February 26, 2009, 12:00 AM

Wall Street 3.0

There was the Internet investment bubble, then years of solid growth. Now chastened investors take an optimistic, but sober, view of e-commerce.

Life is good when Wall Street is gaga over your industry. Just ask Umang Gupta.

The founder of Keynote Systems Inc. took the company public in 1999, raising $40 million, then raked in $350 million in a second share offering in February 2000, even though the company was still losing $20 million a year. The share price of Keynote, which measures the performance of web sites, went as high as $110.

Everyone knows what happened next.

Just weeks after Keynote’s second share offering, the stock market crashed, led by a precipitous decline in prices of Internet companies. But Keynote had its money in the bank, and in the years since used those funds to buy 15 companies, quadruple revenue and buy back half of the shares it had sold-at an average price of $10.

“We were one of the lucky stories,” Gupta says. “We were one of the few dot-com companies that had the opportunity to reinvent itself because we had customers and we had cash.”

Whether other Internet retailing companies-online merchants and the vendors that serve them-will share Gupta’s luck depends in large measure on how Wall Street views the prospects for online retailing. If investors view e-commerce as a growth sector, such companies will find it easier to raise the capital they need for growth; if not, the sector’s expansion will be constrained.

An e-retail index

To track Wall Street’s view of online retailing, Internet Retailer has created an exclusive index of 25 publicly traded e-commerce companies. The variations in the index will be compared to that of the Standard & Poor’s 500 Index, an index of the stocks of 500 large U.S. companies, and the Dow Jones Industrial Average of 30 blue-chip stocks to compare how investors value online retail companies versus the broader market.

The 2008 results weren’t pretty. E-commerce stocks fared even worse than the broader market, falling 39% for the year, while the S&P; 500 slid 37% and the Dow 34%. But it’s been a different story in 2009.

As of mid-February, the Online Retail Index was up 2.9% since the first of the year, while the S&P; 500 Index was down 8.5% and the Dow off 10.5%.

E-commerce stocks outperformed the market because results from the fourth quarter of 2008, which were reported early in 2009, were a little better than expected for many e-commerce companies, says Colin Sebastian, an equity analyst who follows Internet stocks for Lazard Capital Markets.

“This gives investors more confidence that the sector still is an attractive growth opportunity,” he says. “There are obviously still a lot of risks this year, given the challenging economic backdrop, but the Internet is still alive and well.”

Analysts generally see better prospects for online retailing than for bricks-and-mortar stores. For instance, in a recent report on e-commerce technology provider GSI Commerce Inc., analysts Herman Leung and Jeetil Patel of Deutsche Bank Securities Inc. predicted that GSI will benefit from the struggles of store-based retailers.

“With more stores closing, the online component becomes increasingly important as a channel to drive sales, and largely untapped by these retailers,” they wrote last month.

Sebastian took a similar view in his own report on GSI, saying the company “is well positioned to benefit from ongoing, multi-channel retail trends and moves by traditional brands, retailers and manufacturers to establish stronger online footprints.”

Winners and losers

But Sebastian cautions that Wall Street no longer assumes all e-commerce companies will be winners, the way it did a decade ago.

“There is a sense there are winners and losers,” he says. “Wall Street is being more picky. This recession is broader-based, and investors will pay more for a company they think will survive, that is generating cash and has potentially a better growth profile, such as Amazon, but not for companies that are not growing or not very profitable.”

That pickiness shows up in the difference in share prices between the two biggest e-commerce companies in stock market value, Amazon.com Inc. and eBay Inc., Sebastian says. He notes Amazon’s stock price is about 40 times projected 2009 earnings, while eBay’s stock is at 10 times expected earnings. “One company is growing, gaining market share and generating a lot of cash, while the other is perceived to be in somewhat of a downward spiral,” he says.

Overall, he says, “e-commerce is still considered an attractive sector for investment. It’s just that investors are being a little more granular in terms of where they put their money.”

E-commerce vs. stores

A bigger problem for some e-commerce companies is that some investors don’t distinguish between online and offline retail. Julie Bradley, chief financial officer at e-commerce platform provider Art Technology Group Inc., says she spent much of 2008 trying to explain to investors that the much-publicized problems of store-based retailers did not imply similar troubles for the web-based retailers ATG serves.

ATG’s stock price lost 55% of its value in 2008, and Bradley attributes much of that decrease to investor confusion. “They’re saying the consumer is sick, they’re not going to be spending, retail is suffering, and making the association that ATG equals retail,” she says.

She welcomed the Online Retail Index as a way to help investors distinguish ATG, and e-commerce in general, from retail as a whole. “When they see companies like Shutterfly or VistaPrint bucking the trend on total retail, and they see e-commerce technology providers doing well also, there’s a realization that you can grow revenue and reduce cost and survive quite nicely in an uncertain economy.”

A higher stock price potentially would make it possible for ATG to raise capital by selling more shares, if, for instance, it wanted to make an acquisition. (The company, which went public in 1999, has not sold stock since then and has no plans to do so, Bradley says.)

A better price also would improve morale among company employees, each of whom is given stock options upon joining ATG, Bradley says. There likely are more smiles at company headquarters of late now that ATG’s stock price went up 24% in the first six weeks of 2009, after ATG reported 20% revenue growth in 2008.

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