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OCTOBER 24, 2003

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Finding Keepers among the Net Stocks
S&P's Internet analyst Scott Kessler has several rated buy, even though overall he thinks they're mostly fully valued


Investors can find opportunities in the Internet sector -- but they need to be much more careful than they were before the dot-com bubble burst. So says Scott Kessler, Standard & Poor's analyst for Internet software and services stocks, and he urges investors to apply the same standards to Net names as they would to any other sector.


During the dot-com boom, of course, little attention was paid to traditional measures such as the price-earnings ratio. But Kessler sees little chance of such overvaluation today, with most of the surviving companies "either profitable or well on their way to earnings." Although most appear fully valued, he still has several Internet stocks on his buy list.

Kessler cites as recommendations in the buy category InterActiveCorp (IACI, the parent of Expedia, Hotels.com, Match.com, and other successful Web ventures), Open Text (OTEX ), and Fair Isaac (FIC ). He recently downgraded DoubleClick (DCLK ) from buy to hold on the basis of lackluster earnings.

These were some of the points Kessler made in an investing chat presented Oct. 21 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 full transcript is available from BusinessWeek Online on AOL at keyword: BW Talk.

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

Q: Do you have any observations on the broad market? I note that the S&P 500 eked out a small gain today.
A: Overall, Standard & Poor's Equity Research Services is cautiously optimistic on the broader indexes, reflecting both the (anticipated) rebound in economic activity and corporate profits. And those of us in the technology sector are even more positive, as we are overweighting the information-technology sector.

Q: And how about Internet stocks? Any keepers?
A: No question, there are a number of attractive stocks from which to choose. It's my opinion that the years of retrenchment and consolidation are in the past. Leading firms are really poised to capitalize on individual company improvements, as well as a rebound in the economy.

Q: Do the incubators -- such as Safeguard Scientifics (SFE ), CMGI (CMGI ), and Internet Capital Group (ICGE ) -- have a chance?
A: It's astounding to me that each and every time I do one of these chats, I'm asked about these companies. Together, their aggregate market capitalization is roughly $1.2 billion, and their most recent annual revenues amounted to roughly $2.1 billion.

While these are companies that have a place, in that they promote young companies from a capital and operating perspective, I think the fact that none has generated net income since 1999 would suggest that investors look elsewhere. Keep in mind that I do not cover any of these stocks.

Q: Do valuations on Internet stocks cause you to be cautious about recommending buys?
A: Unlike in 1999 and even early 2000, investors and analysts alike should be not only concerned with but focused on valuations as a primary method to evaluate potential investment opportunities. Based on what I would characterize as fairly common valuation methodologies, such as p-e, p-e to growth, relative and historical analyses, and discounted cash flow considerations, there's no question that many Internet stocks appear fully valued.

The trap of the Internet bubble was that investors and analysts both rationalized new ways of evaluating stocks, particularly those that were unprofitable. I can honestly tell you that the chance of overvaluation like we saw in the late 1990s is unlikely. Most of the remaining players are either profitable or well on their way to earnings. So in sum, yes, valuations are a concern, but there are opportunities to be had.

Continued on next page>>  | 1 | 2 | 3



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