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Peeling Back Value: Steve Harmon's 10 To Watch For 1999

In 1998, the top 10 Internet stocks I selected as worth watching ended the year up 312 percent. 1998 was the year that Internet stocks became household words -- taxi drivers spit out ticker symbols and discussed online trading, CNBC broadcast the ups and downs by the second of everything from Amazon to eBay and Beyond (.com, that is).

Old line money managers on Wall Street scoffed at valuations, analysts threw away their abacus or tried to make the Internet fit in a shoe box of old metrics. In short, now everyone follows Internet stocks, something we've done since 1994. Conventional wisdom says: Internet stocks are overvalued. We would agree that's true for some of them. We've seen bubbles burst and bubbles come back. The constant has been industry growth.

Our fundamental investment thesis for 1999 is that as long as the industry continues to permeate every aspect of consumer and commercial life, Wall Street should reflect that robust growth.

Thematically, we see 1999 shaping up with some plain Jane opportunities in new ways of e-mail management, more targeted marketing and advertising, industrial-strength services, smarter e-tail and e-commerce and consolidation with perhaps Internet media companies acquiring "traditional" media companies, the exact opposite of the conventional wisdom that prevails today.

This latter point, of upstarts buying oldtstarts, is ironic but testimony to the Web's global outlook and rapid rise, effectively unlimited scalability--and stock values that make stock deals attractive.

With these themes in hand we've scoured the Web, turned over the rocks, thrown the balance sheets into the blender, pulled many an all-nighter and culled the five years experience doing this to deliver to you the 10 stocks we think may be worth watching in 1999.

1999's watch may not perform as well as 1998 and a correction in Internet stocks is probably on tap soon. Watching means watching. We are not recommending you buy, sell, trade or hold these stocks -- what you do with your money is your decision (see disclaimer). Intense staring is OK.

The 10 for 1998 remained the same all year. For 1999 we may or may not have the same 10 month to month. With a drum roll and a modem:

Steve Harmon's HotWatch '99 - 10 To Watch

Who

Ticker

Why?

in alphabetic order

@Home

ATHM

Next-gen online service

AOL

AOL

Eyeballs and wallets leader

Beyond.com

BYND

Web-delivered software sales

Broadcom

BRCM

broadband chips

CMGI

CMGI

many in one

community

see list

traffic kings

DoubleClick

DCLK

ad network leader

Go2Net

GNET

portal in the making

Preview Travel

PTVL

Travel and web go together well

ShopperConnection

see list

whole worth more than parts?

(c) 1999 internet.com LLC. Internet Stock Report, isdex.com

  • CMGI (NASDAQ:CMGI). We believe this stock, more than any one other stock in this space, offers the best of what the Internet has to offer in its breadth and approach to the Internet. CMGI gets in early to future possible stars and then capitalizes on the arbitrage. Lycos (NASDAQ:LCOS) and GeoCities (NASDAQ:GCTY) are two examples.

    Our CMGI outlook is one we've held since 1995 but it's much stronger in 1999 as its success has rolled out.

    In our view, no other one Internet stock offers an entire array of Internet growth as efficiently. Money managers looking to dress up their boring blue chip portfolios with Internet stocks who don't have CMGI in their portfolios should retire, in our opinion.

    Through its majority-owned startup investments, operating units and minority equity in its venture side, we believe CMGI shares may be severely undervalued, that this firm may be a Yahoo-like entity in its pioneering approach, value creation and critical mass of capital. We also like the fact that Microsoft and Intel own just under 5 percent of CMGI. Risks? if the IPO market dries up then its investments may not find liquidity as quickly as possible. Or if the stock market tanks then the same also applies. But overall, short of having an ISDEX Mutual Fund (which we want to see), CMGI may represent a good proxy to the Internet in our opinion. Decide for yourself, see its Web site, ask your broker.

  • Community. The entire sector! Despite the rally in e-tail and ecommerce stocks (online trading and enablers), the core of what these services and sites want to reach are real people. Real people matter most in our view. And they're hanging out on the three or four large community sites. Lycos (NASDAQ:LCOS), GeoCities (NASDAQ:GCTY), XOOM.com (NASDAQ:XMCM) and theglobe.com (NASDAQ:TGLO).

    Our theory goes like this: Lycos represents a model for the integration of directories, e-mail, home page, community, chat and content to which the others here may follow or be swallowed by those that discover the equation that it's cheaper to buy users/traffic than build it.

    We don't see large percentage growth occurring in the top 10 Web sites (Media Metrix rankings), of which both GeoCities and Lycos belong. We think the top 10 Websites in the world (namely AOL.com/Netscape, Excite, MSN, etc.,) may start buying traffic. These community sites rank in the top 25 in terms of users globally. So "community" looks attractive to us simply because it's been ignored in the recent Internet stock rally and traffic rules, real people matter. The risk is that each looks like it needs to add some missing pieces to make their site(s) fully-functional e-commerce machines and not hobbyists freebie hangouts. As the year goes on we think the winners and losers in this sector will begin to emerge--revenue growth is our top item we're watching here.

  • DoubleClick (NASDAQ:DCLK). Advertising on the Internet is a mainstay of many business models. You can either invest in content to get at this ad pie or go for the source, in our opinion. Outsourcing this functionality with its ad network that delivers billions of ads offers a perfect example of how the Internet is unlike any other medium. We see DoubleClick further establishing this field, with LinkExchange and 24/7 (NASDAQ:TFSM). More granulated targeting, smarter marketing, more timely offers, all factor in where we think this field is headed.

  • Broadcom (NASDAQ:BRCM). With its broadband chips deployed in both cable Internet set top boxes and in Digital Subscriber Line, we consider market dominator Broadcom as an essential play on the need for speed. We know it's "just" silicon chips here, but this looks like the "right" silicon to be chipping with.

    Broadband chips may matter as much as PC chips some day. Maybe not 1999 but 2000, 2001 and beyond. There's a ton of TV sets, two or three per household in the U.S. we believe, that may eventually have processors in them. They may not all be Broadcom chips--many will likely be Sony or Korean made--but Broadcom has the edge in our opinion with its cable and telco approach, playing both sides against the middle.

  • AOL. AOL was one of our picks to watch in 1998 that we're bringing over to 1999. We think AOL (NYSE:AOL) has become, or is fast becoming, the "operating system" of the Internet, especially with its pending purchase of Netscape (NASDAQ:NSCP).

    We also think Yahoo (NASDAQ:YHOO) is fast filling AOL's valuation shoes. In 1996 before Yahoo went public we said it was what AOL wanted to be on the Web. Our new mantra goes thusly: AOL is what Microsoft wants to be on the Web--everywhere in everything from dial up to shopping to community and content to critical mass (critical masses more like) of users.

    We especially like AOL's leverage in the capital markets. AOL could acquire @Home (NASDAQ:ATHM) and end its battle to get cable carriage in one swoop. That removes what we see as AOL's biggest weakness: lack of broadband platform.

    If it executes well, AOL could outpace Cisco on the valuation front. To us what's in the network is worth more than the network itself, a TV "show," for example, is valued higher than the TV "set." Cisco is the set or pipes, AOL is why people are "watching."

  • ShopperConnection network companies. This is actually a network of various etailers who have come together to battle Amazon.com (NASDAQ:AMZN). ShopperConnection network includes Cyberian Outpost (NASDAQ:COOL), CDnow (NASDAQ:CDNW), which is in the process of merging with N2K (NASDAQ:NTKI), Preview Travel (NASDAQ:PTVL), and Reel.com which CMGI exchanged for a third of Hollywood Entertainment (NASDAQ:HLWD). It also has other merchants.

    Together these stocks represent less than $2 billion market value, or 10 percent of Amazon. Yet combined ShopperConnection (from COOL to HLWD) sales rival Amazon. If I ran a roll-up fund I'd roll these four up into Amazon Junior in no time flat and add in CyberCash's (NASDAQ:CYCH) InstaBuy service that lets consumer input once and buy over and over. Risks? these are still separate entities and working together may prove challenging. Another way to do this, Wal Mart buys the bunch and integrates marketing and sales: instant e-tail powerhouse.

    It'll cost Wal Mart more than that over the next 10 years to build and market its Web site successfully to beat out Amazon and others. With the buy, the Walton family would become Web e-tailers across a wide swath of a desirable demographic. Or Barnes & Noble (NYSE:BKS) follows its Ingram offer with this group and the e-tail space gets very heated. Bertelsmann is another contender here.

  • Go2Net (NASDAQ:GNET). Humming along at the edge of the portal race is Go2Net with its search, stocks and games, shopping and business info. One of the top stock message boards/communities, Silicon Investor alone represents to us a huge value that Wall Street hasn't yet seen. We think that if SI went public on its own it could fetch $200 million at today's Internet IPO valuations.

    Hypermart, one of the top free websites for businesses, also holds considerable opportunities to exploit for Go2Net. Direct marketing to these businesses in office supplies and services such as outsourced e-mail are just two things we thought of that Hypermart can do easily. Go2Net just acquired Web21 also, which features the 100hot Website list. Latest quarter had positive earnings even. GNET's been on the rise since December -- it was actually the first stock we slated for the HotWatch '99 and even though it's risen we see a lot of potential under the hood here that could get discovered in 1999.

  • @Home (NASDAQ:ATHM). Another holdout from our 1998 watch. Broadband is on everyone's mind but the pipes need to be there to make it happen. If @Home can deploy--or, more appropriately, ride the coat-tails of the cable industry's capital expenditures on upgrading--then we reiterate the statement that @Home looks like AOL on steroids.

    This is why AOL made such a stink about having the cable Internet backbone "open." Risk? It'll cost $30 billion to upgrade the U.S. cable infrastructure, built when Richard Nixon was in a different plumbing business, to make these pipes two-way. But AT&T (NYSE:T), which is acquiring cable heavyweight TCI, has already cut a deal with @Home for backbone. (TCI owns a stake in ATHM and was an original investor in it, along with venture capital firm Kleiner Perkins).

    If successful, the cable industry could usurp the future of the Internet in many ways, rein it in under its coaxial control. Another reason why AOL should acquire @Home or go on a cable spree. On ATT-TCI, we think we'll see telco and cable mergers en masse very soon.

  • Preview Travel (NASDAQ:PTVL). There isn't much available in a public Internet travel stock that we like. Preview trades substantially off its $44 per share high. Revenue grew 43 percent the nine months to September, 1998 to $14.4 million, giving this one an 11x run rate annualized multiple. Losses increased also so that's a concern. But we think travel and the Internet look attractive and that the few stocks worth noting here could be in PTVL's favor. It's another reason why we added it to the ISDEX.

  • Beyond.com (NASDAQ:BYND). Its electronic software delivery (ESD) model looks like the future of software (and anything digitizable) etailing. Beyond.com and Digital River (NASDAQ:DRIV) both have models which we believe are netcentric and poised to exploit the coming opportunities in software sales. We see software shifting from boxed, wrapped, shipped via truck, to instant buying and downloading over the Internet.

    A forecast we did in 1994 predicted this but until bandwidth was "tolerable" to consumers to actually download--something it barely is today even--the ESD was more like LSD (likely science dreaming). Risks? if software developers sell direct. But we think coders may be more than happy to let Beyond.com handle selling. Added bonus, CEO was former VP marketing for Amazon (which could be a rival soon perhaps in software). But Beyond's focus appeals to us, along with its government contracts. And BYND revenue puts it ahead of Digital River.