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2HRS2GO: Razorfish rises on relativity

Razorfish Inc. (Nasdaq: RAZF) sure picked the right underwriters.

Or at least one with Lehman Bros., judging by today's sharp rise in Razorfish shares following Lehman's decision to upgrade the stock to "buy" from "outperform". At least for the moment, Razorfish has broken out of a range that saw its price drifting between 25 and 37 1/16 for the last three months.

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Lehman analyst Karl Keirstead sees Razorfish as an undervalued stock, which sounds wacky considering the company is expected to earn just 25 cents a share next year, but not so wacky considering we're talking about a company in the currently hot field of e-business consulting. Keirstead points out that Razorfish's peer group -- including recent IPOs such as Viant (Nasaq: VIAN), iXL Enterprises (Nasdaq: IIXL), USWeb/CKS (Nasdaq: USWB), Proxicom (Nasdaq: PXCM), and Sapient (Nasdaq: SAPE) -- has risen about 50 percent on average in the last three weeks. Razorfish had gained just 12 percent over the same period, until today.

Keirstead blames Wall Street's relative lack of enthusiasm on Razorfish's recent $625 million acquisition of i-Cube. He also believes stock buyers are put off by Razorfish growth will slow in the third quarter because the company gets half of its business from Europe, a region that often sees a third quarter slowdown because of vacation and holidays. but Keirstead is convinced neither acquisition nor seasonality will hurt Razorfish.

"Our recent conversations with the CEO, CFO and head of acquisition integration for the combined company did not reveal any near-term issues," Keirstead writes in today's research note.

Razorfish is expected to still make money in third quarter, unlike some of the aforementioned competitors. Razorfish's gross margins were actually the highest in the industry in the first half of this year -- if you use i-Cube's gross margin calculation method. Margins are expected to keep improving in the third quarter; price increases in the fourth quarter should boost revenue per professional.

Viant, Scient, Proxicom and IXL have been trading at higher revenue multiples than Razorfish, but the latter might post the biggest upside surprise in the third quarter. Executives led Keirstead to believe that Razorfish and i-Cube could see sequential revenue growth of 15 percent, "which adjusted for the European seasonsality represents one of the highest expected growth rates in the sector."

Since Wall Street is a relative world, there is some logic behind Keirstead's argument that a $48 price target is actually conservative for Razorfish. But isn't it a bit much to "adjust for" (read: discount) half of a company's entire revenue base? I'm sure IBM would love it if Wall Street were to forget about its slow (or no) growth hardware businesses, but that doesn't happen, so it's baffling that today's market would do something similar for Razorfish.

Perhaps it's simply the weight of consensus bearing fruit. Keirstead isn't the only analyst in recent weeks to promote a new outlook for Razorfish. The Chapman Co.'s David Moy last week started the company as a "buy"; and Edward Caso Jr., of First Union Capital Markets, last month upgraded the stock to "outperform" less than a month after starting coverage on it with a "hold" rating. Incidentally, Razorfish was at 33 3/8 back in July when Caso decided the stock wasn't worth buying.

While you could ask why Razorfish is cheap compared to its peers, you could just as easily ask why its peers are so expensive. Probably because several of them went public after Razorfish, so they're fresher in the market's mind. But ultimately, are the likes of AppNet and Viant worth so much money? Don't even start with "they're worth whatever the market says they're worth", because the market changes its mind all the time. And don't bother me with arguments based on technical trading, because that's trading, not investing.

If you're thinking long term, you need some kind of solid, fundamental -- and yes, absolute, not relative -- business foundation on which to base to your decision. But it's too early to have one for e-business consultants.

Other issues:

  • Internet stocks
  • There might not be an end-of-year rally at all, despite what much of Wall Street expects, says PaineWebber's Jim Preissler. "If momentum does materialize near-term, we believe momentum could slow down as early as Thanksgiving as the holiday-season e-commerce hype comes to an end," he writes in a research note released today. "The heady, momentum driven days of the last two years in the Internet sector may be coming to an end, and several hundred percent year-over-year stock returns for the sector could become a thing of the past."

    Maybe that's why Net stocks aren't doing much today. When reality bites, it hurts.

  • Visage Technology Inc.
  • (Nasdaq: VISG) Trading event if there ever was one: this maker of digital identification products is rising today after announcing the completion of a system for Arkansas driver licenses and Medicaid cards. Arkansas is a fine state, to be sure -- hey, it produced a president, which is more than most states can say -- but somehow it doesn't strike me as being a huge market.

    Speaking of markets, today's stock market seems lethargic. With two hours left in regular trading, the Nasdaq Composite Index was up 12.64 to 2882.26, the S&P 500 down 1.42 to 1334.00, and the Dow Jones Industrial Average higher by 4.75 to 10808.38. 22GO>