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Oct. 2, 2000, 12:01 a.m. EDT

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By Jack Willoughby

"The market we went public in is not the same market that exists today. The public markets are not nearly as open to a company at our stage today," says Philip Yawman, Choice One's senior vice president of corporate development. He says the business plan is fully funded to enable his operation to become cash-flow-positive by 2002.

Table: Burn Victims

Choice One also has a $350 million credit facility from First Union, a $200 million preferred equity investment from Morgan Stanley Capital Partners, and a $180 million bridge loan from Morgan Stanley.

Morgan Stanley also played the roles of lead underwriter, lender and adviser to US Xchange, while Morgan Stanley Venture Capital Partners held a 35% position in Choice One. (UBS Warburg advised Choice One on the merger.) Despite the manifold potential conflicts, Yawman declares, "I tell you from firsthand experience that the Chinese Wall at Morgan Stanley exists."

Several companies argue that our projections are faulty, because second-quarter data fail to take into account subsequent positive changes. Among them is Lending Tree , based in Charlotte, North Carolina, and No. 16 on our list. Lending Tree allows borrowers to seek the best deal on mortgages from multiple lenders over the 'Net.

Doug Lebda, the company's chief executive and founder, disputes any notion that Lending Tree is foundering, declaring that the firm will be EBITDA-positive by the second quarter of 2002. "We are tracking significantly ahead of our plans and spending considerably less money now than we did in the second quarter. Revenues are coming up because our ad campaign has increased consumer awareness, making it possible to spend less to acquire new customers," he says.

Still, Lending Tree's stock price implies some loss of confidence. It's currently hovering in the $5 range, down from February's IPO price of $12. Chief Financial Officer Keith Hall attributes the decline to the general aversion to dot.coms. Fidelity Investments, for example, which bought at Lending Tree's IPO, has bailed out. Declares Hall: "Some folks have gotten scared of anything with a dot.com."

Value America, of Charlottesville, Virginia, filed for bankruptcy on August 11 and shut its retail operations. In a prepared statement, Chairman Glenda Dorchak gave the following obituary: "The prospect for near-term profitability of a company engaged exclusively in the retail side of the electronic commerce industry is not assured." Note that Value America failed three months after a reported $90 million bailout.

Not all the news was bad for dot.coms. As noted, CDNow has found new life as a subsidiary of the German conglomerate Bertelsmann. And Bluefly /zigman2/quotes/219429270/composite BFLY +0.44% , a New Yorkbased specialty e-tailer and No. 10 on the list, has done much to improve its ranking. Revenues for the second quarter rose to $4.3 million from $741,000 a year earlier. Customer acquisition costs dropped to $73.21 per person from $239.46 last year. Wrote Ken Seiff, chief executive of Bluefly: "We are refining our merchandising and marketing strategy based on information we have learned from a five-month-long customer profile analysis we conducted." Kyle of Pegasus Research International recommends Bluefly shares, which trade around 2.50, or a bit more than one-tenth their peak in late 1998.

FOR A FULL COPY of the Barron's -Pegasus Burn Rate Scorecard, call 212-687-1522 or go to www.pegasusri.com . The report contains detailed data on profit and loss margins, rankings by industry sector and earnings and loss trends for 339 Internet companies. The cost per report is $2500.

To some CEOs, the mere act of turning cash-flow-positive represents a buying opportunity. Alan Meckler, CEO of internet.com, a New York-based Internet media concern that has turned the corner, recently bought 29,000 shares of his company's stock, at prices ranging from 15 to 21.75. That's below the recent quote of 30, but well off their late 1999 peak of 72.25 and up from their June 1999 IPO price of 14. Now that internet.com no longer burns cash, Meckler quips, it's just a matter of time before "the economics catches up with e-conomics."

While some companies haven't completely stopped burning cash, they've made inroads in reducing the rate at which their bankroll is disappearing. The roster includes Organic , Tut Systems , Travelocity , MP3.com and Priceline.com (whose stock was pummeled last week, after it announced disappointing revenue prospects).

The market doesn't appear to have recognized the real improvements of some companies. Besides Bluefly, Kyle notes that iGo Corp., based in Reno, and online insurance broker Quotesmith , in Darien, Illinois, have achieved results that haven't been reflected in their share prices. Operations at iGo, which sells wireless accessories, improved dramatically in the second quarter, thanks to price breaks obtained from manufacturers, and shifting to "pay-for-performance" advertising, which ties ad costs more closely to actual sales produced. The change cut iGo's advertising costs to 30% of revenues from 53% in the first quarter. Says CFO Mick Delargy, "The changing economic climate has made people less willing to pay for impressions."

Such changes are part of a broader transformation occurring within the Internet sector. "The sales cycle has started to lengthen in the dot.com arena," says Promod Haque, managing partner for Norwest Venture Partners, an information technology specialist. "The dot.coms are now selling to bricks-and-mortar companies, which generally take a lot more time to decide. Instead of one 25-year-old, they have to convince three committees led by 50-year-olds."

Dwayne Nesmith, the chief financial officer of Viant , an e-consultant based in Boston, says it has found that the 2,000 largest global companies "are taking a longer investment horizon" and that this is slowing e-business initiatives. "They're looking to achieve long-term sustainable returns, time-to-value, as opposed to time-to-market. A lot of us were surprised at how quickly the decision-making changed."

At the same time, says Scott Sipprelle, founder of Midtown Research, an investment boutique specializing in troubled companies: "Evidence is mounting that demand for advertising is ebbing, both at the large Internet portals as well as traditional media outlets, such as radio."

That could filter down the food chain in cyberspace. Stocks that might be affected could include Juniper Networks, which trades at 240 times revenues, Sycamore Networks, which trades at 160 times revenues, and Corvis, which sports a $24 billion valuation without any revenues yet. "What we're seeing here is a standard sector rotation," says Kyle. "First came the e-tailer, now it's business-to-business, and sooner or later infrastructure itself is going to have a downward adjustment."

The dot.coms that do survive will be those that can handle innovation better than the less-nimble, bureaucratic older firms.

"The next wave will be a realization that these bricks-and-mortar companies are not going to be able to do it easily," says William Hambrecht, founder of W.R. Hambrecht & Co, the designer of the open IPO auction.

Sharp, short-term corrections make it important to focus on the big picture, says Alberto Vilar, president and founder of Amerindo Investment, a major technology investor. "The large-cap technology stocks are vulnerable, because all but a few will be unable to convert to the next generation of scalable Internet technology," he asserts. Conversely, "what happens to a bunch of companies that should never have gone public in the first place bears little relation to the multitrillion-dollar transformation that will ultimately take place through leading companies in global telecommunications, B2B and infrastructure."

Even so, in the short run, infrastructure valuations can be hurt by competitors entering markets to eat up potential profit. Meckler of internet.com says the rapid deployment of competition can undermine even the most sophisticated model. "The current valuations have to be based on the domination of a few firms," he says. "I believe we'll likely see a repeat of the fragmentation that has occurred with Internet service providers."

One sign of trouble: Insider selling of Internet stocks almost doubled in the second quarter, compared with the level a year earlier, according to CommScan, an investment-banking statistical service. In the quarter, there were 14 Internet follow on or secondary offerings, which raised $1.7 billion. Of the total, 47% represented shareholders cashing out. In the second quarter of 1999, when the market for 'Net stocks was still blazing, CommScan reported 24 deals for $4.7 billion, only 28% of which constituted insider sales.

"We've seen a lot of opportunistic selling," says Chris Pelgrift, managing director, technology equity capital markets for Banc of America Securities in San Francisco. "We have urged management to hold on to their stock to avoid the [market's price] penalty."

While venture-capital funds still lure tens of millions, they have proven even more fickle when it comes to e-commerce investing. According to VentureOne, VC funds invested a mere $479 million in 29 deals during the second quarter, down significantly from the first quarter when they poured $705 million into 34 deals. Says Sasha Talebi, research director at VentureOne: "They'e choosing to rotate their capital, from e-commerce and content to infrastructure and companies forming the framework for the next generation of the Internet and e-business, including fiberoptics, wireless, networking and communications."

With market values depressed, the so-called incubator companies have come under strong selling pressure, as institutional stockholders abandon the holding companies. For example, Fidelity Investments trimmed its stake in CMGI Holdings 50% in the second quarter. Pegasus estimates that CMGI has only 7.6 months' worth of cash left to burn. That excludes the value of the roughly $1.6 billion in Internet stocks held in CMGI's portfolio. Of course, these could be sold to raise cash, but probably only at discount prices if word got out that CMGI was unloading its portfolio.

Internet Capital Group saw two of its largest institutional holders sell big holdings in the second quarter: Fleet Investment Advisors sold 5.8 million shares; Fidelity Investments, 1.6 million. (Neither company would comment on its investment position.)

"These incubator companies operate on the assumption of a healthy new-issue market," says Meckler of internet.com. "The whole incubator model hinges on the ability of going public. When this doesn't happen, serious problems can arise. There wouldn't be an incubator concept in today's market."

Such a selloff will undoubtedly leave some diamonds in the rubble. Consider a closed-end fund such as meVC Draper Fisher Jurvetson , which came public March 28 at 20, and now trades at 13. Even though the company holds more than two-thirds of its $316 million in assets in cash and equivalents, the fund trades at a 30% discount.

E-mail comments to editors@barrons.com
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