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Stone-Throwing Net Companies and Their Glass Houses

Sure, a house made of bricks protects against wolves better than ones made of grass or sticks. But when molten lava starts flowing down the mountain, everyone is toast.

That porcine parable sums up the lesson from a series of articles that TheStreet.com published a year ago to examine the then-newly fashionable concept, among Internet companies, of a "path to profitability."

There's a lesson here for investors trying to separate winners from losers in the current tech wreckage. Though one might perceive wide quality differences between apparent survivors and Nasdaq lunchmeat, those distinguishing features may be meaningless if the economy doesn't improve. Indeed, the last year's bloodshed suggests that handicapping stocks may be as pointless as predicting avalanche survivors based on snowball-throwing skills.

At the time, TSC suggested that the earlier a money-losing Net company was slated to generate positive cash flow from operations -- based on the company's own target or analysts' forecasts -- the better an investment it was. To figure out which companies had the best chance of success, all you had to do was rank them in order of closeness to their expected break-even date, as well as verify that they had sufficient cash and securities on hand to fund operations until then.

In retrospect, however, it wasn't a wolf at the door that investors had to fear, but an erupting volcano up the block. Nearly every one of the 30 companies we ranked on the path-to-profitability scale has performed poorly. Out of the 27 stocks still trading, 23 are down more than 80%. Only one is trading at a higher price than it was last June.

Furthermore, there appears to be no correlation between the speed with which companies expected profitability and their actual performance or survival rate. The winners -- such as they are -- were just as likely to be longshots at the back of the profitability pack as they were to be clear leaders.

Twisted Paths to Profitability
E-tailers
Company June 2000 - Positive Cash Flow?* June 2000 - Cash to Get There?** Current Status Stock Performance***
eBay (EBAY:Nasdaq) Yes Not necessary Getting better. Now, positive free cash flow, too (operating cash flow minus capital expenditures). -22%
Amazon.com (AMZN:Nasdaq) Q4 2000 Yes Behind schedule. Company promises positive cash flow in Q4 2001, one year late; sufficiency of company's cash uncertain. -83
priceline.com (PCLN:Nasdaq) Late 2000/early 2001 Yes Close enough. $2.8 million net income in second quarter. -84
buy.com Late 2001/early 2002 No Fire sale! Founder Scott Blum purchasing still-unprofitable retailer for 17 cents per share. -97
eToys Quarter ending Dec. 31, 2001 No Pulled the plug in February -100
Cyberian Outpost (COOL:Nasdaq) Q4 2001 Yes Time running out: only $4.5M in cash this spring, after burning through $15.1M in May 31 quarter; hopes to be acquired. -93
Barnes & Noble.com (BNBN:Nasdaq) Q4 2001 Yes Final chapter unwritten: now expecting to break even in Q4 2002. -89
Egghead.com (EGGS:Nasdaq) Q1 2002 No Not going to happen. Announced bankruptcy plan Aug. 15; selling assets. -92, trading halted
Fogdog.com Q2 2002 No We'll never know. Purchased for stock by money-losing Global Sports Network (GSPT:Nasdaq). --
Drugstore.com (DSCM:Nasdaq) 2003 No Chronic condition. Pro forma net loss of $16.8M in Q2, leaving $101.5M in cash; won't break even until 2004, says Gruntal. -84
Source: Companies, analysts, Securities and Exchange Commission filings, TheStreet.com
* Positive operating cash flow in most recent quarter, as of June 5, 2000. If not, when analysts projected company would reach that threshold.
** At June 2000 burn rate and excluding loans, whether cash would last until cash-flow-positive target date
*** Percentage change from June 2, 2000, close to Aug. 15, 2001, close (split-adjusted, if applicable)

To illustrate how wrong we were then and how wrong one can be now, we've revisited, in the charts accompanying this story, the 30 Internet companies we surveyed last June -- 10 each from the investment categories of etailing, business-to-business and advertising and portals.

We start with two of the statistics from last year: expected break-even date, and whether companies had enough money on hand, at their then-quarterly cash burn rate, to last them until they started generating cash instead of consuming it.

We finish with two updates: one, what's happened to each company and its cash in the past year; and two, its stock performance over the same period.

Advertising & Portal Companies
Company June 2000 - Positive Cash Flow? * June 2000 - Cash to Get There? ** Current Status Stock Performance Since June 2000 ***
Go2Net Yes Not necessary Acquired by InfoSpace (INSP:Nasdaq) last fall; InfoSpace nearly breaking even in cash flow from operations. --
LookSmart Q2 2001 Yes Not yet. Used $5.9 million in cash in June 30 quarter. -97
About.com Q2 2001 Yes Acquired by Primedia (PRM:NYSE); apparently still losing money. --
LifeMinders.com (LFMN:Nasdaq) Q2 2001 Yes Negative EBITDA of $3.7M in June 30 quarter, with $54.8M in cash remaining; due to be acquired by Cross Media Marketing (XMM:AMEX) by year's end. -96
GoTo.com (GOTO: Nasdaq) Q4 2001 Yes Ahead of schedule: Break-even EBITDA in June 30 quarter. +15
Ask Jeeves (ASKJ:Nasdaq) Q4 2001 Yes Bad news, good news: Has formally given up on target, but expects to finish 2001 with $60M in cash, not tap out in Nov. as TSC forecast last year. -96
24/7 Media (TFSM: Nasdaq) H1 2002 Yes Looking grim: pro forma net loss of $15.3M in June 30 quarter; only $14.4M in cash left. -99
Netcentives (NCNT:Nasdaq) H2 2002 Yes Even more grim: $10.5M in cash as of June 30, after burning through $15.3M in quarter; company is restructuring, seeking cash. -99
Engage (ENGA:Nasdaq) January 2002 No Yup, grim. In early August, backed off cash operating break-even target of October 2001; on Monday announced layoffs and plan to sell or shut media business. -99
Digital Impact (DIGI:Nasdaq) Early 2002 Yes Not so bad. Said in July on track for break-even in December 2001; burned $4.5M in cash in June 30 quarter, ending with $30.6M in cash. -90
Source: Companies, analysts, Securities and Exchange Commission filings, TheStreet.com
* Positive operating cash flow in most recent quarter, as of June 5, 2000. If not, when analysts projected company would reach that threshold.
** At June 2000 burn rate and excluding loans, whether cash would last until cash-flow-positive target date
*** Percentage change from June 2, 2000, close to Aug. 15, 2001, close (split-adjusted, if applicable)

As you can see for yourself, the numbers aren't pretty. Here are some of the sore-thumb lessons that stick out:

  • Molten lava alert: The only unacquired company to be trading at a higher price than it was a year ago is pay-per-click search engine GoTo.com (GOTO), up 15% as of mid-August. The second-place stock in the performance sweepstakes, auctioneer eBay (EBAY), is down 22%. For B2B firm Freemarkets (FMKT), a 66% price decline was enough to win a very distant third.

  • Trust no one: The correlation between analysts' and companies' forecasts of profitability on one hand and actual performance on the other seems nonexistent. Heck, even profitability itself last June was no measure of future profitability -- note the fates of fallen B2B firms Ariba (ARBA) and i2 Technologies (ITWO). But last June, investors were believers: Among etailers and B2B stocks, at least, there appeared to be a correlation between speed to expected profitability and company valuations, as measured by price-to-sales multiples.

  • The higher they fly, the harder they fall. B2B companies now in the black, or at least within striking distance, have been hit just as hard as the financially troubled ones. Blame that on a sector that was, in hindsight, wildly overvalued last June; our basket of stocks was trading at an average price-to-sales multiple of 46.

  • Passion is no substitute for foresight. In January of this year, responding to a Barron's story on the same path-to-profitability issue, online marketing firm Netcentives (NCNT) issued an angry press release, saying the company had more than enough money to get to break-even cash flow by the fourth quarter of 2001. Six and a half months later, the company's new CEO backed off that projection, noting in a statement that the company was at a "critical point" in its history, with continued survival dependent on a restructuring and cash infusion.

  • But enough of all this garment-rending atonement. Last June, we did say it was safe to assume that investment money wasn't rushing back to the Internet anytime soon. And in a related story, we pointed out that having plenty of cash on hand was no safety net for an Internet company's stock price. At least we got those points right.

    Business-to-Business Plays
    Company June 2000 - Positive Cash Flow? * June 2000 - Cash to Get There? ** Current Status Stock Performance Since June 2000 ***
    Ariba (ARBA:Nasdaq) Yes Not necessary Fun while it lasted. Pro forma loss of $26.1 million in June 30 quarter; no forecasts beyond Sept. 30. -95%
    i2 Technologies (ITWO:Nasdaq) Yes Not necessary Same story as Ariba's. Pro forma operating loss of $107.2 million in June 30 quarter; $625.4M in cash left. -88
    Commerce One (CMRC:Nasdaq) Q2 2000 Yes Another backslider. Operating loss of $70.2M in June 30 quarter, excluding $1.7 billion noncash charge; $219.3 million in cash left. -93
    VerticalNet (VERT:Nasdaq) Q3 2001 Yes Cutting it close: Aiming for Q4 2001 positive pro forma earnings; only three quarters' worth of cash left. -98
    Agile Software (AGIL:Nasdaq) Q4 2001 Yes Almost, but bad momentum; $139.9M in cash as of May 31, but single-digit losses appear to be increasing. -77
    E.piphany (EPNY:Nasdaq) Q4 2001 Yes Widening losses, but four years of cash left. -89
    PurchasePro (PPRO:Nasdaq) Q4 2001 Yes Running on low: $22.6M pro forma net loss for June 30 quarter; $34.5M in cash left. -94
    webMethods (WEBM:Nasdaq) Q4 2001 Data not found for June 2000 article. Do-able: $1.2M negative cash flow from operations in June 30 quarter; $178.5M in cash and securities on hand. -91
    FreeMarkets (FMKT:Nasdaq) Q4 2002 Yes Not there, but ahead of schedule; expects operations to break even in Q2 2002, excluding restructuring charges and other costs. -66
    Ventro (VNTR:Nasdaq) 2003 Yes Looking tough: $21.6M in negative cash flow from operations in June 30 quarter, with $54.2M in cash and securities remaining. -98
    Source: Source: Companies, analysts, Securities and Exchange Commission filings, TheStreet.com
    * Positive operating cash flow in most recent quarter, as of June 5, 2000. If not, when analysts projected company would reach that threshold.
    ** At June 2000 burn rate and excluding loans, whether cash would last until cash-flow-positive target date
    *** Percentage change from June 2, 2000, close to Aug. 15, 2001, close (split-adjusted, if applicable)

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