Businessweek Archives

Incubators Are Feeling The Chill


Information Technology

Incubators Are Feeling the Chill

If you think the dot-com correction has been terrifying for investors, consider what it has done to firms like Internet Capital Group Inc. and CMGI Inc. These companies, called incubators because they invest in or acquire growing Net companies and nurse them along, saw explosive share price gains in 1999. But when investors grew skittish about the valuations of cyberstocks, the incubators got hammered. Since their peak in January, CMGI shares have dropped a stunning 65%, to 58, while IGC's plummeted more than 80%, to 38 13/16, from their December highs.

Such dramatic declines could trigger changes in how the companies operate. Like venture capitalists, incubators help launch Net startups in exchange for ownership stakes. The money for those investments often comes from selling their own richly valued stocks or holdings from previous investments. But thanks to the market correction, the cost of raising such funds could go higher. What's more, the startups in which they have invested might not be able to raise cash through initial public offerings in this hostile market. So the incubators may have to help their chicks find other sources of capital, such as private placements. The new market environment "makes it much more difficult to harvest these investments," says Ethan McAfee, Internet analyst at T. Rowe Price Associates Inc., which holds shares in ICG, CMGI, and Japanese incubator Softbank.BUYERS' MARKET. Not that it's time to pass the hat for these incubators. ICG raised $1.4 billion in cash in December, through a combination of stock and debt offerings, when its shares were trading at 108. Pasadena (Calif.)-based idealab!, which has yet to go public, did a $1 billion private placement in March. And CMGI has a war chest of more than $10 billion in cash and marketable securities. That cash may go farther than it did in the past: With Net company values down across the board, many potential investments will be far cheaper than during the dot-com frenzy of a few months ago. "This gives us an opportunity to buy [stakes in] more of the winners," argues Kenneth A. Fox, co-founder and managing director of ICG.

If they can still get those stakes. One problem created by the decline in incubator stocks is that the companies won't be able to use supercharged shares to bid aggressively for promising Net companies. A spokesman for CMGI, which made more than 20 acquisitions in 1999 primarily using its stock, acknowledges that the pace could slow now. What's more, these Net incubators could find raising additional capital by issuing shares or selling existing holdings won't give them the same edge over rivals. "In some cases, they were paying prices that were five times what we might pay," says James W. Breyer, managing partner at venture-capital firm Accel Partners.

The biggest impact, however, could be on how Internet investment companies cash in on their holdings. While companies like ICG and CMGI often act as long-term investors, they're valued by the market largely on the worth of their portfolios. A popular way to realize that value is to take these Net upstarts public. But the correction has slammed the window shut on most IPOs for now. In fact, AltaVista Co., CMGI's search-engine operation, postponed its widely anticipated IPO in mid-April due to the market's softness. Analysts expect idealab's pending IPO to be put on hold, too.

Until that IPO window opens again, some analysts say these incubators may have to get more creative in helping their partners find funding. Industry pros say that's likely to include more private equity deals and additional asset sales. Some, like Fox, see this tougher period as a positive. "This type of environment forces all parties to focus on business fundamentals," he insists. That could be a painful--but productive--shift.By Amy Barrett in Philadelphia, with Rochelle Sharpe in Boston and Arlene Weintraub in Los AngelesReturn to top


Tim Cook's Reboot
LIMITED-TIME OFFER SUBSCRIBE NOW
 
blog comments powered by Disqus