A Slow Leak in the Net Bubble

The signs are subtle, but it looks as if some measure of sanity is emerging in the market for Internet stocks. Of course, with many Net stocks still trading at historically unprecedented price-to-revenue (let alone price-to-cash-flow) ratios, “sanity” is a relative term. But the events of last week suggest that two important things are happening to Net stocks. First, Net companies are recognizing that they can’t remain profitless forever. Second, paying an audacious premium when you acquire a Net company is no longer automatic. And together, these two things suggest that at least when it comes to the third- and fourth-tier Net companies, the days of living in the future may be done.

There were two key Internet mergers last week that speak to these points. The first, and most striking, was electronics retailer and auctioneer’s “acquisition” of software and hardware retailer for $400 million. I put “acquisition” in quotes because the company’s operations are actually going to continue under the Egghead name, since its brand is supposedly stronger, even though Onsale is actually doing the buying.

Regardless, the deal was striking. Egghead shareholders received essentially no premium for their stock, and in the days since the deal was announced Egghead’s shares have plummeted more than 20 percent. Onsale’s shareholders, meanwhile, were no more happy about the news; their shares have fallen 15 percent since the announcement.

That’s because the merger basically looks like what it is: a desperate attempt by two online retailers to avoid the irresistible price pressures of both the computer industry and e-commerce. There don’t appear to be any real synergies here, other than the fact that the deal removes one online retailer from the field. And the underlying economics of these businesses are not going to improve any time soon. I’ve always been happy to buy from Onsale, which appears to sell goods at a price as close to wholesale as you’re going to find. But I’ve never understood how the company expected to turn a profit.

At one time, that seemed not to matter. Onsale’s stock has been as high as $108 a share in the past year. It’s now at $18. Egghead’s reached $40 a share. It’s now below $10. Investors’ patience with money-losing operations, at least those that do not have a clear growth strategy, has run out. Which is, needless to say, a good thing.

The other important merger last week was online ad buyer and seller Doubleclick’s $530 million acquisition of Netgravity, a provider of software that helps companies enter the Internet ad business. Since the two companies’ businesses appear to be complementary rather than competitive, this is one deal in which actual synergies might exist. Yet Doubleclick’s offer valued Netgravity at slightly less than the market did. Instead of the kinds of premiums that Yahoo paid for GeoCities or @Home paid for Excite, we’re starting to see deals with no premiums at all, which is presumably a comment on the potential upside of the acquired companies’ fates if they had chosen to stand alone.

Neither Doubleclick nor Netgravity is profitable, but this deal wasn’t, like the Onsale-Egghead merger, provoked by the thought of permanent losses. At the same time, Doubleclick’s stock is down more than 50 percent from its 52-week high, and Netgravity’s shares have also been cut by more than half. What we seem to be witnessing is a gradual deflation of the Net bubble, a deflation in which bad companies are going to be bought or go out of business and in which good companies will acquire assets on the cheap.