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HolidayBuyer's Guide
Tech Industry

2HRS2GO: Neverending marketing cycle hurts profits

You know it's a bad day for the market when the only gainer on the Nasdaq most active list is up because it canceled a stock offering.

Shares of Ameritrade Holdings Corp. (Nasdaq: AMTD) gained slightly after the company killed plans to offer $250 million of stock to the public. Instead of diluting shareholder returns now, the company decided to issue $200 million of convertible notes in a private placement.

That could just be putting it off until later, since the notes can be exchanged for stock if holders decide they don't want the cash. Still, the debt placement doesn't get called in for five years, so you can't fault current shareholders for being relieved.

But the fact that a profitable, established company like Ameritrade still feels the need to raise money highlights the question of whether Internet business ultimately is a zero-sum game. When Web watchers began buzzing about business a few years ago, conventional wisdom believed that once a Internet commerce entity started posting profits, it could start scaling back on expenditures.

Instead the opposite seems to be happening.



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Even as the likes of eBay Inc. (Nasdaq: EBAY) and MindSpring Enterprises Inc. (Nasdaq: MSPG) this week announced better-than-expected profits, they unveiled plans for higher-than-expected expenditures budgets for the next few quarters. eBay sees higher across the board spending, while MindSpring expects to double its marketing budget, as the ISP spends heavily on TV ads, mainly in the fourth and first quarters upcoming. "Which implies that you're willing to basically wipe out the cash flow and the earnings for that period," ING Barings analyst Fred Moran noted during MindSpring's conference call.

They're not alone in going with bulked-up marketing. The top 100 e-commerce sites spent an average of $8.6 million on marketing last year. The top five -- Amazon.com, E*Trade Group, Barnesandnoble.com, CDnow, and Ameritrade -- saw marketing budgets last year ranging between $133 million (Amazon) to $44 million for (Ameritrade), according to a recent survey from a San Diego-based outfit called the Intermarket Group.

During MindSpring's call, Robinson Humphrey analyst Miles Russ wondered if the ISP's new ad campaign would continue beyond the mid-2000 target date currently envisioned by the ISP. To which executives basically responded: Yes. "You're absolutely correct in your assumption that if this is successful, this is something that we're going to want to continue on," MindSpring CEO Charles Brewer said.

Russ and other MindSpring analysts were happy with the answer. From a strategic standpoint, you can't blame any of these e-commerce players for unloading their wallets for TV and other media campaigns. After all, brand building is important.

Problem is, it looks like it's never going to end.

eBay and Amazon.com are already widely established names, but because of the Internet's unprecedented level of competition -- eBay sees as many as 200 rivals right now -- no one can afford to let up on the advertising. Same thing holds true in other e-commerce niches; E*Trade, Ameritrade, Charles Schwab and all the other online brokers run ads one after the other on CNBC, to the point where it's hard to remember whose ad is whose.

This isn't brand-building. It's brand protection. Because the Internet makes switching loyalties so easy, no one dares let up on advertising; instead, everyone just buys more airtime. "Please don't forget we exist," plead websites.

Even if revenues continue growing, investors will be frustrated when profits never rise above miniscule levels while margins fall and promotional budgets increase. Judging by this week's declines in the share prices of eBay and MindSpring, it may already be happening.

Unfortunately for investors, the media blitz won't be over any time soon.

Other issues:

  • Ingram Micro Inc.
  • (NYSE: IM) The tech distribution Goliath is also one of the day's few gainers, on the company's report of second quarter earnings a penny above estimates. Traditional retail and distribution channels might be under severe pressure from direct sales and falling prices in general, but at least Ingram Micro is solidifying its place atop its industry and even boost profits. That's all anyone can reasonably ask for.

  • BMC Software Inc.
  • (Nasdaq: BMCS), Electronic Data Systems Inc. (NYSE: EDS) This pair of technology old-timers reports quarterly results after market close today, with First Call predicting profits of 40 cents for mainframe software vendor BMC and 43 cents for IT consulting firm EDS.

    Market indices in the afternoon continued their daylong retreat in the inflationary face of the highest jump in eight years for the U.S. government's index used to track labor costs. With two hours left in regular trading, the Nasdaq Composite Index was down 70.09 to 2635.75, the S&P 500 lower by 29.07 to 1336.33 and the Dow Jones Industrial Average down 231.12 to 10740.95. 22GO2HR>