Don't be shocked if, in coming weeks, you hear people who have pumped money into Internet stocks crooning the Sinatra classic, That's Life. Sure, the stocks were riding high in April. But will they get shot down in May? From the lofty valuations that such Net plays as Amazon.com and Yahoo! are fetching, you might be willing to bet that will happen. "It's dangerous to believe that traditional valuations need not apply to this group," says Seema R. Hingorani, an analyst with T. Rowe Price Associates.
Dangerous or not, investors have been singing the Internet's praises for most of this year. Hambrecht & Quist's 50-stock Internet Index is up 32% for the year through Apr. 27, against 12% for the Standard & Poor's 500 (chart, page 108). Some individual issues have gone through the roof (table, page 108). A week after Yahoo!'s first-quarter earnings came out twice as high as Wall Street expected on Apr. 8, for example, the stock soared to a record $129.63, giving the four-year-old Net search company a market capitalization approaching $7 billion. Yahoo!'s shares have since slipped to about $112, but they're still nowhere near their $20 low of nearly a year ago. Shares of three other search-engine operators--Excite, Lycos, and Infoseek--also spiked to highs in April. And Broadcom, a supplier of chips for set-top boxes and cable modems, saw its $24-a-share initial public offering make a buzz on Apr. 17, when the stock climbed as high as $70 before settling back to $53.63.
One cause of the Net stock frenzy is a squeeze on short-sellers. Shorts make money by selling borrowed shares in hopes of buying them at lower prices down the road. Michael Murphy, editor of the Overpriced Stock Service newsletter, for one, has been advising clients to short the search companies Excite, Go2Net, Lycos, Infoseek, and Yahoo! Also on Murphy's hit list were Amazon, the Web's leading bookseller; Onsale, an online auctioneer; Preview Travel; SportsLine USA; and two music retailers, N2K and CDNow. "We don't pay 300 times 1999 or 2000 earnings," he explains. But when stock prices rise instead of fall, as has happened lately, shorts have to scramble to buy shares to cover their positions. That pushes their prices even higher.
Can this help explain the mysterious rise of K-Tel International? It's certainly one of the oddest Net plays around. Best known for hawking music compilations on late-night TV, K-Tel announced plans to market its wares via the Web on Apr. 9 and saw its stock jump from almost $7 to an astonishing $44.62 less than two weeks later. K-Tel's trading volume, virtually nil on most days, hit 14.2 million shares on Apr. 20, triple the number outstanding. It has since settled back a bit. But even on Apr. 27, a day when Dow Jones industrials slumped 147 points, K-Tel spurted 30%, to $34.75.
BROWSER BRUISING. The shorts can point with some justification to the decline of browser maker Netscape Communications to explain their pessimism. Netscape shot up sharply when it went public in 1995. But its shares fizzled when Microsoft began giving away its own browser for free. Now, Microsoft's plan to get into the business of making Web transactions secure is helping to pummel the shares of another onetime Net software star, Israel's Check Point Software Technologies. Check Point's stock is trading at $32.38, down from a high of $50.50 in November.
But for every Check Point or Netscape, there are many other Net companies that may be worth investing in--if you have a taste for expensive stocks and a high degree of risk. "Companies came public two years ago on a hope and a dream," says Geoffrey Yang, a partner in the IVP venture capital firm in Menlo Park, Calif. "Now that they're starting to put up results, people are saying, `Hey, this is a real business."' Take Yurie Systems, a maker of equipment for transmitting data over the Net. Just over a year ago Yurie went public at $12 a share. On Apr. 27, Lucent technologies agreed to buy the company for $35 a share.
Net stock fans insist the industry's growth is nearly limitless. By the end of 1997, more than 100 million people were online, and Internet traffic has been doubling every 100 days, the Commerce Dept. reports. Cheaper PCs, set-top boxes, and browsers in phones will only make the Net more accessible. Moreover, by 2002, Net commerce between businesses should surpass $300 billion. That could be a boon for investors in such companies as Harbinger and Sterling Commerce, providers of E-commerce software and services.
Opportunities also abound overseas. On Apr. 21, America Online Europe, a joint venture between AOL and Bertelsmann, struck a one-year deal with N2K to sell music via AOL to European customers. AOL also recently passed the 12 million- mark for subscribers, including more than 1.3 million users abroad. Gaining such a crowd makes AOL a huge portal to the Web and affords it an advantage in attracting adverti- sers and shoppers. But Yahoo!, Excite, Microsoft, CNet, and others also are scrambling to become portals. "To compete effectively, search engines must evolve into media companies," says Alan Braverman, a Credit Suisse First Boston analyst who has buy ratings on Yahoo! and Lycos, in part because of their success so far in managing that transition.
Yahoo!, of course, has one of the premier brand names on the Internet. Keith Benjamin, an analyst with Banc-America Robertson Stephens, says that although Yahoo!'s current market cap is stunning, its audience level exceeds that of most TV shows. Benjamin also favors Excite, whose reported first-quarter revenues soared 206%, to $23 million, although the company probably won't turn a profit until next year. Excite has about one-fifth of Yahoo!'s market cap and about three-quarters of its revenues.
Excite or Yahoo! clearly are Net plays, of course. But Mary Meeker, an analyst with Morgan Stanley Dean Witter, puts Dell Computer in that category as well. The PC manufacturer's shares have nearly quadrupled, to $74.31, in a year. Early last year, Dell was selling $1 million in computers over the Net each day. Dell is now up to an average $4 million daily and expects to do half its business via the Internet by 2000.
HYPERGROWTH. Don't overlook Microsoft as an Internet play, either. Or Cisco Systems. The computer-networking equipment maker has the dominant share of the routers used to move Internet traffic from place to place. With a market capitalization of $73 billion, Cisco looks expensive. But the company merits the premium price because it now defines the standard for routers in a hypergrowth market, says Geoffrey Moore, co-author of The Gorilla Game: An Investor's Guide to Picking Winners in High Technology.
If you don't want to try to pick individual stocks, you may want to invest in a Net fund. The Internet Fund (www.theinternetfund.com; 888 fundwww), Munder Capital Management's NetNet Fund (netnet.munder.com; 800 4Munder), and WWW Internet (www.webfund.com; 606 263-2204) have posted gains this year. Paul Cook and Steve Appledorn, co-portfolio managers at NetNet, are snapping up Cendant, which plunged 46% after reporting accounting irregularities. Cendant owns NETMarket, an online mall. Cook and Appledorn also see promise in a more traditional Net play--DoubleClick, a recent IPO that provides Web advertising services for businesses. And they like online brokers E*Trade, Ameritrade, and Charles Schwab. To Net fans such as these, the opportunities in cyberspace have no bounds. It's just that the price of entry for investors isn't exactly cheap.