By Amey Stone Probably the last place you would expect to find stocks that derive some benefit from a weak economy is in the Internet sector. But when sifting through the limited number of positive second-quarter earnings reports, a surprising number of Web stocks with countercyclical attributes emerge. They aren't all good buys -- quite a few are looking pretty pricey after steep runups following their reports. But given that economic weakness will likely persist into 2002, these companies, which so far have been able to buck all the bad news, are worth keeping an eye on.
EBay (EBAY), which on July 19 reported second-quarter earnings of 12 cents a share -- 3 cents better than Wall Street expected -- on revenues of $181 million, is the best example of a countercyclical Web stock. In a weak economy, more buyers are drawn to eBay in search of good deals and more sellers turn to the site to generate cash from unwanted items, says Derek Brown, an analyst with W.R. Hambrecht & Co. Even businesses are turning to eBay to unload surplus goods, says Paul Shread, an analyst with Internet.com. He notes there are about 2,800 Cisco products for sale on the site now.
EBay's stock price, which has more than doubled this year, to about $62 a share, already reflects this positive news. But the company has a history of outdoing itself. "Just when you think the bar has been raised too high, they clear it with the ease of a professional athlete," says Scott Kessler, an analyst with Standard & Poor's. Brown, citing eBay's high growth rate, market leadership, strong management, and still-large market opportunity, believes the stock can go to $75 in the next year.
TRAVEL TAKES OFF. Less visible than eBay is University of Phoenix Online (UOPX), which offers Web-based courses to adult students and posted 86% enrollment growth last quarter. "They seem to have no problem attracting students, probably because they give adults a chance to get training and education on their own time -- a very important thing in a tough economy," says Shread. The stock, which split 3-to-2 on July 23, has about tripled in price since its debut last September.
Hotel Reservations Network (ROOM), a leading online discounter of hotel rooms, is another company analysts say is turning in strong results, thanks in part to the weaker economy. On July 23, HRN posted second-quarter cash earnings of $21 million, up 60% from the same quarter in 2000, on revenues of $138 million, up 77% from the year before. Its revenues have jumped as the number of available hotel rooms that it can sell through its system increases, says Steve Weinstein, an analyst with Pacific Crest Securities. And while business travel has slowed substantially, HRN caters mainly to leisure travelers, who are more likely to turn to the Web in search of deals in a slowing economy.
The search for cheap travel online has already boosted some of the Web's top gaining names this year. Expedia (EXPE), which is being acquired by USA Networks (USAI) (also the majority owner of HRN), has risen roughly five-fold this year, to $50 a share, on growth in the online-travel industry. Priceline.com (PCLN), Cheap Tickets (CTIX), and Travelocity (TVLY) also have jumped in 2001 as consumers and businesses turned to the Web for discounted travel -- and investors decided they are viable businesses after all. But their good results are dependent on folks continuing to book vacations, which may not happen if economic weakness persists, says Weinstein.
RAIDING THE PIGGYBANK. In fact, many of the Internet stocks that are doing well aren't so much countercyclical as tied to consumer spending, which has held up well -- especially compared to the drought in corporate spending. With an extra boost from a strong business model, many consumer-oriented Internet names have done quite well.
Kessler puts AOL Time Warner (AOL) in this camp. "Thanks to its 135 million subscriptions, it is able to withstand a lot of weakness in the economy," he says. "People are not shutting off their cable or canceling their subscription to Time magazine in this environment," he says. Although the company disappointed investors with its second-quarter earnings report, Kessler says the shortfall was mainly due to the impact of the capricious music business on Warner Music Group. But that should rebound, he feels, with the help of some strong new releases due out in the second half of 2001.
Alloy Online (ALOY), which markets clothing to teens through its Web sites and catalogs, has turned in strong sales, as its target demographic continues to spend. "The teen audience is largely immune to the economic slowdown," notes Brown. They're not in danger of being laid off and seem to still manage to get some spending money from their parents, even as the jobless rate continues to rise. Brean Murray analyst Kathleen Heaney also mentions Delia's (DLIA), which caters to girls, as another on- and offline retailer which benefits from strong teen spending. After falling below $1 a share late last year, the stock is now at about $6. Alloy has risen from $7 to $16 a share this year.
NO-FLY ZONE. Homestore (HOMS), which reported earnings July 25, dominates the online niche for what's probably the strongest part of the economy -- the housing market. "People are still shopping for houses, and considering more than 90% of online home listings are on their network, business isn't hurting at all," says George Nichols, a stock analyst with Morningstar. Although the volatile stock stumbled from its high of $35 a share in May to around $26 as analysts raised concerns about its high price, it started off the year at only $18.
For Web-related companies that sell to businesses, stocks that have been able to thrive are few and far between. One standout is WebEx (WEBX), which provides online-conferencing services. The monthly fee for the service can easily pay for itself by eliminating the cost of even one coast-to-coast business-class airfare, says CIBC World Markets analyst John Corcoran, who rates the stock a strong buy. WebEx jumped 25% to $22 a share on July 25, after posting strong second-quarter results.
Precise Software Solutions (PRSE), which helps companies improve the performance of their computer systems -- and theoretically avoid spending more on new infrastructure -- has been another recent bright spot. Following strong second-quarter results, which Merrill Lynch analyst Mark Fernandes called "precisely what the doctor ordered," the stock gained $3.50, to close at $22 a share on July 25.
RIDING THE BEAR. Results of some large business-software companies, like PeopleSoft (PSFT) and Siebel Systems (SEBL), which in theory help companies cut costs and improve productivity, have also been fairly strong in the recent quarter, but investors are still avoiding the stocks. That's because this year has seen most companies that sell Web-related software, hardware, and services to businesses being brutally punished -- a group that includes many companies Wall Street predicted would hold up in a tech-spending slump. Security and data-storage stocks have been pummeled, even though analysts thought businesses would have no choice but to increase spending in those categories. "It doesn't seem like that's been the case," says Fernandes.
Indeed, it seems the only way to tell whether a Web-related strategy will work in an economic slowdown has been to wait to see actual results. Still, that doesn't necessarily mean all the companies that look set to continue to perform well are buys. Web stocks have a troubling tendency to fall after reporting positive news. Plus, if consumer spending crumbles, most of these stocks will flounder.
That said, there are few convincing signs the economy is turning around and the next few quarters are likely to continue to be tough for tech companies. The stocks most likely to do the best are those already bucking the downward trend. Stone is an associate editor of BusinessWeek Online and covers the markets in our daily Street Wise column.
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