Going, Going,
Gone: Business-To-Consumer Sector Goes Bust
By Betsy Schiffman
Forbes.com
04.19.00
Well, at least Internet stocks
aren't terribly overvalued anymore.
Once Wall Street's darlings, dot-coms--particularly
those that comprise the business-to-consumer part of
e-commerce--have turned into pariahs. Their
"spend now and earn later" strategy isn't as
cute as it first seemed. And it's dawned on investors
that companies with paltry revenues, millions in
losses and no profits in sight may not be the best
bets.
The recent slide in the Nasdaq,
capped by the April 17 record plunge of 355 points,
has been a dose of reality for a market that had
behaved like a parent in denial, ignoring the
potential pitfalls of Internet stocks, choosing to see
only the potential growth. Dozens of previously
high-flying young companies have been caught in the
selling frenzy, turning employee stock options into
wallpaper. And the drop has been all-encompassing,
hitting startups as small as Drkoop.com (nasdaq: KOOP),
whose stock has fallen from $36.80 to $2.16, and
giants as big as Amazon.com (nasdaq: AMZN),
which has gone from $113 to $54.94.
The fall has also virtually wiped
out Wall Street's appetite for new Internet public
offerings, for the moment at least. More than a dozen
IPOs have been scrubbed this month alone, including
CoolSavings.com, Yupi.com and AltaVista, the
high-profile Internet search engine.
The end of the Internet party came
as no surprise. As far back as last September, Steve
Ballmer, then president (now also chief executive) of
Microsoft, remarked that Internet stocks were
"absurdly" overvalued. The net result of his
comment was that Internet stocks were thrashed and the
Nasdaq composite index was sent down 3.8%. The
strangest part of the story is that Ballmer is not a
man looked to for market guidance. Analysts believe it
was a case of investors looking for a reason to let
off some Internet steam.
Last month, a Pegasus Research
International report for Barron's showed that many
Internet companies were running out of cash fast
(prominently highlighted were CDnow, Drkoop.com, and
Peapod). The market reacted violently to the report,
inflicting particular pain on the tech sector. The
drop left analysts wondering how, if investors were
fully aware of the risks facing Internet companies,
the study could stun the market so dramatically. Even
Pegasus Research President Greg Kyle was caught off
guard by the market's reaction.
"We were a little surprised by
the response. The report didn't show anything new, but
I guess a lot of investors haven't been focusing on
the risk factors of Internet companies, they've just
been focusing on the rewards," Kyle said.
The final nail in the dot-com coffin
came on April 11, when Forrester Research issued a
scathing report in which it predicted that "the
combination of weak financials, increasing competitive
pressures, and investor flight will drive most of
today's dot-com retailers out of business by
2001." Can't get more pessimistic than that.
Besides the traditional problems
facing Internet companies (namely ongoing marketing
and customer acquisition costs), the consumer space
has a few additional problems. The market for
e-tailing is still small; analysts estimate that the
e-tail sector will never make up more than 10% of the
total retail industry. And most e-tailers are selling
low-margin goods. Kozmo.com, for example, is trying to
make a go of selling snacks (ranging from $1.50 to
$3.50) and delivering movie rentals ($4 a video). In
addition, many companies have dug themselves into a
deeper financial hole by offering enormous discounts
on merchandise and even free shipping in an effort to
build a customer base.
Meanwhile, dot-coms have spent
lavishly on marketing and advertising. The Super Bowl
ads alone cost dot-coms an average of $2.2 million for
30-second spots, and research firms estimate that in
1999 Internet companies spent more than $3 billion on
offline advertising. All the idealistic talk about the
Internet leveling the playing field proved just the
opposite as businesses interested in pursuing the Web
had to at least match the marketing and advertising
budgets of competition, which meant that the only guys
eligible to play were those with thick wads of cash.
Alan Weiner, Vice President of Analytical Services for
Nielsen/NetRatings, believes market conditions have
fundamentally flawed the e-tail and consumer Internet
business.
"The marketing and advertising
budgets of [Internet] companies are outrageous,"
says Weiner. "And they've got to sell goods
cheaper to keep customers, so margins are going down
and marketing spending goes up. It's a recipe for
disaster."
Investors aren't alone in writing
off the consumer space: Venture capitalists are
equally reluctant to touch it. Ashish Raina, an
associate at IDG Ventures, lists a number of areas of
interest to the venture capitalist community, none of
which contain the words portal, content or community,
the buzzwords of 1999.
"We're looking at commerce,
communications and some of the enabling
technologies--the features that are required to make a
commerce exchange happen," Raina says.
Even the business-to-business
sector, which gained momentum in late 1999, is now
considered passé by many. "It's only a matter of
time before [the business-to-business space] is fully
saturated," says Raina. "In fact, there's
some sense in the venture community that that space
has already been saturated and companies could
consolidate even faster than they did on the
business-to-consumer side."
Steve Harmon, longtime Internet
analyst and CEO of e:harmon, takes a more severe
approach to the business-to-business sector.
"There are going to be a lot of companies in the
space that will hit hard times," he predicts.
"We're looking at industrial applications of the
Internet--not business-to-business but applications
that manage manufacturing, manufacturing processes,
manufacturing that is controlled with the
Internet."
"After
the shakeout," says Greg Kyle, "we'll see
more sensible investment coming to the consumer
side."
As valuations drop into sane
territory, analysts predict that investors will return
to dot-coms, albeit less naïve than before. In a
research note issued on Monday (titled "Internet
Investing while Rome is Burning"), Merrill Lynch
Internet analyst Henry Blodget called the market
weakness "an excellent buying opportunity,"
maintaining that the leading companies' fundamentals
haven't changed.
Similarly, Robertson Stephens e-tail
analyst Lauren Cooks Levitan wrote in a research note:
"While downturns can often leave investors
staring at their quote screens in amazement, we view
them as an ideal time to separate the wheat from the
chaff and shop for high-quality stocks at
bargain-basement prices."
"After the shakeout we'll see
more sensible investment coming to the consumer
side," says Pegasus' Kyle. "Investors aren't
going to see 100%, 200% or even 1,000% returns. It'll
be about 14% to 15% returns over the long term.
The IPO market for dot-coms should
also pick up again after investors catch their
breaths. "I think a couple weeks is all it will
take," says Brad Sinrod, President of IPO.com.
"There are some strong brand deals, such as the
AT&T wireless [tracking stock], which I think will
get done anyway. But some of the copycat Internet IPOs
are just going to fall off the calendar."
Welcome back to Earth.
