By Amey Stone
Like a spritz of water revives a dry and withered house plant, it hasn't taken much nourishment for the Internet sector to show some surprising signs of life. While it can't really be called thriving, the sector has perked up quite a bit recently.
Take a look at Internet.com's index of Internet stocks: up over 60% since it hit bottom on Apr. 4. Many of the stocks with the strongest percentage gains are niche companies that seemed like they were destined for penny-stock status only a few weeks ago.
Optimism over online travel has sparked major rallies in Travelocity (TVLY ) and Expedia (EXPE ). Priceline.com (PCLN ) is probably the strongest-performing Internet stock this year, up over 400% from its lows. Florist sites FTD.Com (EFTD ) and 1-800-Flowers (FLWS ) have both surged lately on signs of profitability, and TicketMaster CitySearch (TMCS ) is faring much better recently. Search site Goto.com (GOTO ) recently hit a new 52-week high.
The most obvious sign of the turnaround is that several Wall Street analysts have issued positive reports on Web companies. Granted, for the most part they're not pounding the tables, but just hearing upbeat comments is what's noteworthy. On June 4, SG Cowan analyst Scott Reamer raised his rating on Yahoo! (YHOO ) to neutral from sell because he sees the online advertising market stabilizing. Goldman Sachs analyst Anthony Noto initiated coverage of Earthlink (ELNK ) on June 4 with a buy rating and pointed to a solid second quarter for eBay (EBAY ) in a May 31 note. Scott Kessler of Standard & Poor's has upgraded both Yahoo! and AOL Time Warner (AOL ) in recent weeks.
Derek Brown of WR Hambrecht, who raised eBay to a $75 price target from $60 on June 4, says lately he has been fielding a lot more calls from clients who are interested in getting back into high-quality Internet names. "There is a very real long-term trend that is still in place. More people are spending more time using the Internet today than there were two years ago," he says. "That will continue." Even though he thinks only a handful of individual companies are clear winners, "As an underlying force, that is a very positive growth driver for the Internet group broadly defined."
Investors have even shown new willingness to invest in the downtrodden pack of Internet mutual funds. While far more investors had been withdrawing money from rather than investing in these funds this year, the group got a major cash infusion of nearly $67 million (or 1.35% of total assets) in the week ended May 2, according to AMG Data Services. "It's very heartening to us," says Ryan Jacob, portfolio manager of the Jacob Internet Fund (JAMFX ), which is down 76% in the past year and still has nearly $35 million in assets.
A flurry of new deals show there's value even in the $2-and-under crowd, and they're sparking interest from investors, says Jacob. DoubleClick (DCLK ) announced on June 1 that it's buying MessageMedia (MESG ) at a 40% premium over its stock price of 43 cents on May 31. An investment subsidiary of United Airlines (UAL ) is buying MyPoints.com (MYPT ), trading recently at $1.50, for $2.60 in cash. Investment firm Warburg Pincus announced on June 4 that it's buying Cobalt Group (CBLT ), which provides e-commerce services for auto dealers, for $3.50 a share -- an 80% premium.
Consolidation is an investment theme that will continue this year, says Jacob, who is hoping some of his holdings, like iVillage (IVIL ), HotJobs.com (HOTJ ), and MarketWatch.com (MKTW ) will benefit.
To be sure, renewed strength in dot-coms isn't apparent across the board. "It's still a two-tiered market," says Michael Davey, technology analyst at Investec Ernst, pointing at Salon.com (SALN ) at 32 cents a share. "It's not that every business is coming back," he says. Internet.com stock analyst Paul Shread points out that i2 Technologies (ITWO ), a business-to-business play, is recently up 60% off its lows, while Commerce One (CMRC ) and Ariba (ARBA ) haven't really budged from their lows.
Until the latest rally, those stocks traded in tandem, he says. "I think investors are looking to separate the profitable wheat from the nonprofitable chaff," says Don Luskin, chief executive of money management firm MetaMarkets.com.
As far as positive views from investors, eBay is the hands-down winner among the large-caps. Brown picks Alloy Online(ALOY ) as his favorite small-cap, and he also likes Homestore.com (HOMS ) and FreeMarkets (FMKT ). Davey thinks Yahoo!'s new chief executive is on his way to convincing Wall Street that it can produce more revenues from its massive user base. And even Amazon has convinced most investors that it won't be going out of business, he says. As for small-caps, he thinks INT Media (INTM ) has promise.
Still, many big investors don't want to go near dot-com names. Erick Maronak, head of research at NewBridge Partners, says he still think barriers to entry are far too low and is more confident of the long-term growth prospects in other technology subsectors, including storage and communications. The only big-cap Internet stock that has a solid enough model to tempt him is eBay. "It's interesting," he concedes, "but not anything serious enough for us at the moment."
Optimism for Internet investing is far from unanimous even among analysts that focus on the sector. Jordan Rohan of Wit Soundview cut his second-half revenue estimates for Yahoo! because he sees little sign of improvement in online advertising. Amazon (AMZN ) didn't get much of a lift from its "analysts' day" on June 5. "There is a lot of selective opportunity out there," says Davey. "But you really have to go one by one and cherry-pick them," he says.
Even in Jacob's fund, dot-coms make up just 15% to 20% of assets. He owns both Yahoo! and DoubleClick on the expectation that Internet advertising will improve, by later this year, he hopes, but he's mainly staying away from e-commerce names.
Luskin points to Oracle, Sun Microsystems, and Cisco as the best way to play the Internet. "These are the core Internet companies," he says. But he warns that the rally in Web stocks is being fueled by the same dynamic as the broader rally in all equities -- hopes for a stronger economy in the second half. If second-quarter earnings don't meet expectations, the sector may well turn rocky.
Internet.com's Shread points out that the rally in just this past week has been on low volume, and leading companies aren't pointing to signs of a rebound. "Barring companies like Cisco and Sun saying business is improving, we should probably just be hoping for a trading range here," he says. "So far, there is a lot of hope built into the rally that the Fed rate cuts will turn the economy around. For the time being, it's just hope."
Clearly, Net stocks have benefited from that hope, and Wall Street is taking notice of new life in the sector. Investors who can handle risk may want to pick up a favorite name. But keep in mind, the dot-com sector has really just only gone from flashing red to yellow.
Stone is an associate editor of BusinessWeek Online and covers the markets in our daily Street Wise column.
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Edited by Douglas Harbrecht