Sector Spotlight: One Trick Isn't Enough for 'Vertical' Web Sites

The shares of Internet sites with content tightly focused on a single subject -- verticals, as they're usually known -- have fallen flat, all right. Unfortunately, most of them don't have the equivalent of the Lifecall necklace to call for help.

The charts look depressingly similar. Women-oriented iVillage (IVIL), which once closed at $103, ended Friday at $1.69. SportsLine.com (SPLN), down from a 52-week high of $60.50, closed at $6.13, though at least the stumbling has been cushioned by a pile of cash. Wedding site The Knot (KNOT), iVillage competitor Women.com Networks (WOMN), technology center CNet Networks (CNET), college-targeted Student Advantage (STAD), Latin-America-focused site El Sitio (LCTO) and its liquidating competitor Quepasa.com -- they're all down more or less, mostly more.

All Together Now Verticals iVillage, SportsLine and Women.com are all off badly over the past year.

And yet pockets of hope, though not fabulous riches, are visible in the vertical world, especially if you have a slightly expanded definition of what a vertical is. But if you're holding on to be bailed out by a content roll-up or some other acquisition -- well, don't hold your breath.

Blocked Shot

What seemed like a slam dunk a few years ago -- making money by selling to advertisers who want to reach a particular segment of the population -- has yielded few high-profile verticals with instantly recognizable NBA credentials, notably CNet. The company, which acquired rival technology operation ZDNet last year, is reporting major losses, thanks to noncash charges. But as far as cash goes, CNet is doing fine: In the third quarter, pro forma for the ZDNet acquisition, the company reported earnings before interest, taxes, depreciation and amortization of $16.7 million off revenue of $110.5 million, an EBITDA margin of 15%.

CNet's been able to make money from advertising when others haven't, says Kriss Damon, partner at boutique research firm Nomad Partners. "It's been almost impossible, as a content provider, to make money just from advertising," she says. The problem, as Damon sees it, is that the banner ad, the mainstay of Internet advertising to date, just wasn't able to generate enough revenue to support the cost of creating original content. It's no coincidence, she says, that CNet, which led verticals in profiting from advertising, has recently developed new advertising formats to replace the banner. "The question is, can you monetize content in a nonbanner environment?" she asks. "And CNet has taken the first step." (Damon is a holder of CNet stock.)

That being said, the advertising outlook is making analysts nervous about even CNet; several downgraded the stock earlier this month based on concerns about the soft ad environment. CNet is scheduled to release its fourth-quarter results after the market's close Tuesday.

The Pitch

It used to be that vertical sites pitched their business models as a mixture of content, commerce and community. But some of verticals that are generating investor interest, along with CNet, are those with a heavy dose of commerce.

Derek Brown, an analyst at W.R. Hambrecht, is a big booster, for example, of Alloy Online (ALOY), a site for teens to gather -- but also to shop; it got 86% of revenue in its latest quarter from merchandise sales. Brown has a strong buy on Alloy, which he expects to show cash earnings for the first time in the not-yet-reported fourth quarter ended Jan. 31; his firm hasn't been an underwriter for Alloy. The stock closed at $10.13 Friday, up more than 31% for the year, though still 50% down from its 52-week high of $20.25.

Homestore.com (HOMS), which focuses on homes and real estate, is well off its 52-week high of $106.50, but it, too, has been rising in recent days. The stock, which closed at $28.56 on Friday, reported 4 cents a share cash profit for the fourth quarter, beating the consensus estimate. Professional subscriptions amounted to 52% of the company's $79 million in revenue for the fourth quarter, with advertising accounting for the rest. The stock is up 42% for the year.

Showing Life Alloy Online and Homestore.com have shown gains this year.

These stocks aren't without risks, though. Alloy may be discarded like other teen fashions, and Homestore.com, according to one calculation, is trading at 125 times 2001 earnings.

Of course, behind every falling stock is an investor with rising hopes that low prices will encourage a buyer to pick up a company that he or she has a stake in.

It's an intriguing and entertaining scenario. Last June, for example, Salomon Smith Barney analyst Lanny Baker published a report in which he did hypothetical roll-ups of different companies in three different vertical sectors: music, women's and, ahem, financial news and services. Stressing that these roll-ups were "lab tests," not predictions, Baker found that companies within each sector could get to break-even a lot earlier if they joined forces than they could separately -- primarily through sales and marketing savings.

But, as Baker points out in a recent email, the current economic environment is a barrier to such consolidation. "While a company is downsizing and divesting its own money-losers and trying to point the business to profitability amidst a world of negative revenue surprises," Baker writes, "taking on an acquisition of another money-losing venture -- no matter how good the fit -- is a serious management challenge and a real belly-up, double-down kind of bet. Few have been ready to place that wager."

Looking Elsewhere

Were he to update such a speculative report, Baker says he'd instead look at the scenario of horizontal portals -- general-interest sites such as those operated by Yahoo! (YHOO), Terra Lycos (TRLY) and AOL-Time Warner (AOL) -- acquiring firms -- remember, these are academic exercises, not predictions -- such as CNet, SportsLine or MP3.com (MPPP).

"Today, it is more about the portals extending their content reach," Baker writes, "and the main strategic objective is to touch the consumer longer, to hold them from online entry to exploration to evaluation to execution of a purchase." And that's because consumers' "monetizable potential," as Baker puts it, "keeps climbing as they move from the entry point to the execution point."

An interesting idea, to be sure. But still a long shot for many of the verticals, as are acquisitions by major media companies with similar editorial coverage. Another sell-side analyst, speaking on condition of anonymity, says there won't be many mergers and acquisitions among these companies until revenues stabilize. "Traditional media guys don't want to buy losses, they want to buy only profits," the analyst says. "And they want to buy profits at cheap rates."

>To order reprints of this article, click here: Reprints