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Net Stocks: Diamonds Amid the Debris?

Despite the slowdown in the market and the economy, there are Internet stocks still worth buying, according to John Corcoran, analyst of Internet and digital new media stocks for CIBC World Markets. Nevertheless, Corcoran expects the market to remain under heavy pressure from depressed corporate earnings throughout 2001.

He has a strong buy on AOL Time Warner, which he thinks is well positioned for the growth of the Internet. He gives the same high rating to Gemstar TV Guide and WebEx, a small-cap company in the high-end Web collaboration business. Corcoran also recommends speech-recognition software companies Nuance and SpeechWorks. Longer-term, he expects mobile-access devices to bring vast expansion to the reach of the Net, with companies such as InfoSpace among the beneficiaries.

Corcoran's comments were made in a chat presented July 5 by BusinessWeek Online on America Online, in response to questions from the audience and from BW Online's Jack Dierdorff and Amey Stone. Edited excerpts from this chat follow. A complete transcript of this chat is available from BW Online on AOL, keyword: BW Talk.

Q: The Dow dropped 91 points today, again on earnings news. Is the market going to continue to react to earnings minute-to-minute?

A: I think so. We're just entering second-quarter earnings season. If you remember, the beginning of the first quarter looked similar. Lots of preannouncements of bad results were driving the market down sharply. People thought that period would have the record high on negative announcements. Now that may happen in the second quarter, so movements like the one today don't surprise us.

Q: If earnings season is rough this time around, do you think things could start looking up after that?

A: I do -- but it will take time. The second quarter will be rough. The third should be a little better, and we'll probably see noticeable improvement in the fourth. But portions of the market will continue to remain under heavy pressure throughout 2001. Companies in the advertising space have been hit hard -- we just completed the broadcast upfront season, which was down 15% from 2000, and the online ad space remains under pressure as well. We expect the ad market to claw its way back in the middle of next year, with possibly some upside in the second half of 2002. But the markets will not return to the wild euphoria we saw in 1998, 1999, and early 2000. Unfortunately for investors, those days are over.

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

A: We don't cover that company officially, but I think the segment InfoSpace competes in -- I'd call it the mobile Internet space -- has significant potential. Five years from now, consumers will use a host of mobile-access devices to enjoy a much wider range of functionality than is available today over the Net....This trend will benefit players like InfoSpace, but it'll take some time.

Q: Broadening out from INSP, what's your outlook for the sector you cover at CIBC World Markets? Who are the best bets for survival -- and prosperity?

A: In the mega-cap segment, our top pick is AOL Time Warner (AOL), which we rate a strong buy. This company is extremely well-positioned to take advantage of growth in the Internet and convergence in the new-media space.

In the large-cap space, we like Gemstar TV Guide (GMST), which we also rate a strong buy. This company will be the dominant provider of interactive program guides on a worldwide basis, and its patent portfolio is extremely broad, strong, and deep. In the small-cap space, we like WebEx (WEBX), which we rate a strong buy. This company is the leading player in the high-end Web collaboration market.

Q: Yahoo! (YHOO) reports second-quarter earnings next week, and the new CEO is supposed to come up with a plan for restoring the company to health. What are you looking for?

A: The short-term answer is: I'm looking for a miracle to turn Yahoo! around, but I'm not sure we're going to get one. Longer term, Yahoo! will one day thrive again. But in the near term, the company still generates about 80% of sales from online advertising. It needs to diversify from that revenue stream.

Q: I have been in CMGI (CMGI) and Exodus (EXDS) a long time -- any comeback?

A: Don't hold your breath. Both are worth something, but institutional investors are giving them a very wide berth these days. Regarding CMGI, investors are skeptical of incubators with portfolios of companies that are burning a lot of cash. This is really hampering CMGI's performance. Exodus is competing in a very competitive space and faces a lot of near-term challenges. If it makes you feel any better, I myself lost money on Exodus.

Q: Amazon (AMZN) -- should I buy it for the long term?

A: Amazon is a very solid company that will likely survive and eventually thrive. But it will not swallow the whole world. Nor will it put players like Wal-Mart (WMT) out of business. The lesson we learned from Amazon is that controlled growth is better than hyper growth at any cost.

Q: Why is it taking so long for broadband to get here? And when it does -- whenever that is -- will it change the list of winners and losers on the Web?

A: Starting with the second question, the big players today will probably get bigger with the advent of broadband to the home. The marginal players won't be helped very much. Part of the problem with the broadband rollout is that the telcos had strong incentive to trip up the new DSL [digital subscriber lines] providers. And the cable deployment process was almost as much of a nightmare as the DSL deployment process. Broadband will eventually arrive, but it'll be several years later than most people anticipate. Once a customer has access to broadband, he does not go back to narrowband.

Q: Do you follow any of the Internet infrastructure plays -- the pick-and-shovel approach to the gold rush?

A: Yes, I do. Names like RealNetworks (RNWK), which we rate a hold, is a good example. We do believe streaming media will grow large over time. But Real will have to battle mighty Microsoft (MSFT), and the network can't handle much more than streaming audio today. We also follow WebEx, which is an enhanced Internet communications provider. It helps businesses reduce the cost of communication, both within and outside the organization. Two more names we like: Nuance (NUAN) and SpeechWorks (SPWX), both of which provide automated speech-recognition software that voice-enables the Internet and the enterprise database.

Q: Any possibility of E-Loan (EELN) making it or getting bought out?

A: That's always a possibility, but that space remains quite challenging. We don't officially follow this company, but generally speaking we like companies that use the Internet to take costs out of the system, as E-Loan does. If it can survive, it may find a profitable niche as other competitors exit the marketplace over time.

Q: Do you like any Net and e-commerce software companies, such as Check Point (CHKP)?

A: Two companies that fall in that general category include SpeechWorks and Nuance. I don't follow Check Point, but I recognize that one of the major gating factors for the Internet today is security -- at the enterprise level and the client level. Part of the reason players like Napster and MP3 have faced so much litigation is that every content provider out there is scared of digital replication of its offerings without getting paid for them. I think there will be some interesting investment opportunities in the security space.

Q: Do you think privacy concerns are a major factor impeding the Internet's growth? Or do you think those concerns are overblown? Should we be worried about privacy?

A: Yes, we should be. I don't think the privacy concerns are overblown. At the same time, we advocate a reasonable approach to addressing those concerns. The Chicken Little approach -- "the sky is falling" -- isn't particularly helpful in our view. Players like Microsoft and others are positioning themselves to collect a staggering amount of information about consumers and their surfing, shopping, and viewing habits. Reasonable rules about how that information can be collected and used will help augment the growth of the Internet in the long term.

Q: Any comments on educational Internet companies?

A: We don't officially follow them, but it's our view that distance learning will grow very large. This includes not just intra-company training, but expanding the classroom boundaries to the outer edges of the Internet. Ask yourself why the best graduate schools don't offer admission to larger numbers of students. It's typically not because of a dearth of qualified candidates, but rather the limitations of the physical facilities of the institution. We think that several years from now a degree from Stanford Business School online will be worth almost as much in the business world as [one from] Stanford -- the bricks-and-mortar version -- is today.

Q: The Internet has been a real roller-coaster. What has been the biggest surprise to you personally?

A: My biggest surprise has been that the most sophisticated institutional investors and venture capitalists sometimes make mistakes so obvious that the most casual of retail investors could have done better. That's not to say they always make mistakes -- they wouldn't have jobs [if they did] -- but there's no monopoly on good ideas and no monopoly on making mistakes.

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