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Dashed Hopes for Dot-Coms


On Sept. 10, Expedia Inc. (EXPE) Chief Executive Richard N. Barton thought he had a nice earnings surprise in store for Wall Street. Only two quarters after posting its first profit, the online travel agency was piling up revenues at a clip to reach $90 million for the quarter ending in September--$10 million above target. Then planes hit the World Trade Center and the Pentagon, and Expedia Inc.'s revenues came up $10 million short over the next three weeks. That drop will reduce its profits from $10.1 million to $6.1 million, says Prudential Securities Inc. analyst Mark J. Rowen. Now Barton is worried about deepening gloom. "I'm waiting for signs people are ready to get back to normal," he says.

Barton and other leaders of the consumer Internet industry may be waiting a long time. The September 11 disasters hit at the heart of some of the success stories of the Net--travel and finance companies, in particular--that had defied the odds and actually become profitable, most of them on a pro forma basis. While the A-team players have bright prospects long term, a short economic downturn could slow profit growth for such players as Expedia, travel agent Travelocity.com (TVLY), name-your-price site Priceline.com (PCLN), and real estate site Homestore.com (HOMS). A long recession could make a number of the profitable companies profitless again.

For dot-coms that were barely hanging on, this crisis could be the knockout punch. Dozens of consumer Web sites were already low on cash and losing money fast. Struggling jewelry retailer Ashford.com Inc. (ASFD), with just $6 million in cash at the end of the second quarter, has agreed to be purchased by Global Sports Inc. (GSPT) Buy.com Inc. (BUYC), the discount e-tailer, has only $14.5 million in cash after burning through $51.8 million during the first half of the year. Closings of consumer sites have tapered off in recent months since the weakest ones have already been flushed out. But more failures are likely now.

The setback comes at a particularly inopportune time for the profitable dot-coms. After edging into the black in recent quarters, some of these companies were poised to turn in sizable income--the long-awaited payoff for years of investing to gain traction. They finally had enough revenues to cover their fixed costs and marketing expenses. Additional business required little extra staff or computer gear. Now, profits are getting squeezed because the same logic works the other way. Even small interruptions in sales take an outsize toll. Witness Homestore's Oct. 3 announcement that a $9 million to $13 million revenue shortfall could produce a loss of up to $6.5 million in the third quarter. Goldman Sachs had earlier projected a $14.6 million profit.

"GAMBLING." For investors, the profit crunch means these company's stocks may be significantly overpriced. The prospect of long-awaited profits sparked an early-year rally that had a BusinessWeek-compiled list of 37 profitable Web companies trading in late August at 97 times this year's expected profits and 41 times next year's estimates, according to First Call/Thomson Financial. Investors have driven down their stock prices recently, and analysts have cut estimates. But the group of Web companies is still trading at 31 times next year's earnings--55% higher than the Standard & Poor's 500-stock index. Shares of online trader E*Trade (ET) began the year at $7, peaked at $15, and now trade at $6--giving it a multiple of 149. Experts warn investors to be wary. "To bet on things that are not likely to happen is gambling," says Penn State finance professor Gary Gray.

Some companies are reacting quickly. Priceline and Expedia responded first by cutting advertising almost entirely. Both companies have subtly rearranged their sites to push close-to-home hotel and rental car packages they hope will be less affected by consumers' fear of flying. Priceline also has cut back on the number of outsourced customer-service reps it hires from contractors.

They're right to react, since the most vulnerable piece of the dot-com universe is online travel. Air travel has been all but moribund since September 11. Even with most airlines canceling up to 20% of their flights, planes are half-empty. As a result, Travelocity and Priceline are likely to come close to losses in the fourth quarter. Prudential's Rowen says Expedia will make about $1.5 million in the fourth quarter, down from the $11.1 million he forecast before the attacks.

RESERVES. Online mortgage and real estate sites aren't hurting yet, but that could change if people stop buying houses and borrowing. The shaky real estate market holds the key to the fortunes of Web players such as Homestore.com, LendingTree.com (TREE), and E*Trade, which sell real estate-related ads or mortgages. In the short term, real estate lending is improving from a near-crisis right after September 11. LendingTree says its applications were 42% below normal the week of the crashes, but 40% above normal by the week of Sept. 24.

Earnings estimates are coming down sharply for companies that depend on Web advertising. Yahoo Inc. (YHOO) tops the endangered list among the profitable ad-dependent dot-coms. The reason: It's almost alone among profitable Web companies in relying on ads for more than 80% of revenues. Just to break even on estimated revenues of $608 million for 2002, Yahoo would need to make cost cuts. U.S. Bancorp Piper Jaffray analyst Safa Rashtchy says Yahoo's sales could drop 10% to 20% in this year's fourth quarter.

The good news is that none of the profitable dot-coms are facing cash shortages. They're cash-flow positive now, and even if the downturn is deep and long, they have enough reserves to tide them over if they become unprofitable for a few quarters. Homestore.com has $175 million in cash. Priceline.com has $165 million.

Long-term trends in online travel and e-finance are still favorable, and even online advertising will find its niche in the media constellation. But the striking thing about the profitable Web companies was how quickly the market last spring bid up their stocks. Next time, investors will likely be more skeptical. By Timothy J. Mullaney in New York


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