeguard Scientific], WCAP [Winfield Capital]? A: It's clear that they have suffered -- and potentially more so than the broader technology and Internet sectors. These companies are proxies for the health of the Internet IPO market, which, as I'm sure you know, has been in serious jeopardy in recent weeks...
Q: I'm interested in MP3.com [MPPP]. What's your opinion on their future outlook? A: ...Obviously, MP3 has some serious legal issues with which to deal. In an environment that seems to be punishing companies without earnings and with potentially questionable business models, the storm cloud of significant litigation and possible damages would suggest that the shares might remain under pressure. We, however, believe that the dissemination and sale of music over the Internet is going to be one of the most sought-after applications used by Netizens.
We see, for example, the advent of broadband, combined with the major record companies warming up to the concept of online music sales, creating a very dynamic and strong Internet music marketplace. I would point you to Lycos, for example, for when the company completes its merger with Terra Networks, it will have preferred access to the music content of partner Bertelsmann.
Q: Do you feel CNET will recover -- and if so, where does it fit in? A: ...We believe the company has a significant advantage in comparison with other Internet companies for one main reason -- the company has generated earnings and will likely continue to do so in the future. We see CNET as a leading player....
Q: Scott, has S&P added coverage of any Net stocks recently?
A: I initiated coverage of DoubleClick [DCLK] last month with an "accumulate" recommendation.... DoubleClick is the No. 1 player in the rapidly growing online-advertising industry, which the company projects will increase in terms of revenues by a factor of 10 on a worldwide basis from 1999 to 2004.... We see the shares as a strong value and expect the company to report a profit this year.
Q: The Net is worldwide, of course -- any non-U.S. companies worth a look?
A: ...There are those who would characterize companies such as Nortel Networks [NT], Ericsson [ERICT], and Nokia [NOK]...as smart ways to play the growth of the Internet. I would also say that I anticipate picking up shares of Terra/Lycos after the combination of the two companies is completed. It would appear that this entity is going to be one of the top players in the Internet space on at least four continents.
Two interesting companies traded in the U.S. that are plays on the European Internet sector are Via Net.Works [VNWI, an ISP and Web-hosting concern], as well as a controversial stock called Xcelera.com [XLA], which has been investing aggressively in Europe and which some have called a potential European CMGI.
Q: Any stocks to watch in Internet security and privacy?
A: In terms of the security sector, I currently have a "hold" recommendation on shares of VeriSign [VRSN]. I actually had an "accumulate" recommendation on the shares, despite an extremely high valuation, because of the extremely exciting prospects the company has with respect to the digital-certificates industry. However, upon the announcement that the company was purchasing Network Solutions [NSOL], the No. 1 Internet-registration concern, for some $21 billion, I became less positive on the stock.
Two stocks in this area that we do not cover but that are strong competitors to VeriSign include Entrust Technologies [ENTU], a former spin-off from Northern Telecom, and Baltimore Technologies [BALT], which is based in Ireland and would be another possible way to play the growth of the Internet in Europe. Another company that we at S&P currently like in the security industry is RSA Security [RSAS].... The company, in fact, incubated VeriSign and then spun that company off.
Q: What do you think about Juno Online [JSWEB] for the next year? A: ...Although the company is quite interesting, in that it offers traditional ISP connectivity as well as free ISP services, we see the non-first-tier players having difficulty in terms of monetizing subscriber bases and generating revenues, while at the same time committing an increasing amount of resources to marketing as well as infrastructure buildout. We would be more inclined to look to market leaders such as AOL and EarthLink.
Q: Earlier you mentioned that search engines were now a commodity business. Is it possible to pick a winner? A: The key with respect to becoming a winner in the search-engine business is to be more than just a search engine. That is what Yahoo and other companies such as Lycos -- and, when it was an independent company, Excite -- were able to do. The key is to build a large subscriber base that's loyal to your offerings and monetize those subscribers effectively to generate advertising and e-commerce revenues. Currently, I think it's clear that at least in terms of search engine companies, Yahoo is the leading company.
EDITED BY JACK DIERDORFF
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