Gloomy Internet Study Still Attracting Attention

Is time–or more importantly, money–running out for Internet firms?

Research International
got widespread attention Monday for its prediction that at least 51 publicly-traded
Internet companies–including some big names like and CDnow — will
burn through their cash supplies within the next 12 months.

The dry-up dates from Pegasus were based on the assumption that the 207
dot-coms studied would continue booking revenues and expenses at the same
rate as in the last quarter of 1999. That assumption, and other aspects of
the study’s burn-rate methodology, quickly prompted several Internet firms
to issue press releases Monday refuting the study.

VerticalNet (VERT)
and others pointed out that Pegasus failed to take into
account the full picture of their financial condition, including recent outside investments.

Among the companies atop the list of Pegasus’ so-called “Burn Victims” were,
in descending order of their likelihood of running out of cash: Pilot Network Services (PILT),
CDnow (CDNW),
Secure Computing (SCUR),
Peapod (PPOD),
VerticalNet, (MKTW), (KOOP),
InfoNautics (INFO),
and MedScape (MSCP).

The study, which was published in the latest issue of Barrons, a magazine known among Internet
investors for its bearish views on the Net sector, revealed that 74 percent
of firms have negative cash flows.

That Internet companies are losing money is hardly news. Indeed, Pegasus
said it simply reviewed publicly available financial documents to compile
its list. Nonetheless, the report has some investors and Internet startups
wondering anew whether a change in the investment climate is on the way.
Will burn rate become the metric for screening Internet stocks?

“All we’re doing is looking at one factor of the equation in Internet
investing,” said Greg Kyle, founder of Pegasus Research on Tuesday. He said
other elements that investors must gauge include: what is the company doing
to capture market share? Are its margins improving? What is its
profitability relative to others in its market?

“What we wanted to get across is that they are opportunities and risks out
there, and you have to look at both sides,” said Kyle.

But many investors simply unloaded shares upon learning Monday that their
stocks were high on the burn-rate list, with CDnow falling almost 17
percent. Secure Computing slid 14 percent on the day. And was off
nearly 16 percent. In mid-day trading Tuesday, all continued to trade lower,
though not nearly so steeply.

According to Barrons, burn rate only creates problems when a company’s share
price comes “unglued” or falls precipitously. When that happens, a firm’s
ability to raise fresh fundst

o keep stoking the fire can be difficult.
Witness Peapod, the online grocer which recently saw institutional investors
back away from a $120 million financing commitment after the company’s stock
tanked and its CEO resigned.

But columnist Michael Wolff, author of the bestseller Burn Rate said Tuesday that
while being able to arrange successive rounds of financing is crucial for
many dot coms, that pool of money isn’t close to drying up.

“If you can’t return to the capital markets and you’re financing steep
start-up costs, you’re going to be screwed. But it’s an extreme view to say
the financial markets are suddenly going to dry up. There’s never been more
money that essentially has to be invested than there is now,” said Wolff.

Kyle of Pegasus granted that the flows of money into Internet companies are
likely to continue. But he said that investors are realizing that not every
Net firm is executing on the popular “grow to greatness” strategy.

“Some companies have failed at that strategy, and investors need to do their
due diligence and look at a particular company’s financials,” said Kyle.

The Pegasus study may spur another flight to quality in the Internet sector,
or at least a pause in which investors inquire whether their favorite dot
com has enough cash on hand to reach profitability.

But Wolff notes that because so much in the sector remains in flux, Internet
companies will have to continue operating in what he calls “existential”

“They have to say, ‘We’re going to spend this money that we have, and then
it’s going to be gone. And either the world is changed by that point, or
we’re bankrupt.’ But I still think you could make a strong case that the
world will change.”

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