eMailbag Monday: CDNow/N2K, Onsale, Sharper Image, Sportsline

First reader up writes:

“Steve: I have been watching the Internet group for well over 6 months, but
I have stood on the sidelines in disbelief as these stocks rise to
unbelievable heights with astronomical P/E ratios. There is so much hype
and so little substance that I am nervous to “take a chance”.

I have
also heard that the companies that will be the leaders in the future have
yet to be even developed. I performed an analysis of one of the Internet
indices on 12/10/98 and picked what I felt like were the most likely
winners: AMZN–AOL–BRCM–CMGI–CSCO–EBAY–ELNK–LCOS–MSPG–NSOL–YHOO.

This particular group happened to jump 15% in the last week. However,
their prices per share are now reaching fairly lofty levels. I almost feel
like I should be in Las Vegas. Do you have any suggestions for now and/or
the near future?

P.S. I keep telling my broker that I would like to be
more active in this area, and he keeps telling me that it is a huge risk.
The returns on these are so phenomenal that I feel like I am missing the
boat.”

Reply: One of the challenges with Internet stocks is finding a
market leader at an attractive valuation. Of the stocks you mentioned above
all seem particularly overexposed in the media and therefore subject to
wild mood swings depending on the caffeine quotient on Wall Street. There
may be two in there that warrant a closer look, however, and we’ll do so at
our year-end outlook for 1999 where I pick the top 10 stocks to watch for
next year. Look for it 12/31.

As far as your broker goes, he or she
should be able to find a program that suits your desire to be active in the
Internet. But the sector is very volatile and transitory. Risks are high.
Many brokers don’t know a thing about the Internet also. You may ask your
broker if he/she knows what AOL is or ask them to spell AOL. If there’s any
hesitation or they misspell the obvious then perhaps it may be time to find
a new broker.

Playing Your Song

“Dear Steve, what is your take on CDNW and NTKI (Music BLVD)? They are
trading at 5X sales while Amazon is trading at 31X sales. Together CDNW and
NTKI sell more CD’s than Amazon. CDNW and NTKI are featured on every major
portal, AOL, MTV, Rolling Stone, E-trade and USA Today. According to
sequential order numbers from both sites, revenue should be up over 300%
from last quarter BUT their stock prices are mired in the teens. What am I
missing?”

Reply: Brandshare and mindshare. CDnow (NASDAQ:CDNW) may be better
known than N2K (NASDAQ:NTKI), and the firms plan to merge. But Amazon
gets so much free press that its brand and sales dominate. In one quarter
since launch Amazon’s music sales surpassed CDnow’s. But once merged
CDnow-N2K would have had 40% better sales in music vs. Amazon in the latest
quarter.

Is there room for CDnow-N2K in the jungle? We think so. And
CDnow’s e-tail network takes on Amazon mano a mano. The strange part is that
there are better spaces to be in than thin-margin e-tail lines like books or
music.

One point on Amazon worth making. It’s amazing that Oppenheimer
let out an analyst report (or sci-fi novella) predicting Amazon
(NASDAQ:AMZN) at $400 per share and the media hasn’t gotten it right yet.
We’ve followed Amazon as long or longer than any analyst. Now if you
consider that AMZN set a 3-for-1 stock split then what that price target
means is a pro forma split $133 per share.

So making a $400 prediction is
more like a no-brainer knowing that once a stock splits it tends to creep
back to where it was pre-split because many retail investors (‘retail’ in
the indy investor definition of it) look at price per share first and maybe
never look at market capitalization. Big mistake but common one. Also
fueling AMZN that’s forgotten: 42% of its float is sold short, that is,
investors bet AMZN will drop.

On CDNow and N2K we think they belong as
part of a larger e-tail/Web effort, that a barnesandnoble.com or Barnes &
Noble (NYSE:BKS) proper ought to acquire them if BKS really wants to
compete on the Web. Until then, no one’s stepping on Amazon’s blue suede
shoes.

Sale-A-Bration

“Steve, what do you think about ONSL being undervalued compared to all the
other Internet stocks. Do you think they have a lot of potential as a long
term investment? Your input is highly valued and I weigh it heavily when
making my financial investments.”

Reply: I’ve always been a fan on Onsale (NASDAQ:ONSL) and think
its model of e-tail to be superior to straight e-tail as in the Amazon model.
If done correctly Onsale should be bigger than Amazon since Onsale sells
everything while Amazon wants to sell everything. (But brandshare favors
Amazon, see above).

That’s why eBay (NASDAQ:EBAY) is so hot–it’s stolen
some thunder. Onsale was public long before EBAY and while they’re
different auction models eBay looks like an even better way of doing
it–almost zero overhead, no inventories to speak of. Huge profit margins.
The downside to EBAY from our view is simply that it’s a classified ad
service under the hood, with far too much hype surrounding it. Not to
mention the dictator approach it has with customers who complain. Off they
go. Truly great companies welcome criticism and learn from it.

Sharp?

“SHRP & MCRE. What can you tell us about the future for these stocks.
Should we dump and take our lumps or hold on?”

Reply: Quite honestly SHRP’s market cap surprised us since the
brand is well known, sales seem strong and customer service (we hear) is
also good. Sharper Image (NASDAQ:SHRP) is a retailer chain that sells
high-tech gadgets mainly for men, what we think may be a perfect gizmo for
the Web surfer demographic. This small cap stock’s sales look strong–for
the month of November alone it reported sales of $31.4 million vs. $23.6
million November of 1997. That one month sales comes via land-based stores,
catalogs and Web site. Its Web site, sharperimage.com, sales grew 436%. For
the nine months ended 10/31/98, revenues rose 10% to $132.2 million (or
what could be $176 million annualized at that rate).

With a market cap
of $89.4 million that implies SHRP trades at less than 1x annualized sales,
or 1/2x sales, for the hybrid land-catalog-web retailer. SHRP has to raise
its profile, though, with more agreements with high-traffic sites, we
think, to help boost its marketing for web-based sales, even though they’re
growing fast.

The other stock you mention, MetaCreations (NASDAQ:MCRE)
makes graphics software. Its co-founder, Kai Krause (Kai’s Power Tools), is
a graphics genius who’ve we’ve seen in action many times. MCRE shares rose
on news late last month that its 3D software will be distributed as part of
Windows 98.

Red flag though: for the nine months ended 9/30/98,
MetaCreations’ revenues dropped 41% to $31.5 million. We blame it on the
increasingly-crowded graphics application space and lack of brand awareness
of the products.

Eye On The Net

“Steve, do you think CBS might pull a Disney-like move and consolidate
Sportsline-DBC etc? What about Vocaltec with a Lucent competitor, or PSINet
with a WorldCom competitor?”

Reply: Until now CBS wanted to play cheap, air time for equity.
But it did just exercise warrants to acquire 380,000 SPLN shares at $15.00
per share, raising $5.7 million cash to the sports content firm. DBC
(NASDAQ:DBCC) is a separate company, although a good partner for
quotes.

On IP communications outfit VocalTec (NASDAQ:VOCLF) a Lucent
(NYSE:LU) rival may want its IP expertise someday, maybe 1999. Deutsche
Telekom already owns a minority stake. Last of the public and indy backbone
ISPs, PSINet (NASDAQ:PSIX) has been a perpetual buyout candidate since MFS
took out UUNET years ago. Plenty of tire kickers have kicked PSI’s tires we
believe, but nobody’s driven it off the lot yet.

Attention Internet Startups! LaunchPad West StartUp
Pavilion, part of Spring Internet World ’99, one of the world’s
largest Internet industry trade shows offers exhibit space for startups
ONLY at a reduced price in order to meet their often limited capital
available at the startup stage. Contact Sean Moriarty (hurry, space
limited): mailto:moriarty@mecklermedia.com