Net Stocks for the New Year


The best bets among Internet stocks for 2004 can be summed up in one word: content. That's what Scott Kessler, Standard & Poor's analyst of Internet software and services stocks, sees as a major theme for the new year, thanks to expected increases in corporate spending on information technology and advertising.

Kessler sees digital content being created "everywhere we look" and, as a result, companies spending to create, deploy, manage, and store it. Along those lines, his favorite company right now is Open Text (OTEX), which he rates a buy. He also reports a recent upgrade to buy for Macromedia (MACR), a developer of software to create and distribute online content.

In the world of online services, Kessler likes EarthLink (ELNK), which S&P lists as a stock to accumulate. S&P, he notes, has a similar ranking on Time Warner (TWX), the parent of America Online, but that's largely in spite of prospects for the online-service business.

These were some of the points Kessler made in an investing chat presented Dec. 30 by BusinessWeek Online and Standard & Poor's on America Online, in response to questions from the audience and from BW Online's Jack Dierdorff. Edited excerpts follow. A complete transcript is available from BusinessWeek Online on AOL at keyword: BW Talk.

Note: Scott Kessler has no affiliation with or ownership interest in any of the companies under discussion today. He is a registered representative of Standard & Poor's Securities, Inc. Other S&P affiliates may provide services to the companies under discussion.

Q: Scott, the broad market seems to be ending the year with a pretty big bang. How are the Internet stocks doing?

A: Not surprisingly, Internet stocks have had a quite jolly 2003. Weakness over the past couple of weeks has largely subsided over the course of recent trading sessions. Overall, it was difficult to go wrong in the Internet subindustries for which I'm responsible.

Q: This one pretty much sums it all up: What are the best Internet stocks to buy now?

A: In terms of my coverage universe, which consists of a lot of companies in our Internet software and services and Internet retail subindustries, my favorite company right now is Open Text (OTEX). I currently maintain a buy, or 5-STARS, opinion on the shares, reflecting the vibrant enterprise content management market in which it participates, as well as market-share gains afforded by competitive wins and acquisitions.

Open Text is also a leader in the collaboration-software segments. This is a company that trades at a substantial discount to its peers and has excellent prospects, which, to some extent, are being driven by increased regulation around the archiving and accessing of content. The stock closed today -- December 30, 2003 -- at about $19. Our 12-month target price is $26 per share.

We believe that content is going to be a major theme for 2004, as corporate spending on information technology and advertising will increase materially in our opinion. OTEX is a play on this theme, and so, too, is a relatively recent upgrade to 5 STARS or buy: Macromedia (MACR). We believe this developer of software to create and distribute online content is a compelling value at a recent $18 a share.

In just October, the MACR shares were as high as almost $30...we believe the company is particularly poised to benefit from momentum in rich media advertising. Our 12-month target price is $23 a share.

Q: What about the online service providers? Is AOL continuing to lose subscribers?

A: A very timely question, in that published reports suggest that AOL has recently launched a preliminary version of a lower-priced Internet service. The service debuted earlier this month under the Netscape brand, costing $1 per month until the end of February. It will cost $9.95 per month beginning in March.

We think that AOL to some extent is fighting a difficult battle, in that this new offering could cannibalize its existing subscriber base. We currently rate Time Warner (TWX) [AOL's parent] 4 STARS, or accumulate, largely in spite of, not because of, the online-services business.

That being said, I currently recommend accumulation of EarthLink (ELNK), [rated] 4 STARS, which has done quite well since reporting better-than-expected results for the third quarter in October. At that point, we upgraded the shares, and our target price on the shares is $12, reflecting anticipated continuing momentum in its broadband business.

We also believe the company's value offering, PeoplePC, is doing quite well.... At a recent 17 times our forecast [61 cents in earnings per share for 2004], the shares trade at roughly the multiple of the S&P 500 with what we believe is notably more growth potential. EarthLink also has a very healthy balance sheet.

Q: What's the S&P line on Microsoft (MSFT)?

A: We currently rate the shares 5 STARS, or buy. There's a long list of reasons supporting our investment thesis, but basically, we believe in 2004 MSFT will benefit from a resurgence in corporate PC demand, given that the last time many companies purchased PCs was in 1999 in anticipation of Y2K.

Given the relative age of these PCs, and tax benefits being offered to purchasers of technology equipment such as computers in 2004, we think that corporate demand will finally kick in. We also believe that Microsoft will make use of its $58 billion in cash and investments to deliver shareholder value. The stock currently trades at a notable discount to our target price, which was derived using discounted cash flow analysis.

Q: What do you think of Yahoo! (YHOO) at the current price? Would you buy, hold, sell?

A: In a word -- hold. My recommendation on the shares is 3 STARS, or hold, indicating that I believe the shares will trade in line with the broader market over the next 12 months. And when I say broader market, I mean the S&P 500.

Yahoo has a great franchise and brand. It's the most widely used and heavily trafficked collection of Internet sites in the world. The company should benefit from a continuing recovery in online advertising, where the company's inventory has become a must buy for Internet marketing campaigns.

We also believe that Yahoo's HotJobs unit should be aided by a rebound in employment. However, notwithstanding these tailwinds, Yahoo is hardly an inexpensive stock, and we believe the shares are trading relatively close to our calculation of their fair value.

Q: Priceline.com (PCLN)?

A: Priceline.com is a very interesting company. We believe that despite its recent efforts, it remains exceedingly reliant upon opaque airline ticket sales (those which exclude certain specifics until the transaction is completed, such as airline). The company has successfully started a retail travel business and has been successful with its name-your-price format with hotels.

However, we just think Priceline faces competition from the likes of InterActiveCorp (IACI), which recently acquired Priceline's primary competitor, Hotwire.com, and the likes of Travelocity and the [travel-industry] supplier Web sites as well.

Ultimately, we believe that Priceline and its name-your-own-price business model, as currently constituted, are simply anachronistic and don't offer enough value to make for a compelling option for most travel consumers. That being said, we believe these negatives are largely reflected in the stock, and we rate it 3 STARS, or hold.

We much prefer the bigger and better diversified InterActiveCorp, which we rate 4 STARS, or accumulate. IACI owns and operates businesses including Expedia, Hotels.com, TicketMaster.com, Match.com, LendingTree.com, and CitySearch, to name a few. We believe InterActiveCorp, based on discounted cash-flow analysis, is quite undervalued, and we have a 12-month target price of $40.

Q: What do you think of InfoSpace (INSP) and CNET (CNET)?

A: Unfortunately, we don't cover either CNET or InfoSpace. In terms of another name that I would recommend, I continue to like shares of VeriSign (VRSN). VRSN is rated 4 STARS, or accumulate. We believe the company's leading businesses in the domain-name registry, Internet-security, and value-added telecommunications-services businesses are poised for a rebound in 2004.

Q: We have questions about two other giants in e-commerce -- eBay (EBAY) and Amazon (AMZN). Your ratings?

A: I don't cover Amazon.com -- that's actually covered by one of our consumer-discretionary analysts. Amazon.com clearly is the most powerful company in Internet retail, but we believe the stock is fully priced and rate it 3 STARS, or hold.

eBay is another great company with an outstanding business model and management team. We believe that it continues to succeed as it pursues new categories, geographies, and businesses. But again, we believe the shares are reasonably valued at current prices. Our recommendation on eBay is also 3 STARS, or hold.

Q: You cited content as a major theme for 2004 in your sector. Any other themes? What about Wi-Fi?

A: Wi-Fi is definitely a theme that we're focused on for 2004. We believe that it plays into our content theme in that essentially Wi-Fi and its widespread deployment and usage contribute significantly to overall gains in Internet activity, which in turn benefits companies engaged in all levels of content-related activities.

We believe one appealing way to benefit from the emerging trend of Wi-Fi is Intel (INTC), which we rate 5 STARS, or buy. I don't cover INTC, but we believe that the company should benefit from its Wi-Fi-oriented technology and products, including Centrino, as well as what I referred to earlier as increasing corporate demand for PCs.

Q: Finally, can you amplify a little on the content theme? What's likely to be changing, and who will benefit?

A: I'm not necessarily sure if a lot is going to change per se. However, I think that most importantly, corporations are going to be spending more to create, deploy, manage, and store content. Everywhere we look, digital content is being created, and companies positioned suitably are going to benefit from what I perceive as essentially increased activity around content.

So Macromedia, which makes software to create and disseminate content, Open Text, and FileNet (FILE

, which is rated 4 STARS, or accumulate), offer products to manage content. And even a stock I don't cover, Emulex (ELX

, which is rated 5 STARS, or buy), to store the content, should all benefit from increasing volumes of information and data created across Corporate America in 2004.


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