Internet Stocks’ Hard Times May Close Financing Pipeline

The severe, two-month slide in Internet stocks that has so far caused stiff losses for many individual investors has raised fears of a long-expected shakeout in the Net sector, as weaker companies become unable to raise capital to compete with better-financed rivals.

Internet shares got a reprieve Tuesday as some investors went bottom-fishing, but few analysts seem convinced that the sell-off is over. Despite a 4.3% rise Tuesday, the CBOE Internet stock index is off 44.3% from its April 13 high. Thanks to an early-year surge, it’s still up 2.2% in 1999.

For many of the stocks, the latest pullback is the most devastating since Net mania began in early 1998.

If the selling continues--and if interest rates continue to rise--many Net companies could have difficulty raising cash to fund their growth, analysts say.

On Tuesday, online brokerage National Discount Brokers Group canceled a planned offering of 2.6 million shares to raise fresh capital. The company cited “current market conditions affecting Internet brokerage stocks generally.”

In the fourth quarter of last year and first quarter of this year, scores of Net-related companies raised huge sums via new stock offerings, as investors were eager to jump aboard the runaway Internet locomotive. In some cases those companies quickly came back with secondary offerings that raised additional cash.

Because most small Net companies still are unprofitable, they need large cash infusions to fund their businesses. Many have used capital raised from investors for aggressive marketing efforts--on the assumption that only sizable market shares will translate into earnings down the road.

“Many of these companies, if not most of them, that are not profitable . . . probably expect at some point in the future to raise additional funds, either through equity or debt,” said David Presson, a retail Internet analyst at Bank of America Investment Management. “If the capital market does dry up for them, they may have difficulties staying in business.”

To be sure, some fledgling Net companies have still been able to float initial stock offerings in recent weeks. But the reception for the new stocks has been much less rousing than in the first quarter.

Now, the troubling financing outlook could compound the negative sentiment already surrounding many Net stocks, causing more investors to question some firms’ ability to survive long term. Bottom-fishing rallies in the stocks since April have repeatedly failed, further eroding confidence.

Among “retail investors and day traders, I think a lot of those guys have been decimated,” said Youssef Squali, Net analyst at Ladenburg Thalmann & Co. “A lot of investors have been using any kind of rally to sell into.”

The selling appears to be exacerbated by increased “margin calls” at online brokerages. In a margin call, a brokerage asks an investor who has bought stocks with borrowed money to put up additional cash to cover paper losses. If the investor can’t do so, either the investor or the firm may liquidate shares.

Earlier this year, several online brokerages boosted so-called maintenance margin requirements on Net stocks. That means margin calls are triggered more quickly in those stocks than in other issues.

Ameritrade Holding Corp., for example, said margin calls on Internet stocks have increased this week. A spokesman at Charles Schwab Corp. said, “In general, if these stocks are down, then margin calls will be up.”

Not all is gloom for Internet companies or their stocks, some analysts say. A brake on new offerings issues could help existing stocks by reducing the supply of shares competing for investors’ attention, Squali said.

Some analysts also think small investors are massing on the sidelines and will soon rush back into Net stocks at the first sign of a strong rally.

However, Nick Moore, a technology stock analyst at Jurika & Voyles, believes the sell-off might accelerate if the year-to-date returns on Net stocks turn negative. That would lead institutions, which have been relatively light sellers, to dump shares, he said.

“When you see those leading stocks [down for the year], it wouldn’t surprise me to see the selling turn a lot more institutional,” Moore said. “If you want a real panic, it takes the institutions to do it.”