By Amey Stone Seems like everything dot-com is being shunned by investors these days. But perhaps no other group has experienced quite the brutality that Web consultancies have. Once the sweethearts of Wall Street, their stocks are now high-tech whipping boys. Even financial analysts, who usually strive to be positive about companies they cover, seem to have given up on the sector.
Look what Prudential Securities analyst Jim Dougherty wrote in a Feb. 12 report discussing fourth-quarter results of Web consultancy Razorfish (RAZF): "Survival will depend on revenue growth and managing the current challenging markets. Thus far, we believe that RAZF has had more difficulty with this than its peers, and therefore, we doubt it will be one of the survivors." Ouch!
RISKS, SPECIFIC AND GENERAL. Or consider MarchFirst (MRCH). On Feb. 13, it fell well short of expectations when it reported fourth-quarter numbers. The stock fell 88 cents. Not bad, you say? Well, that was 35% of its value. From a high of $52 a share last March, the stock closed that day at $1.63. Wit Soundview analyst David Mahoney rates MarchFirst a hold, noting that given company-specific risks (low cash, employee turnover, more cost-cutting ahead), as well as a weak environment for consulting in general, "we do not foresee any short-term catalysts that would drive the stock higher."
The brutal assessments have come with good reason. Many of these firms were built on the back of the dot-com boom. Now those clients are gone. At the same time, pressure on bricks-and-mortar companies to build online businesses has lifted, leading to the cancellation or delay of Web projects.
But lost in all the negativity is the fact that there likely will be some survivors. And when sentiment about a group is so poor, there is often (but not always) opportunity for investors who are brave enough to step in. "The economy doesn't have to pick up," says First Union Securities analyst Edward Caso. "There just has to be a perception that it has bottomed."
STRONGER RELATIONSHIPS. Sapient (SAPE), now around $13 a share, may be one to watch for a rebound. With $510 million in revenues last year, it's effectively the bellwether. "That's the one name that we'd like to see improve before getting more positive," says Barry Chubrik, an analyst with Credit Suisse First Boston. Analysts credit Sapient with having stronger relationships with more big companies.
Sapient hit analysts' reduced targets for its fourth quarter reported Jan. 25 -- with net income at $8 million, or 6 cents a share -- but fell when management was cautious on the company's outlook. Nonetheless, U.S. Bancorp Piper Jaffray initiated coverage of Sapient on Feb. 6 with a buy rating and a $22-a-share price target. "In our view, Sapient is the stock to own for long-term investors in the IT-services sector," wrote analyst Terrance Tierney.
Another potential winner is Proxicom (PXCM), which also has traditional business clients and a strong technology focus. Chubrik says it "follows closely behind" Sapient, with $207 million in revenues in 2000. Its share price has climbed recently into the respectable $7 range after falling below $3 last December. Chubrik also likes consultants Answer Think (ANSR), which jumped almost 26% on Feb. 14 after reporting acceptable fourth-quarter results.
LOFTY PRICE. DiamondCluster (DTPI) is another Web consultancy pegged as a survivor by certain analysts. Like Sapient, it has strong management focused on profits, says Peter Cohan, an Internet strategy consultant. With some deep-pocketed customers, he thinks it will be a survivor. The company is trading at the relatively lofty share price of around $30.
Some niche consulting firms may have an opportunity to build their client bases in hot areas of the field. First Union's Caso likes eLoyalty (ELOY), which helps companies improve customer-relationship management. He also thinks digital-security and privacy consulting firm Predictive Systems (PRDS) has a big opportunity.
But for many other companies in this sector, the outlook is dire. Net consultants had thrived on Old Economy companies' fear of "being Amazoned" -- of having a huge online startup erode their market share. Building a business on clients' fears is unhealthy over the long term, says Michael Dunn, president and CEO of San Francisco marketing firm Prophet Brand Strategy. Now that the Internet bubble has burst, bricks-and-mortar companies are focused on return on investment. "They are looking to the Internet to cut costs, not build revenues," Dunn says. Projects going forward involve tasks such as automating a supply chain or human resources on a corporate intranet, Caso says.
RELIABLE SOURCES. This is leaving consultants that specialized in front-end and design services out in the cold. The Big Five consulting firms have made up for the ground they lost through a slow start and now offer the brand of Web consulting large companies still require. The big accounting firms -- and large computer-services firms such as IBM, EDS, and CSC -- can seem like more reliable sources for the kind of expertise that's in demand these days.
The difficult environment is compounded by, "lest we forget, weakness in the overall economy," Mahoney notes. John Peschier, MarchFirst's managing executive of investor relations, says that although the firm's projects revenue is "flattish to down" for the first quarter, there are signs business could pick up in the second half when the economic situation is expected to have improved.
Given all these factors, it's hardly surprising that Web consultants are reporting lower sales and higher losses. In the recent quarter, Razorfish's sales dropped to $50 million from $77 million in the third quarter. It also announced its second round of layoffs in a month -- 400 employees, or about one quarter of its workforce -- while its stock stagnates at around $1.50 a share.
"GOOD FOR NO ONE." Net consultants including iXL Enterprises (IIXL), Viant (VIAN), and Scient (SCNT) may not be in much better shape. These stocks are below $5 a share, indicating that Wall Street doesn't see much chance for survival. "Obviously, the backdrop now is good for no one," Caso says.
But analysts expect a wave of consolidation in the sector. That may provide some upside for Web-consulting firms that get bought at a premium. Still, even there, the strongest firms that have held on to the most talented consultants are the best bets. And given the tough business climate and negative sentiment, even the winners don't offer much upside near-term. "Invest soon, but it doesn't have to be today," Caso advises. The safest strategy is to wait for signs of a rebound in the sector. With Darnell Little in Chicago
Stone is an associate editor of BusinessWeek Online and covers the markets in our daily Street Wise column.
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