2HRS2GO: Making an Internet Choice

Negative sentiment surrounding Internet stocks in recent months hasn't deterred members of the so-called Old Economy from seeing online opportunity.

It's not often that a ZDNet column talks about a company best known for brands like Quality Inn, Comfort Inn, Clarion Hotels and Econo Lodge, but when Choice Hotels (NYSE: CHH) plays up Internet businesses, it moves into this realm.

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PaineWebber analyst Keith Mills started coverage of the world's fourth (second according to Choice itself) largest hotel franchiser with an "attractive" rating. Can't accuse Mills of taking a big risk with Choice -- his price target of $14 isn't far above the stock's closing price of 11 3/4 yesterday, and sits near the middle of CHH's 52-week trading range.

No one can reasonably fault Mills for being cautious on the price, given its record over the past year. On the hand, you might question what he considers "attractive" about Choice.

The PaineWebber analyst likes what he sees in Choice's Net businesses. Stay Connect, which was formally launched this week, provides hotel rooms with desktop computers (Compaq (NYSE: CPQ) iPaqs) and high-speed Internet access for mobile PCs. ChoiceBuys.com is a B2B marketplace for Choice Hotel franchisees and suppliers.

"We do not believe the value of Stay Connect and ChoiceBuys.com is reflected in Choice's current valuation multiple," writes Mills, who sees Stay Connect and Choicebuys.com as candidates for an IPO eventually.

(I love these true-false questions that Stay Connect feeds to "learn if we are right" for your hotel: "I want to increase my occupancy rates. Yes or No?"; "I want to be able to increase my my room rate"; "I want to make my guests happy"; "I want my guests to return and/or recommend my hotel". And if you answered "No" to any of those, please go out of business now.)

A look at growth expectations for Choice's core operations tells you why the company has been highlighting its Internet units in press releases.

First Call consensus forecasts EPS growth of less than 11 percent in the current year, to $1.14 from $1.03. At least one analyst, Robertson Stephens' Harry C. Curtis, sees per-share profits rising just 8.8 percent, to $1.12.

If you exclude non-cash interest income, Choice's EPS will come in at 96 cents per share, Curtis predicts.

Despite that somewhat mediocre outlook, Choice at the start of this month was trading at a higher multiple than other hotel stalwarts such as Marriott (NYSE: MAR), Starwood (NYSE: HOT) and Hilton (NYSE: HLT), Curtis notes.

Maybe that's why he only has a "market performer" rating on the stock and sees it as overvalued at 13 3/16, which is less than Mills' target.

Curtis doesn't address the Internet businesses.

Mills believes Stay Connect and ChoiceBuys.com will each increase their revenue by 40 percent or more over the next several years, but remember that they're not coming from a large base. Choice predicts Stay Connect will be in 50,000 hotel rooms by 2001, which isn't that much when you consider that Choice alone has more than 339,000 rooms. Factor in the bigger franchisers and any number of smaller ones, and you can see Stay Connect has a long way to go to capture any kind of sizable market share.

Nonetheless, 50,000 rooms in a year isn't bad from a standing start.

ChoiceBuys.com has been around since early 1999. "Been There, Done That; ChoiceBuys.com a Full Year Ahead of Upstart E-Purchasing Systems" boasts the headline of a Choice news release this week.

The latest quarterly report for Choice didn't list detailed numbers for Choicebuys.com, but you can assume B2B commerce fees are part of the $1.1 million revenue listed in the "Other" line of the first quarter announcement.

Accounting rules require companies to break out figures for individual units once those units generate at least 10 percent of overall revenue.

The PaineWebber analyst admits Choice's main revenue drivers will continue to be in the traditional areas of franchise royalty increases, new hotels, and growth in revenue per available room. But he thinks the Internet businesses will get their due on Wall Street.

"We believe Choice's valuation multiple will expand over the coming year as Stay Connect and Choicebuys.com grow and the likelihood of their spin off increases," he writes.

I wouldn't be so certain.

Over the last few months, the market's appetite for Internet companies has decreased noticeably. The Street isn't keen on conferring high valuations on Net businesses these days, unless they're seen as established market leaders. Choice's Internet initiatives won't get that perception.

CAIS Internet (Nasdaq: CAIS), which specializes in Net access for the hospitality industry, has been trading publicly for nearly a year already. On the B2B side, the market currently prefers broader marketplaces to industry-specific players, judging by the market cap for a company like Commerce One (Nasdaq: CMRC) compared to a niche specialist like eMerge Interactive (Nasdaq: EMRG).

Should Choice take its online efforts public, it will need to show profits on the horizon, because Wall Street is tired of losses. Just ask CAIS, whose stock has plunged nearly 70 percent since peaking in February.

Unfortunately, as with all new businesses, it will take Choice years to wring a profit out of its Internet units. Having the Choice franchisees as an easily accessible market helps with marketing and sales, but you still have to build out the infrastructure. And ultimately, the businesses need to go beyond the Choice family if they're going to be spun out.

If and when Stay Connect and ChoiceBuys.com get to that profitable point, Internet access and B2B will be even more passe than they already are in the eyes of IPO investors.

That's not to say it can't be done. But to buy shares of Choice -- or any traditional business -- largely because of its Internet assets asks for an awful lot of faith in the market these days. 22GO>