Internet Stocks in Latin America: Why They Fail (or Not)

After my article about Latin American Internet stocks taking a serious hit during the last few weeks, Irma Rentani wrote, "The poor economic power of the people is key to understanding why Internet companies fail in Latin America." Although I appreciate her comment that, "Articles like yours are the ones that really help," I have to take issue with some of her comments, because they go to an important point concerning the growth of the Internet in Latin America and emerging markets elsewhere.

While the stock prices of Latin American Internet companies have plunged, the companies have not yet failed. They are still alive and kicking in various degrees, and most analysts believe Starmedia(STRM) and AOL Latin America(AOLA) look the strongest. The outlook for El Sitio(LCTO) could also be improving. According to news reports, the company is discussing a possible merger with Venezuelan media firm Cisneros. Rumors about the deal caused shares of El Sitio to rise 17% on Friday.

While poverty in Latin America is an obstacle to the advance of the Internet in the region, it is not an overriding one. There is a large enough middle and upper class to support strong growth. Analysts estimate 100 million potential Internet users, and with only 15 million using it now, there is enormous opportunity. In fact, the fastest growth in online usage in the world is occurring in Latin America.

For investors, that rapid growth could translate into strong returns on the stock of companies. But therein lies the greater concern, an issue that faces Internet companies everywhere: how to make money off such explosive growth. Myriad problems could impede profitability, from a lack of a credit card culture limiting the potential for e-commerce to the difficulties of accurately tracking usage and limiting advertising, the moneymaker for many of these companies.

Interestingly, there may soon be some progress on that latter issue. Robert Hinchcliffe and Marina Rosero, Latin American Internet analysts at Santander noted in a recent report the importance of the fact that Media Metrix, an Internet traffic auditing firm, has just begun issuing reports on the region.

"There is little doubt in our minds that the lack of credible country and regional information has served to retard the migration of advertising dollars online," Hinchcliffe and Rosero wrote. They estimate advertising revenue will grow at double the rate in the U.S.

Esteban Gowland from Buenos Aires, Argentina wrote specifically about AOL Latin America. The stock closed at $6 Friday, which is 40% from a high it reached in September, a few weeks after its IPO. "Is it cheap enough to buy, or should I wait for a lower price? Do you think it is possible that AOL [Latin America] follows the same luck of other Internet companies, whose prices really crashed? Would you buy this stock or not? If you have to imagine a price target what would it be?" he poses in his report.

"I know that these kinds of questions are hard to answer," he adds.

Boy, I'll say. If I could predict the future, I'd probably spend all of my time at the racetrack.

AOL Latin America's biggest strength is its connection to AOL, and it should be a player in the region for some time. Having said that, since it is a late comer, it has faced some problems getting a foothold in the region, and investor sentiment on the Latin American Internet sector overall, as I noted in my article about Latin American Internet stocks, is pretty bearish.

Santander just issued a hold rating on the stock, with a 12-month price target of $6.50, a less-then-exciting 7.6% increase if correct. A more positive outlook comes from Will Landers, Latin American Internet analyst at Credit Suisse First Boston, who gave the stock a buy rating and a much more attractive 12-month price target of $17, a 183% increase.

If Landers is right, it would certainly indicate the potential of the Latin American Internet sector is coming true.

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