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Analyst: A Bumpy Ride Ahead for Online Advertising

The online advertising sector will go from bad to worse before it recovers, with the bottom coming in the first quarter of 2001, predicts famed dot-com analyst Henry Blodget.

Merrill Lynch's Blodget expounded on his conclusions in a research report spurred by industry giant DoubleClick's third quarter results, which met analysts' expectations but sparked a sell-off when its chief executive officer said he expected weak quarters ahead.

The report, which draws on the DoubleClick third quarter information as well as that provided by Yahoo!, is possibly the most in-depth current look into what has gone wrong in the online advertising business, and what the prospects are for recovery. The admissions of these two companies shed some light on the mix between dot-com advertisers and traditional advertisers, which helped Blodget draw some conclusions about how long the downward slide will last.

Looking back, Blodget said, the tremendous growth of the online advertising industry can be attributed to the free spending of dot-coms. And, although traditional advertisers are coming online very quickly, it's not fast enough to make up for the loss of the dot-com dollars.

"The deceleration from Q3 2000 to Q2 2001 is likely to be as dramatic as the acceleration was a year ago," said Blodget in the report. "We estimate that year-over-year growth in Q1, 2001, could be in the single digits, down from triple digits two quarters ago. Specifically, market growth could drop from 180 percent year-over-year in Q1 2000 to 8 percent in Q1 2001 -- and then accelerate gradually for the balance of the year."

In a move that bodes ill for online advertising companies' prospects in the markets, Blodget counseled investors not to add new money to Yahoo!, DoubleClick or other "advertising-dependent online companies" until at least 2Q 2000. Blodget believes America Online is more cushioned from the downturn, but not immune.

The growth rate resembles a drinking bender, reported Blodget. "Steady, enthusiastic consumption in the early evening (Q1 1997 through Q1 1999), followed by chugging (Q1 1999 to Q1 2000), followed by a nasty hangover (Q2 2000 through Q2 2001)."

But there is good news over the horizon. "In the harsh light of the morning," wrote Blodget, "the only good news is that online advertising is real, is big, and is likely to drive strong growth at the leading companies for several years -- once the brutal transition period is through."