Butterfly Companies: The Web Has Transformed These Utilities Firms

 

Wednesday
Adam Lashinsky on the State of the Internet
Dan Colarusso on Internet Growth Projections
Katherine Hobson on E-tailers' Push for Profitability
Catherine Valenti on Ailing Internet Funds
Jamie Heller on Using the Net to Track Net Stocks
Thursday
Tracy Byrnes on the Frenzy Next Time
George Mannes on Self-Hating Dot-Coms
K.C. Swanson on Old Economy Winners
David Gaffen on Measuring the Internet Economy
Friday
Ian McDonald on 'Butterfly' Companies
Justin Lahart on Real Net Valuations
Joe Bousquin on Building the Perfect Net Company
A Dan Gross Opinion Piece: Were the Old Guys Right?
TSC Roundtable on Predicting Six-Month Winners
Roland Jones on The Last Days of Daytrading
Eric Gillin on Working for a Dot-Com

Like a plant that grows toward the light, there are some telephone and energy companies out there that have pivoted their businesses to tap into the Internet's growth.

One or two might be a Net play for the somewhat squeamish investor.

What? You thought the whole dot-com thing was a bubble for bridge-buying saps, and folks who push on doors marked pull? Well, before we look at smoldering heaps like drkoop.com(KOOP Quote), priceline.com(PCLN Quote), and the (JAMFX Quote)Jacob Internet fund and pronounce the dot-com revolution dead, let's step back a bit.

Remember when Merrill Lynch wasn't going to provide the online trading thing and Fidelity jefe Bob Pozen boasted at conferences that his shop would never launch an Internet fund? Well, both haughty shops have done an about-face, because they had to.

So if you buy into the idea that the Net isn't going away, but haven't drank the Kool-Aid to the point that you're ready to hop on board the Amazon.com(AMZN Quote) hell ride that may end in bonny profitability or, well, flames, there are some alternatives. While they may not offer the 1000% return circa '99 (but what does?), you're getting a toehold in the Net without risking life and limb.

No, we're not going to try to sell you UPS(UPS Quote) as a Net play because they deliver the ill-fitting cords you ordered on jcrew.com or credit-card processor First Data (FDC Quote) because they handled the transaction.

Let's start with a few telephone companies that provide businesses and consumers standard local and long-distance phone service, but also digital subscriber lines, or DSL, services or fast Net access.

Baby Bells to the Rescue

"I think the Baby Bells [have] probably the most broadband potential without paying a big multiple to cash flow," says Mike Hodel, a stock analyst at Morningstar, which doesn't perform any underwriting. "If you're looking for exposure to DSL services, I'd look at the Baby Bells rather than independents like Covad Communications(COVD Quote) that have taken a beating. There's just a much bigger margin of safety."

DSL service provides consumers and businesses with fast Internet access, which sounds good, but Covad shares are down more than 84% this year.

Hodel believes SBC Communications(SBC Quote), owner of traditional phone shops like Southwestern Bell, has been the "most progressive" of the Baby Bells in providing DSL. DSL service now accounts for some 20% of the firm's total wireline revenue and its acquisition of Sterling Commerce helps the firm offer e-commerce services as well.

The stock is up 14.9% since Jan. 1, and its price-to-earnings pricetoearnings ratio is 25.1, compared with 25.2 for the S&P 500. He also believes Verizon(VZ Quote) might be a solid play now that their workers' strike is over. He says that even during the strike, Verizon added more customers than SBC. Verizon, formerly Bell Atlantic and GTE, is down 6.2% since Jan. 1 and trades at a 19.1 P/E multiple, according to Baseline.

While these companies might not be pure Net plays, the consumer DSL business is "theirs to lose," according to Hodel.

If you prefer the bigger phone shops like Sprint(FON Quote), WorldCom(WCOM Quote) or AT&T(T Quote), it looks like a dicier proposition.

A lot of smart people have lost money believing AT&T had bottomed, and between the telecom sector's broad decline and the dissolution of the Sprint-WorldCom merger, it's hard to know what to make of the companies. This week, both firms warned that their earnings would miss Wall Street analysts' estimates.

Utilities Perhaps?

Beyond phone companies, there are some energy shops that are laying fiber-optic cable right next to the wires and pipes they already have in the ground. These include Con Edison(ED Quote), El Paso Energy(EPG Quote) and Williams Companies(WMB Quote), according to Morningstar utilities stock analyst Justin Craib-Cox. These stocks are up 2%, 63.8%, and 38.2%, respectively. Only ConEd shares are trading at a P/E multiple below the S&P 500's though.

"The advantage for these companies is that you're not reinventing yourself. What do you need to know to lay fiber-optic cable? It's not that different from what you did with wires or pipe," he says. "If a company already has wires or pipes in the ground, the cost of entry is comparatively low."

That said, growth in the bandwidth business is tougher to forecast than in the gas or electricity business. Gauging bandwidth demand five years from now isn't easy, says Craib-Cox. While networking could help smooth these firm's earnings, which tend to rise and fall with commodity prices and the weather, it's largely a case of laying cable and waiting (hoping) for Net traffic to rise.

Another way to play bandwidth in the energy sector is Enron(ENE Quote) -- dubbed the New Economy energy company. Instead of simply generating power and supplying it to customers, the firm acts as a consultant and broker for other companies, essentially handling their energy needs for a set price.

Now the shop is looking to translate its consulting acumen to the bandwidth business, basically positioning itself to provide companies with the networking solutions they need. Enron, a favorite among many growth-fund managers, is far from cheap these days. Fund managers gave Enron and other energy and utility stocks a lift as they piled into the defensive sectors when tech stocks tumbled this year.

Enron shares are up more than 84% this year and trade at a steep P/E multiple of 58.8.

The hitch to these companies as Net plays is that the Net-related part of their businesses is fairly young and fragile. There's a risk that you might get stuck with a stumbling, slow-growing phone company or a run-of-the-mill energy company if these firms' Net aspirations fade.

Then again, their other slow-growing businesses do give you a safety Net. That's something many dot-com investors probably would've liked.

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