Bargain Hunters Stalking ‘Dot-Coms’

Tech stocks are rallying off their recent lows, and though there’s no way to know how long this bounce will last, the boldest investors and traders naturally may be looking for opportunities.

Given the destruction in the Internet sector this year, that area would seem to be a prime hunting ground for “vulture” investors--those who pick among market carnage for tasty morsels.

TheStreet.com’s index of 24 Internet-related stocks has gained 17% from the 52-week low it hit Nov. 30. But it remains down 68% from its March peak.

Few market pros expect the buying hysteria of 1999 and early-2000 to return to the Net sector. Many scarred investors obviously will shy away from the group entirely. Even those investors who are looking for a rebound may be quick to sell if the stocks suddenly reverse.

The stock math is daunting: Net-company incubator Internet Capital Group (ticker symbol: ICGE) would have to rise 33-fold from Monday’s close of $6.44 to get back to its 52-week high of $212.

The fundamental math also is daunting: Most Internet companies are still losing money, and many simply won’t survive. Plenty of these stocks are probably headed for zero.

Still, buzzards circling overhead might be able to spot bargains. The Internet, after all, still figures to play a huge role in the global economy during the next decade.

At the very least, some of these stocks may be good for a sharp bounce, for short-term traders who like to play that game.

To find “dot-com”-related shares that might be worth checking out as longer-term investments, The Times screened Morningstar Inc.’s database at https://www.morningstar.com last week for stocks in the technology sector that met these parameters: grades of A or B for growth, profitability, share valuation and financial health, based on Morningstar’s proprietary system; year-to-date declines of 40% or more; and below-average PEG, or price-to-earnings-growth, ratios.

Morningstar’s grading system factors in figures such as revenue and earnings growth (for the growth grade), operating profit margins (for profitability), P/E and price-to-sales ratios (valuation) and debt relative to assets (financial health).

A stock’s PEG ratio, meanwhile, measures a company’s growth and value characteristics in tandem: In our screen, the PEG is the stock’s P/E ratio (based on current fiscal year estimated earnings per share) divided by the company’s projected annualized earnings growth rate over the next three to five years, based on a survey of analysts by Zacks Investment Research.

We limited our list to tech stocks with PEGs of 1.5 or less. The blue-chip Standard & Poor’s 500 index, by contrast, has an overall PEG of about 1.7.

When the screen was finished, we had 29 tech stocks, six of which were Internet-related.

Notably, none of the six is a business-to-consumer Net firm. Rather, they all are consulting or software firms whose business is basically to help other businesses make money on the Net.

Just because a stock meets certain screen qualifications, of course, doesn’t guarantee that it will perform well. At this stage in the tech-stock crash, some investors may figure they’d do just as well throwing darts at a list of names.

So we did something similar: The second list shown in the accompanying chart is a purely random sampling of tattered Net stocks. They were picked just because they’re very depressed.

The names we chose: Internet Capital Group; Red Hat (RHAT), which provides Linux operating system software and services; Net consultant MarchFirst (MRCH); “name your own price” online retailer Priceline.com (PCLN); Web portal Excite@Home (ATHM); and Net service provider EarthLink (ELNK).

We’ll check back in 2001 to see which group--the screened list, or the random list--performed better.

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Among the screened list of six Net stocks, the consulting, or “e-services,” companies that popped up are Cambridge, Mass.-based Sapient (SAPE), and Agency.com (ACOM) and Razorfish (RAZF), both of which are based in New York.

The software firms are Mountain View, Calif.-based Remedy (RMDY), Cysive (CYSV) of Reston, Va., and Braun Consulting (BRNC) of Chicago.

Sapient helps large companies such as Merrill Lynch and SBC Communications’ Pacific Bell unit develop business strategies and software Net applications. Morningstar analyst David Kathman wrote in a recent report that the consistently profitable Sapient has moved aggressively to offer wireless and other services to companies in the “red-hot market for broadband entertainment and e-learning.”

Agency.com helps clients develop online distribution and sales channels as well as marketing campaigns. The company has met or exceeded analysts’ profit forecasts every quarter this year, Prudential Securities analyst Jim Dougherty wrote in a recent report. He noted that 98% of the company’s third-quarter revenue came from “traditional” clients such as Colgate-Palmolive and Compaq Computer, while only 2% came from dot-coms.

Razorfish creates and customizes communications software for companies such as Sony, Disney, Bank One and British Telecom.

Morningstar analyst Mark Sellers noted in a recent report that the information technology consulting industry overall is projected to grow an annualized 46% over the next five years and that Razorfish has among the highest gross profit margins in the industry, at 52%.

Still, these stocks haven’t been taken out and shot for no reason.

Industry bears point out that Razorfish typifies the sorts of risks associated with most companies in the e-consulting field: As the firm grows, it must continually revise its business model and hire highly paid professionals, which can keep a lid on profit margins; it could face integration problems stemming from its 12 acquisitions in the last two years; and with its stock down 95% this year, further purchases won’t be easy to finance.

What’s more, industry growth projections could prove too rosy, in part because troubled pure-play Net companies are scrambling to slash their expenses on administrative functions and Web-site development.

And the field has become crowded with companies offering similar services, Sellers wrote, although that problem could be mitigated by the inevitable industry consolidation that would prop up stock prices.

Other analysts have noted that larger computer and consulting firms with longer track records, including Computer Sciences and Andersen Consulting, are muscling in on the smaller Web consulting firms.

Short-term woes are also weighing on these stocks. Razorfish, for example, reported a third-quarter earnings shortfall in October because of a sharper-than-expected slowdown in its European business.

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Among the software companies on our list, Remedy’s products help customers track service requests and resolve problems involving PC and Unix computing systems. Although Remedy is making money, its stock can’t make headway: In late October, for example, it slid 18% the day after the company beat quarterly profit estimates.

Cysive, whose clients include DaimlerChrysler and First Union, develops software systems that can handle high volumes of customer transactions. The stock got pummeled in late August when the company warned of a third-quarter loss because of its severed contract with freight-billing processor CorPay over a payment dispute, and the shares have slipped further.

Braun Consulting helps companies such as drug maker Pharmacia & Upjohn develop Web-based technologies and identify market trends.

A recent posting on Braun’s Morningstar message board typified the frustration many tech investors appear to be feeling these days: “After seeing that [the company] posted record earnings and the stock was close to a 52-week low of under $13, I bought quite a few shares. The very day, it gets downgraded [by a brokerage analyst] and the stock plummets to $8. Thinking it couldn’t get any lower, I bought more shares, but it kept going down. What is going on?”

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Times staff writer Josh Friedman can be reached at josh.friedman@latimes.com.

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‘Dot-Com’ Bottom-Fishing

Investors looking to find bargain stocks in the Internet sector have plenty of names to sift through--though whether any of the stocks are true bargains remains to be seen. This chart shows two groups of Net-related shares: The first passed a Times screen for profitability and other factors; the second is a list of Net shares picked randomly from among the year’s biggest losers. Of the second group, only MarchFirst is expected to be profitable this year.

Passing a Screen ...

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Est. Ticker Mon. YTD % ’00 Company symbol close change EPS Razorfish RAZF $2.56 --95% $0.17 Braun Consulting BRNC 4.50 --94 0.35 Agency.com ACOM 4.13 --92 0.19 Cysive CYSV 5.38 --85 0.12 Sapient SAPE 12.50 --82 0.46 Remedy RMDY 19.25 --59 1.24 S&P; 500 index 1,380.20 --6

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... Picked at Random

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Est. Ticker Mon. YTD % ’00 Company symbol close change EPS MarchFirst MRCH $1.22 --97% $0.05 Internet Capital Group ICGE 6.44 --96 NA Priceline.com PCLN 2.25 --95 --0.13 Red Hat RHAT 7.19 --93 --0.06 Excite@Home ATHM 6.72 --84 --0.32 EarthLink ELNK 6.84 --74 --1.56

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NA: No estimates available, but the company has lost money so far this year

EPS: Earnings Per Share

Sources: Morningstar Inc., Bloomberg News, Zacks Investment Research