Net consultancies feeling heat of looming shakeout

Internet consulting companies, which peddle seasoned advice to chaotic e-commerce clients, are struggling through a crisis of their own.

Technology consulting companies are having a difficult time finding qualified employees because of the tight job market. Foreign consultancies are starting to snap up lucrative international projects. Accounting giants are forming their own e-commerce consulting divisions, offering clients more established brand identity.

More ominously: A wave of consolidation

Gartner analyst Frances Karamouzis says many buyers that used to look primarily to companies such as Viant are now seeing similar offerings, such as speed and innovation, from the larger competition. see commentary

is thinning the industry's ranks. Only a year after many Internet consulting companies became Wall Street darlings with unprecedented stock valuations, shares have taken a drubbing as investors try to figure out which ones will survive the shakeout.

Investor pessimism seems to have reached a peak this week, as several large brokerage houses downgraded their outlooks for Internet consulting companies.

"The market has changed 180 degrees from a year ago," Credit Suisse First Boston (CSFB) analyst Barry Chubrik said of the Internet consulting niche. Chubrik is most wary of encroachment from top-tier accounting companies such as KPMG International, Arthur Andersen and PricewaterhouseCoopers, which have all developed internal e-commerce consulting units.

"Fortune 1000 companies are going to make bigger bets," he said. "This means larger projects?which favor the top-tier names."

CSFB analyst David Sturtz says chaos in the Internet consulting niche is no different than the turmoil that has racked business-to-consumer companies, business-to-business companies and many other technology players during the past six months.

"This is a direct result of the fallout of the Internet and people coming to their senses," Sturtz said. "The industry is going through a transition. They have to sell and win business rather than having it thrown at them."

But unlike the massive changes rippling through the e-commerce world, particularly the business-to-consumer niche, consulting companies will not likely go bust overnight. Experts predict the larger companies will acquire smaller ones, and even some of the struggling companies may stay afloat as demand for their services continues to grow.

"The consolidation we'll see in this market won't be the type where the power will be in the hands of three or four major players," said Christine Ferrusi-Ross, an analyst at Forrester Research. "It won't be that drastic."

Some Net consulting companies have already been scooped up by larger technology providers that are looking for additional revenue streams or expanding their existing portfolios of services.

Net consulting company AppNet was recently acquired by business-to-business software maker Commerce One. And Web hosting company Exodus this week announced its intentions to buy U.K.-based Grenville Consulting in an effort to bulk up its hosting services overseas.

Though it is not yet a widespread phenomenon, analysts expect the consolidation process to speed up over the coming year.

Dot-closures
"We're at the beginning phases of consolidation," said Dirk Godsey, a financial analyst at Chase Hambrecht & Quist. "We had too many companies enter the (Net consulting) sector too fast."

Godsey, who follows several Net consultancies including Scient and MarchFirst, said the trimming is partly fueled by confusion among investors. Investors are having a tougher time distinguishing competitors in the "me-too" consulting segment, he said.

A host of Internet consultants--including Scient, Viant, Razorfish, iXL Enterprises, Sapient and others--all help clients with projects ranging from Web site development to building an Internet strategy. Though each competitor has a different marketing message, most services are similar to those of their rivals.

The overlap and confusion in the sector seemed to heat up this week. A spate of analysts issued negative reports on Internet consulting companies, and stocks dropped precipitously.

CSFB lowered its rating today on Viant's stock to "buy" from "strong buy." The news sent Viant's shares skidding nearly 12 percent to $14.50 in afternoon trading. CSFB also lowered its rating on fellow Net consultant Modem Media to "buy" from "strong buy."

Deutsche Banc Alex Brown cut its rating on US Interactive today to "buy" from "strong buy." Yesterday, brokerage Janney Montgomery Scott downgraded US Interactive to "accumulate" from "buy."

Also today, analyst Edward Caso Jr. at First Union Securities downgraded US Interactive to "neutral" from "strong buy," with a 12-month target price of $15 per share.

In midday trading today, US Interactive was at $7.69, down 94 cents, or almost 11 percent, since yesterday's closing price.

Two brokerages also issued negative reports on San Francisco-based Scient. First Union Securities downgraded Scient to "buy" from "strong buy." Lehman Brothers analyst Karl Keirstead maintained his "buy" rating but cut his 12-month price target to $45 from $75 per share.

Scient shares were at $28 in midday trading today, down $2.56, or about 8 percent, since yesterday's close.

That is a strong contrast to last summer, when many Internet consulting companies were trading at double or triple their initial public offering (IPO) prices. The companies, many of which went public in the first half of 1999, quickly grabbed Wall Street's attention.

Roughly six months after its market debut, Scient shares traded in the high $60 range, more than triple its IPO price. Earlier this year, Scient reached a market capitalization of approximately $4 billion, and its stock touched a high of $133.75.

Despite the current stock tumble of many consulting companies, analysts say investor confusion, coupled with the overall market correction, has brought some of these companies' stock prices to affordable levels. Some analysts say the companies could represent smart investments.

"There are going to be good buys out there," said industry analyst Tom Rodenhauser, who heads Consulting Information Services. "The only reason we're talking consolidation right now is because the market values and market caps of these smaller Net firms have finally come back to earth. What once was valuable real estate is now reasonable real estate."

Another reason some analysts remain bullish about consulting companies: Though the sector is depressed and flooded with look-alikes, many companies are still meeting or exceeding analysts' earnings estimates and are on schedule to meet profit goals.

In a recent interview, CSFB analyst Mark Wolfenberger said he predicts most of the action will be centered around larger hardware or software companies that need to bulk up their consulting staff to deliver a combination of products and services.

"The AppNet and Commerce One (merger) makes a lot of sense right now," he said. "Right now in technology, you have the products, but you certainly need the people to install them." Product companies "need the intellectual property to make it work."

Merger mania
Meanwhile, a number of Web consultancies have also turned to strategic acquisitions, nabbing a competitor to land a new geographic presence or gain a larger employee head count. Others are forming tighter partnerships to enter markets, including wireless Internet access.

Adding to its set of services, Net consultancy Sapient recently completed its acquisition of Human Code. The Austin, Texas-based company focuses on interactive media strategy and creative services.

To gain a presence in the Asia-Pacific region, Scient also formed an alliance this month with Singapore-based E-millennium 2, an investment fund started by Deutsche Bank.

Many analysts say the companies that survive will be those that focus on getting big fast to staff larger projects and generate more revenue. Some analysts named Sapient, MarchFirst and Scient as examples of long-term players.

And while a number of these companies have already moved away from dot-coms to focus on larger business clients, the greatest challenge now will be staffing those huge consulting projects.

Experts say the most challenging aspect to bulking up will be finding qualified technology consultants in the scorching job market.

According to IT staffing and consulting company Management Decisions Inc. (MDI), the tech industry will create an estimated 1.5 million new positions in 2001. Because of the severe shortage of qualified workers, roughly half of those spots will go unfilled.

That leaves many consulting companies with one path: Merge with rivals to gain valuable talent. But experts caution that acquisitions--which often can come with cultural and political problems that eclipse any positive business synergies--are a risky strategy.

"For the most part, it's very rare that you see a consulting company that has achieved market dominance through acquisitions," Rodenhauser said. "The problem is you're buying people. The assets (to a company) are the people and the culture."