Goldman Sachs came out with a shocker in its blanket downgrade of the technology sector this week: The struggling raft of Internet stocks may actually be a "safe haven."
"Select Internet stocks represent relatively attractive investments within the tech sector given strong earnings visibility, potential upside and continued positive outlook," Goldman Sachs analyst Anthony Noto wrote in his report. "These characteristics are today rare within the broader tech sector."
Noto said that of all the Internet companies he covers--AOL Time Warner, Amazon.com, CNET Networks, eBay, Expedia, EarthLink, 1-800-Flowers.com, Homestore.com, Priceline.com, Travelocity.com, and Yahoo--seven may beat estimates in their upcoming quarterly reports and may even offer a brighter outlook. Only CNET, Yahoo, Amazon and AOL didn't make the list. (CNET Networks is the publisher of News.com.)
But other analysts are reluctant to hop back on the bullish bandwagon. Several said only a few Internet stocks should be considered bargains and that even if most of them meet analyst expectations in the second quarter, there are fundamental problems with the Internet model.
Some analysts balked at the idea that Internet stocks could be due for a comeback.
"I find that a stunning conclusion," said ABN AMRO analyst Arthur Newman. He named only eBay and other e-business companies that are "another step removed" from the technology sectors' problems as ones that could be considered good bets for investors.
Salomon Smith Barney analyst Lanny Baker, who released an overview of the sector this week, was also pessimistic. In a report titled "Fewer things getting worse, not much getting better," Baker said the second quarter of 2001 will be the toughest for Internet companies on a comparative basis, since the peak was exactly a year ago.
On Tuesday, Merrill Lynch analyst Steven Milunovich offered a broader bleak analysis.
"The trough in the tech profit cycle should occur in either the second quarter or third quarter," said Milunovich, who believes earnings for the overall tech industry will fall 45 percent this year.
He did little to support the thesis that Net stocks are a safe haven. The Internet category was noticeably absent from both Milunovich's list of strong sectors within technology and his ranking of 25 stocks that passed muster. The only Internet-related stock to make that list was Internet software and services company Netegrity.
Still, statistics from CNET Networks' indexes show that Internet stocks, as a group, have been performing better than the broader technology sector this year. CNET's Internet Content index is up 29 percent for the year so far. CNET's Internet E-tailers index is up 40 percent, vs. a loss of 11 percent for CNET's Tech index for the year.
Bearish reports Tuesday on technology stocks from Goldman Sachs and Merrill Lynch reiterated that the larger sector is struggling. Goldman Sachs' Laura Conigliaro predicted that when technology does recover, it would be much weaker than investors expect. Fellow Goldman Sachs analyst Rick Sherlund tipped his hat to that strategy call and downgraded the entire software sector Tuesday.
Return of the bulls?
Some analysts joined Goldman Sachs' Noto in supporting second-quarter prospects for a few of the Internet sector's bellwethers. Morgan Stanley's Mary Meeker and Merrill Lynch's Henry Blodget, the two names most associated with the dramatic rise of Internet stocks to bubble-like proportions in the late 1990s, both issued bullish reports this week.
Blodget gave second-quarter updates for AOL, Amazon and Yahoo, predicting that all three companies will meet estimates. Meeker also predicted Yahoo will hit targets and said the shares should rise along with the news.
But other analysts are skeptical that meeting estimates will significantly boost some companies' shares.
"How impressed are we supposed to be if you beat a number that you've already lowered twice?" ABN AMRO's Newman said. Yahoo and CNET have both lowered their estimates for second-quarter results.
Even if these companies' financial performances improve, many problems must be cleared up before Internet stocks can impress most analysts again.
"We wouldn't exactly view them as safe havens," said Wit SoundView analyst Shawn Milne. "There's still a lot of newness to these business models."
Portals, which depend on advertising revenue, received the most skepticism from analysts. The 2001 recovery for the advertising industry that many analysts had predicted is far from materializing.
A recent report from Merrill Lynch's head of integrated marketing, Bill Melnick, predicted the ad market will not come back full strength until the second half of 2002. There will therefore not be a major turnaround anytime soon for any advertising-driven companies, he said.
Advertising-dependent companies will not be safe investments until the market improves, ABN AMRO's Newman said. He added that he's concerned about the long-term prospects for companies such as Yahoo and CNET regardless of any short-term recovery.
Some analysts say there are nuggets in the dot-com rubble.
Alloy Online's stock has doubled since the beginning of April. 1-800-Flowers has tripled. And Expedia "has got to be the poster child" of the recovery, Wit Soundview's Milne said, going from under $10 at the beginning of this year to $47 a share.
"We've been saying since last year that the pendulum went way too far the other way" on Internet stocks, Milne said, adding that those willing to get over the Internet stigma and invest have "made a killing in the last 4 months."
But now that Internet stocks are snapping back, there's a danger the pendulum could swing too far the other way yet again, Milne cautioned.
CNET Networks is the publisher of News.com.