No More Mr. Nice Guy: Blodget Brandishes the Neutral Rating

Merrill Lynch Internet analyst Henry Blodget downgraded a host of Internet stocks Monday, in what he called a "resetting" of his ratings and investors might call too little, too late.

Blodget emphasized the 10-stock downgrade wasn't sparked by current market conditions and isn't intended to "represent short-term forecasts of stock direction." Instead, it seeks to "provide an analytical framework to help investors evaluate the particular investment opportunities within the Internet sector." And to do that, Blodget whipped out the "neutral" rating, a tool he's until now avoided using. Now that he's got the bounty of three ratings at his disposal (the "sell" rating apparently being held in reserve for the apocalypse), he and his team have "reset" the ratings to better distinguish between Internet companies.

Dog With Fleas Sitting with Pets.com

The fallout from the downgrade wasn't great, with a few stocks declining as the Nasdaq picked up about 1.5%. eToys (ETYS) and iVillage (IVIL) fell less than 1%. eBay (EBAY) fell 1.7%. Pets.com (IPET), meanwhile, inexplicably rose 15%, and Barnes & Noble.com (BNBN) rallied 38% on news that it will join with Microsoft (MSFT) to sell digital books online.

It's still hard to take much comfort from that if you're an investor in, say, Pets.com, and look to analysts to actually tell you what to buy and when. Pets.com, which Merrill's investment banking arm took public in February, hasn't seen its opening price of 11 since its IPO. It now trades at 1 15/32.

Hammerin' Hank Blodget discovers neutral
Company	Ratings: intermediate/long-term
Barnes & Noble.com (BNBN)	To neutral/buy from accumulate/buy
Buy.com (BUYX)	To accumulate/accumulate from buy/buy
DoubleClick (DCLK)	To accumulate/buy from buy/buy
eBay (EBAY)	To accumulate/buy from buy/buy
eToys (ETYS)	To neutral/accumulate from accumulate/buy
iVillage (IVIL)	To accumulate/accumulate from accumulate/buy
Pets.com (IPET)	To accumulate/accumulate from buy/buy
Safeguard Scientifics (SFE)	To accumulate/buy from buy/buy
24/7 Media (TFSM)	To accumulate/accumulate from buy/buy
Webvan (WBVN)	To accumulate/accumulate from accumulate/buy

So what good did downgrading the stock from a buy to an accumulate do? "The horse has already left the barn there," conceded Blodget in an interview. But he defends Pets.com, saying it has been caught in the overall market downdraft and that so far, its business has performed better than planned.

There are a bunch of other stray horses out there, too. Take eToys, another Merrill banking client, which once traded at 86 and can now be had for 4: What good does a downgrade from accumulate to neutral mean? Or take Barnes & Noble.com, also cut to neutral from accumulate and currently trading at about 5; or even Amazon.com (AMZN), which Blodget left untouched today only because he'd already downgraded the thing to accumulate from buy after a less-than-stellar quarterly report. Amazon's shares trade at 33 5/8, down from a 52-week high of 113.

Roll Tide Amazon flows south

"Not to let myself or anyone off the hook, but especially with the e-tailing sector, the reason they've gotten hammered is not a function of their own fundamentals," says Blodget. "The market shifted 180 degrees in March. Now whether someone could have predicted that is another question."

Asking equity analysts to time the market is perhaps a little much. And to be fair, Blodget had the best record of Internet analysts in TSC's Analyst Survey. Nor is he only analyst who might be accused of being a little, er, breathy during the earlier, happier days of e-tailing. He's only the most visible, thanks to his quickly fulfilled prediction that Amazon's stock would hit 400 back in December 1998. Goldman Sachs' Anthony Noto has also recently downgraded eToys and Barnes & Noble.com, two banking clients, and pretty much every analyst who follows the e-tailers has had to toss valuation fundamentals out the window. How else could they justify the outrageous prices that these stocks were commanding?

Blodget says all the warnings and risk factors were there in the text of his previous research notes, if not the ratings. The re-evaluations were released Monday because August is relatively quiet, and because second-quarter earnings have given analysts a recent peek of how the companies they follow are doing. "This is not in response to events of the last two to three weeks or even of the last two to three months," he says.

Instead, "The mind-set is to look at it as if we were going to rate [the sector] today," he says. In other words, start all over and wipe the slate clean.

If only investors in Pets.com could do the same.

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