The Web Is Finally Catching Profits

Soon, more than 100 Net companies could be in the black

For once, the ever-tart Web site F**, which keeps track of the death struggles of troubled companies, didn't have something nasty to say about a dot-com in its crosshairs. "Hey look," the site's proprietor, Philip Kaplan, noted in a posting on Jan. 28. "FC favorite posted a profit. Weird." Indeed, LookSmart Ltd., a search engine company, bagged its first quarterly profit, $3.4 million on $31 million in sales.

In spite of the wretched economy and molasses-slow corporate spending on technology, profitable Web companies are no longer weird or even unusual. The tally of profitable Internet companies in the fourth quarter reached 84--more than 40% of the 208 publicly traded Net companies tracked by stock researcher Pegasus Research International LLC. That's up from 49 profitable dot-coms for the first quarter of 2002, the last time BusinessWeek conducted such a survey. In key areas such as e-tailing and online finance, profitability has become the rule rather than the exception. And those profits are measured by generally accepted accounting principles--no "pro forma" tallies need apply.

This means the much-maligned dot-com generation of tech startups is beginning to prove the skeptics wrong. Sure, too many companies were created during the boom times, and many have failed or are sure to expire or be acquired in coming months or years. But, by the end of the year, more than 100 of the public dot-coms will likely be showing a profit. Many of them are growing at healthy rates and have their business models clicking--finally delivering on the promise of harnessing the Internet to reach a vast online audience, eliminate the middlemen, or create Web-only businesses that never existed before.

Which of the sectors are making money? Take your pick. Auto shopping Web site Autobytel Inc. (ABTL ), financial news site, and Web search site Ask Jeeves joined the list of successes in the fourth quarter. Among the e-tailers that turned profitable in 2002 are (AMZN ), (OSTK ), and USA Interactive (USAI ). And the public companies are only part of the story: Dozens of private Net companies have also become profitable, especially in online retailing. Among the success stories: photo printing and sharing site Shutterfly Inc. and jewelry retailer Blue Nile Inc.

While cost-cutting is a necessary part of the journey into the black, many of the profitable Net companies are also growing fast--and have a long way to run. For instance, Blue Nile's revenues grew 78% in the fourth quarter, to $30 million, and the company expects to increase its $72 million in sales last year to more than $100 million this year, aided by a 100% jump in January sales. "It's easy to just cut costs, [but] this time, growth in profits is accompanied by strong revenue growth," says U.S. Bancorp Piper Jaffray analyst Safa Rashtchy.

And because of the nature of doing business on the Web, these businesses are poised to see their profits grow even faster than their sales. The key: Web technology can handle more business without the need to open new stores or bulk up on staffing. Newly profitable Digital River Inc. (DRIV ), which manages online software sales for clients such as H&R Block Inc. (HRB ) and Staples Inc. (SPLS ), illustrates how dot-com profits can grow rapidly once they arrive. Digital River's sales grew 35% last year, but its expenses were nearly flat. After barely turning its first profit in the third quarter, it reached net margins of 15% in the fourth. Says CEO Joel A. Ronning: "We can handle 40%-to-50% revenue growth" without adding staff. A lot of it is letting the machines do the work."

Now that the dot-coms are making money, the market is paying attention. Since August, BusinessWeek's Real World Internet Index of 20 top dot-coms, which includes and eBay Inc. (EBAY ), has beaten the Standard & Poor's 500-stock index by 18 percentage points. Investors who had the stomach to buy at the bottom are now glad they did.

By Timothy J. Mullaney in New York

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