Irreverent Analysis
Aram Fuchs is more than willing to buck conventional wisdom. In fact, he considers it his job description. The 29-year-old New Yorker is chief executive of FertileMind.net, a stock-research Internet site that he envisions as “the start page for the educated investor.”
After two years as a research analyst at Spaide Partners, an investment firm, and a year with Jupiter Communications, an Internet market research firm, Fuchs launched the site in December with a staff of eight. The site has attracted attention for irreverent critical analysis of such Internet favorites as Amazon.com, Red Hat and Priceline.com.
Neither is Fuchs afraid to stick his neck out on the positive side. For example, all four of the Internet stocks he recommended in interviews over the last few days have been trading at less than one-third of their 52-week highs: MediaBay, NetZero, Nextcard and PC Order. He spoke with Times senior financial writer Thomas S. Mulligan at FertileMind’s office in New York’s Chinatown.
Question: What is FertileMind all about?
Answer: The basic goal is to be a research house and community for educated investors, for people who might feel patronized by a site like Motley Fool or frustrated by a site like Raging Bull, with all its testosterone-fueled trash talking. Combine that with what we see as Wall Street analysts selling their immortal souls to investment banking and we think we have a niche.
*
Q: Have the events of the last week--particularly the 575-point drop in the Nasdaq index Tuesday--signaled a return to more rational investing?
A: This is the first prick into the bubble. I think investors are going to start demanding, if not profits, then at least declining losses from Internet companies. I also think people are going to stop bragging about their day trading at cocktail parties.
Maybe there will be a further, steroid-induced rally, but this is probably the start of a long trip down.
*
Q: But the Internet sector has fallen before and come back even stronger, no?
A: Yes, but it’s never dropped on such fundamentally sound news that two of what had been very hot stocks may be on their way out of business.
*
Q: You’re referring to online music retailer CDNow and Internet grocer Peapod. What do their troubles teach us?
A: You don’t expand your business too quickly until you know it’s a viable business. CDNow was making a little money and still getting capital. But they put all their capital into a marketing campaign. They bet the company and they lost.
Peapod never had a business that people wanted. Sales didn’t grow that quickly.
*
Q: You’ve taken a whack at some other Internet darlings, including Amazon.com. Why so?
A: The company is broken. Originally it was supposed to be this virtual store where they wouldn’t have to worry about warehousing and inventory costs, and they wouldn’t have to worry about marketing costs because it’s on the Internet and they have these affiliate marketing groups. Now it’s clear they’re going to have to have incredibly expensive warehousing all around the country, and they have to have hundreds of millions of dollars in marketing expenses because there’s so much capital chasing the retail market that every other store is buying ads on radio, TV, the Super Bowl. Combine that with the fact that the gross margins aren’t that big to begin with, and it’s a terrible business to be in. You have a situation where . . . the stock . . . is going to get killed.
*
Q: What are the implications for the whole online-retailing model?
A: It’s a very difficult business to be in because it’s so easy to comparison shop. Think about going to Wal-Mart in your hometown. To comparison price with Kmart you have to get in your car and go across town. On the Web, you just type in a few letters and you’re at Barnes & Noble or Amazon.com.
*
Q: Can anybody make it in online retailing?
A: Sure. Take EBay. They were the first ones there. Now they’re a market for everything from Pez dispensers to porcelain vases. Those margins will stay strong because they’ve created a barrier to entry.
*
Q: What is EBay’s barrier?
A: Just that they have mind-share. They’ve created this marketplace where the buyer knows the inventory will be there and the seller knows they’ll get the right price. They’ve become the Nasdaq of dreck and tag-sale items. I’m not saying it’s worth $30 billion, but it’s a good business.
Another barrier is if you can develop a product or service that’s truly of value, so much so that customer will never leave. MediaBay [formerly Audio Book Club] gives people samples of their audio books online, so that’s something unique. Also, they took out their two biggest competitors, Columbia House and Doubleday, by making marketing deals with them. And the chairman [Norton Herrick] just bought 250,000 shares in their latest secondary offering.
*
Q: Is insider buying and selling something you watch closely?
A: Yes, especially on the Internet side. The equities are so expensive you rarely see insiders buying, so when you do, you know either, one, they’re incredibly confident, or two, they’re incredibly cocky and self-delusional.
*
Q: What else do you look for?
A: You should look for companies that have great niches--a company like PC Order.com. They have the software that helps computer companies get their inventory on the Web. It’s doing awesome, but Wall Street doesn’t really understand the product.
There are companies that focus on a niche and have created barriers to entry and are selling at a good price. Take Nextcard, an Internet-based credit card company. They let you design your own teaser rate. If you buy a book, you might buy it at Amazon, you might buy it at Barnes & Noble, but there’s no loyalty there. But once you have a credit card in your wallet, it’s really going to stay there for a long time.
Another one that works is Net-Zero, the free Internet service provider. They don’t charge for access upfront, but they’ve been able to create an incredible inventory of ads and they’re showing an ability to sell those ads to advertisers. The consensus is that free Internet cannot work as a business, but they keep their telecom and marketing costs low and revenues are skyrocketing, so we think they’ve proven it can work.
I would contrast that with EarthLink. EarthLink is still charging, and we think that’s a niche that is going away. There may be people who just don’t like ads and will pay not to have them, but most people would rather have the free access.
*
Q: What parameters are useful for investors? Price-to-earnings or price-to-sales ratios? Growth of sales?
A: There are five elements: Growth of sales, operating margins, barriers to entry, if there aren’t profits, at least declining losses, and marketing efficiency. If marketing costs double, revenues should more than double.
*
Q: Don’t you sometimes need to spend defensively on marketing, as in an arms race? Doesn’t E-Trade have to spend because National Discount Broker does?
A: That’s a sign that investors should not go there. You don’t want to be in an arms race.
