The Hole Truth

Every top Net company's plan has a gap so big, only another big concern can plug it.
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Call it the "hole" theory: Every company that matters on the Net has a hole in its story, if not its business model.

America Online

(AOL)

, powerful for its solid brand, loyal customers and e-commerce revenue, is vulnerable for its lack of a slam-dunk broadband strategy as well as the threat from "free" Internet access providers, notably

Microsoft

(MSFT) - Get Report

.

Excite@Home's

(ATHM) - Get Report

hole is its conflicted relationship with shareholder

AT&T

(T) - Get Report

, a known content hater, as well as its own inability to sell high-speed Internet access over cable wires quickly to every customer that wants it. Further, Excite@Home's brand name is perhaps the weakest in the bunch, a problem as the online "industry" matures.

Microsoft's weak spot is that AOL has the most powerful brand on the Web and therefore a relationship with consumers that makes the software giant salivate -- and quake. For the perennially also-ran Microsoft Network (otherwise known as MSN) to succeed, it's got to have more eyeballs, hence the access agenda. The law of big numbers, which dictates that it gets tougher and tougher to grow by the same percentage as you get bigger and bigger, also hobbles Microsoft, at least in theory.

The hole at

Yahoo!

(YHOO)

is the concern that Microsoft, AOL and Excite@Home somehow will lure enough customers to their Internet sites that Yahoo!'s growth will slow. It's believable, by the way, that Yahoo! doesn't need a broadband strategy per se, provided it can figure out how to attract enough eyeballs. But it badly lags AOL as an e-commerce player, a key revenue generator for the oughties.

But Yahoo!, like all the others, must grow to keep its valuation intact. Yahoo!'s stock price, down 48% from its high, still trades for a price-earnings multiple of 227 times analysts' estimates of next year's earnings. AOL, down 51%, is worth 96 times forward earnings. Microsoft, off

just

15% from its high, has a forward multiple of about 47. Excite@Home? It has taken the worst hit, off 57% from its high, and still is worth a whopping 234 times the 18 cents per share of profits that Wall Street forecasts it will earn in its first-ever profitable year.

So how do these Lords of Techland plug their holes? Each publicly professes to have a strategy: AOL focuses on digital subscriber lines and satellite service; Excite@Home spends AT&T's money and ignores Daddy's (Mommy's?) concerns with its child; Microsoft beefs up MSN with its rebate strategy and talk of a tracking-stock panacea; and Yahoo! spins deals to link its spiffed up content with other companies' customers.

That's all good and fine, but there remain the holes. And plugging them will involve some kind of combination of these same players plus others (e.g.:

Amazon

(AMZN) - Get Report

as Yahoo!'s e-commerce channel?). In other words, the end of the century will be the time when the giants of the Internet cut the boldest deals yet. Hold the emails about how 2000, not 1999, is the last year of the century; it doesn't sound as good.

"You should see some major shifts here," argues

Keith Benjamin

, top Net-stock guesser for

BancBoston Robertson Stephens

in San Francisco. "It just makes sense."

Makes sense, but oh, will the egos be tough to sort out. This is strategy stuff, not stock-picking stuff. And good strategy or not, no CEO who's been on the cover of

BusinessWeek

or

Fortune

wants to sell out to another, especially not when his (or her, in the case of

eBay

(EBAY) - Get Report

) stock price is hurting.

But if the stocks stay down, or if the cracks now appearing persist, watch the merger dance begin. Arguably it began last week with somebody's trial balloon (as

TSC's

Spencer Ante

and

Scott Moritz

insightfully

labeled it) that Yahoo! wants to buy Excite@Home and deal the access business to AT&T.

Cheap, Cheap

Required reading for the serious tech-stock investor who wants to stay up on the lingo and the issues facing Silicon Valley is

TSC

contributor Eileen Buckley's

piece last week on so-called cheap stock.

Cheap stock isn't a hidden opportunity for investors to grab undervalued shares nobody else knows about. Instead, it's a term given to options granted to an executive at below fair market value. Salary and wages are compensation expenses but stock-option grants are not. So guess how Silicon Valley companies tried to pull a fast one on investors to make their earnings look good? Give executives inexpensive options, for which no compensation expense is needed, and pay them less in real money. Remember, Watson, smaller expenses equal bigger earnings.

The

SEC

, killjoys that they are, said, "Wait a minute." If options grants are significantly below a company's value, that's more like paying and less like incentive; the difference should be recorded as a compensation expense.

My only quibble with Buckley -- a nearly reformed CPA now wowing readers as a journalist -- is the newness of the debate. This battle was fought -- and lost -- by Silicon Valley about three years ago when video-conferencing equipment maker

8x8

(EGHT) - Get Report

tried going public with a load of hidden cheap stock masking its income statement. The SEC, in its inimitable style of scapegoating one company rather than putting out clear regulations, held up 8x8's IPO for months until the little company buckled, thereby setting an example for everyone else.

That venture capitalists like Geoff Yang are shocked, shocked by the SEC's clampdown is more than a little amusing. That's just like the Valley to want to throw more goodies at executives without showing investors the long-term impact, namely higher dilution when the grantees cash in their shares. Also, Yang, his accountants, lawyers and investment bankers all know the cheap-stock rules well. They're probably just trying to elicit some sympathy for how rough things are for them.

This debate strikes at the very heart of tech-company compensation. Check out Buckley's article, and then ask your CFO or your investor-relations contact at the companies you own who holds cheap stock and how that affects the bottom line. It could be an eye-opening experience.

Adam Lashinsky's column appears Mondays, Wednesdays and Fridays. In keeping with TSC's editorial policy, he doesn't own or short individual stocks, although he owns stock in TheStreet.com. He also doesn't invest in hedge funds or other private investment partnerships. Lashinsky writes a monthly column for Fortune called the Wired Investor, and is a frequent commentator on public radio's Marketplace program. He welcomes your feedback at

alashinsky@thestreet.com.