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Year of the Internet stocks
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December 31, 1998: 3:10 p.m. ET
Almost everyone came out a winner in '98. Will the wild ride continue in '99?
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NEW YORK (CNNfn) - The term feeding frenzy doesn't begin to describe it.
But if you thought the Internet sector was wild in 1998, 1999 promises even more action as analysts expect more players and more industry consolidation. They also expect tighter investor scrutiny, which may already be underway if Wednesday's Internet sell-off is an indication.
Electronic commerce will continue to soar, but Web portals will also be all the rage as more traditional media companies enter the fray.
The Internet sector may be a new game in 1999, but that doesn't mean it'll be any easier to follow.
Into the stratosphere
Nothing better reflected 1998's wild stock market ride than the action that took place in Internet stocks. Individual investors moved stocks like never before. If a company had '.com' in its name, even grandmothers found themselves wondering whether it was a good investment.
Market capitalizations soared to levels previously associated with established - and profitable -- companies. During the year, the e-commerce giant and decidedly unprofitable bookseller Amazon.com Inc. (AMZN) saw its shares rise more than 1,300 percent.
A previously little-known online auctioneer called eBay Inc. (EBAY) became the poster child for Internet frenzy, its shares recently eclipsing the $300-a-share mark. This is the same eBay that had a September IPO offering price of 18.
It was also the year of the outrageously successful initial public offering: theglobe.com inc. (TGLO) soared 606 percent in its first day of trading.
How did the market reach the point in which practically any company even remotely associated with the Internet found themselves a hot item? Analysts said it boils down to one thing: legitimacy.
"The Internet has emerged as a mass medium," said Mark Cavallone, analyst at S&P Equity Group. "The Ken Starr report was a big event. It points to the Internet as a mass medium more than ever before."
'.com' mania
As Internet stocks have soared, investors have notoriously ignored fundamentals in favor of hype, especially when it comes to initial public offerings.
At times, one has had to wonder whether investors were fully aware of what some companies actually do. Take EarthWeb (EWBX), which describes itself as a "provider of Internet-based online services to the information technology community worldwide." Hard to figure out exactly what that means, but the word Internet is involved, so the company's stock soared 247 percent in its first day of trading.
"There is, and will continue to be, I believe, an excess of 'dot-com' frenzy, where investors who feel they missed out on the first wave should jump in on the next wave, and so on," said Kate Delhagen, a e-commerce analyst at Forrester Research.
Internet stocks, especially in the last quarter, have become identified with inexplicable - some would say ridiculous - gains. It seems as if investors use what would normally be an innocuous corporate announcement as fodder for flocking to the Next Big Thing. (Books-A-Million (BAMM) redesigned its Web site and its stock soared 190 percent that day. Go figure.)
"If you put 'dot com' in a press release, even gratuitously, you get a reaction," said Nicole Vanderbilt, e-commerce analyst at Jupiter Communications. "It's a matter of individual investors becoming more educated on what these companies' Web strategies are all about and paying more attention to revenues and the long-term prospects of profitability. That's the only way to curb the overexuberance on the part of individual investors."
"It's been a matter of lack of supply," Cavallone said. "At the beginning of the year, there were not a lot of pure Internet stocks. By the end of the year, with more companies going public, that pushed up the supply. Next year we'll see more companies go public. But it will be tough to distinguish the real Internet companies."
Traditional retailers flocked to the 'Net
The supply is steadily increasing. This year, more traditional retailers, such as Gap (GPS), J.Crew and Macy's, stepped up their online efforts. Most notably, music retailer K-Tel International Inc. (KTEL) was suddenly considered an Internet company after it began selling its wares on the Web.
But instead of leveling the playing field, such online forays have only made the situation even more volatile.
"I find it particularly amusing -- and frustrating on behalf of the pioneers who have been selling online for years -- that brick-and-mortar guys who announce the opening of their e-store see a huge one-day run-up," Delhagen said. "Of course, patience brings rewards, and most of those one-day wonders have returned to more normal prices."
Though analysts expect more brick-and-mortar shops to expand into cyberspace in 1999, they differ in predicting what effect that will have the Internet sector's volatility.
"I think it has to change," Cavallone said. "You're going to see more attention to tie corporate strategy to the Internet. If that happens, not every stock is going to go up."
But Vanderbilt said the infiltration of traditional retail companies has only served to increase the volatility, pointing to the stock gyrations of such companies as K-Tel and Sharper Image (SHRP) after announcing their online plans.
(Click here to see K-Tel's year-to-date stock activity.)
(Click here to see Sharper Image's year-to-date stock activity.)
"We're just now seeing traditional retail outlets recognize the Web as an opportunity, and it's only been in the last couple of months that Wall Street has rewarded them," she said. "It'll be very interesting to watch how the traditional players structure themselves to play to Wall Street's love affair with these kinds of investments."
E-commerce elation
Within the Internet sector, electronic commerce became all the rage by year's end, especially as report after report emerged declaring an expected surge in online sales during the holiday shopping season.
"Investors will look for revenues to grow exponentially," Delhagen said. "Retailers who show strong and sustained revenue growth, such as Amazon, Cyberian Outpost (COOL) and the merged N2K (NTKI) and CDnow (CDNW), will be rewarded, while the laggards will fade to oblivion.
"I also fully expect established real-world retailers to come under increasing scrutiny, as financial analysts start to ask them, 'How's your Internet store performing?' " Delhagen added. "By the end of '99, we will be seeing 'comp store sales' figures included in earnings reports from leaders like J.C. Penney (JCP), Gap, Barnes & Noble (BKS) and others."
But e-commerce stocks may have a hard time keeping up the torrid pace they've set for themselves in 1999.
"Without a doubt, it's been proven that there's room for only three to five players in any distinct category," Vanderbilt said. "The [online] PC hardware and software business is very crowded and the top three haven't emerged yet."
Coming together
Companies in other Internet markets, particularly the Web portal space, will also have a harder time keeping up. With that in mind, analysts expect more consolidation in 1999 as firms scramble to catch up to the market leaders.
"The portal industry will still be prominent," Cavallone said. "We'll see a lot more competition, with the Disney-Infoseek site, NBC throwing its weight behind Snap.com, there's also [the combined] AOL (AOL) and Netscape (NSCP). It'll be interesting to see how it all shakes out. I think we'll see more consolidation, more traditional media companies buying into the Web."
Analysts also expect the gap to widen between the market leaders and the also-rans.
"It will be difficult for Excite (XCIT) and Lycos (LCOS) to catch up, even with a major alliance," Cavallone said. "I think Disney (DIS) and Infoseek (SEEK) will have a difficult time getting traffic to challenge Yahoo."
And in a year in which it seemed everyone came out a winner, Cavallone pointed to Netscape Communications Corp. (NSCP), ironically the company that helped make the Internet a household word, as the one company left out in the cold.
"Maybe Netscape comes up as a loser, but they've been over for a few years," Cavallone said. "Being bought by AOL is the culmination of that. Their future before they were bought wasn't bright at all."
And in the e-commerce realm, Vanderbilt said traditional department stores that have expanded into the Web will have a tough time in the year to come.
"Macy's and Nordstrom (NOBE) have made valiant efforts, but the user experience of the mass product offerings in a department store doesn't translate well to the online world," Vanderbilt said. "Without significant changes, online will continue to be a very small part of their business."
Tighter scrutiny
Now that the stakes have been raised, analysts believe investors will watch Internet companies - or any company aligning itself with the Internet - with more discerning eyes.
"I'd like to think long-term fundamentals will hold," Cavallone said.
Although it doesn't appear that 1999 is shaping up to be the Year of the Internet Backlash, it's possible some of the dot-com frenzy will be subdued.
"The window of opportunity for Internet startups to get in before the big guys is closed in most cases," Delhagen said. "There's a difference these days from the heady early days. The cost of entry is getting higher by the week, and the venture-capital firms are more rigorous about their funding decisions." 
-- by staff writer John Frederick Moore
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