[Street.com] Internet Capital Group Sweating

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From: Linda (joelinda1@home.com)
Date: Fri Jun 09 2000 - 04:39:15 PDT

[Another one which might run into financial difficulties.
Amazingly, their convertible debt has now reached junk-bond status...



Chilly IPO Market Has Internet Capital Group Sweating
By Joe Bousquin
Staff Reporter
6/8/00 11:11 AM ET

Internet incubator Internet Capital Group (ICGE:Nasdaq - news - boards) has
already seen its shares slide 82% this year. But, things could get worse: The
company holds stakes in more than 60 private firms that may not be able to go
public in the current climate. It is also consuming an estimated $200 million per
quarter and its bonds, yielding over 16%, have achieved junk status.

The Wayne, Pa.-based company should be poised to reap the benefits of the
B2B future (should that future come to pass), but so far only seven of its 71
portfolio companies have gone public. With the current window for initial public
offerings in the B2B sector effectively nailed shut -- high-profile filings from
Impresse and Noosh, which are not ICG companies, were pulled in recent
weeks -- it might be difficult for the company to reap the rewards of its
investments, which now add up to more than $1 billion.

"This company is extremely dependent on the health of the IPO market to justify
the premium of its stock price," says an analyst at one West Coast hedge fund
which had shorted the stock, but now holds no position. "Valuing these incubator
companies is a complete crap shoot. They could be worth about $5 billion, $10
billion or more. But they could be worth a lot less if you assume that none of
these companies will be able to come public or to merge with companies that will
be able to."

Jon Ekoniak, an analyst at U.S. Bancorp Piper Jaffray, who rates the stock a
buy, says ICG's portfolio companies may have a harder time going public than
others because they concentrate on B2B exchanges for specific industries,
known as verticals.

"The majority of their investments are in vertical markets, and the vertical markets
will probably hibernate longer than the enabler plays," he says. Those plays
include software makers like Ariba (ARBA:Nasdaq - news - boards) and
Commerce One (CMRC:Nasdaq - news - boards). "This isn't a short-term game
ICG's in, and investors need to be willing to hold on for the long term."

While ICG has scored with investments in the likes of VerticalNet
(VERT:Nasdaq - news - boards) and Breakaway Solutions (BWAY:Nasdaq -
news - boards), ICG has by and large invested in less recognizable names like
PaperExchange.com and traffic.com.

ICG, of course, has been called the CMGI (CMGI:Nasdaq - news - boards) of
B2B -- a sort of a New Economy mutual fund without the capital-gains taxes.
Yet, unlike the now legendary investments of that incubator company, which
made its name in the business-to-consumer space, ICG's picks haven't inspired
the same awe. That may well be because, when CMGI started catching investors'
eyes, an appetite for B2C stocks was just developing, before turning into a
ravenous hunger. With B2B, investors got their fill much faster, stopped eating,
and started regurgitating what they ate soon after.

That distaste for B2B, and for ICG, in particular, has shown up in its share price,
which trades around 37, down 83% from its 52-week high of 212 set in
December. CMGI, meanwhile, has held up better in the overall market downturn,
trading around 55, off 66% from its high of 163 1/2 set in early January.

A shuttered IPO window alone usually wouldn't be a problem for a company
sitting on top of $859 million in cash, which ICG is. But it's planning to spend all
that money within the next 12 months.

Doug Alexander, managing director for operations at ICG, told investors at a
conference in New York last week that the company will spend $200 million per
quarter on new and follow-on investments. At that rate of cash deployment, ICG
estimates it has enough cash to fund operations through the first quarter of 2001.

Which brings the company into the fray of operations that have just a year -- or
less -- of cash left. With investors showing less and less tolerance for
money-losing Internet operations, cash is becoming the yardstick by which
companies are being measured. Ones with just a year of cash or less left have
quickly been shunned by Wall Street.

Of course, ICG has more than its share of defenders when it comes to the cash
issue. U.S. Bancorp's Ekoniak notes that, with stakes in public companies like
VerticalNet and Ariba, ICG could take proceeds from those holdings to fund
operations. He does say, however, that this wouldn't be the "preferred means" of
funding the business. After all, it's usually better to let your winners run.

Patrick Walravens, an analyst at Lehman Brothers who rates the stock a buy --
his firm helped underwrite ICG's secondary stock offering -- points out that ICG
could raise cash through a public offering in Europe as well.

"You've got to be fair to these guys," Walravens says. "This $200 million they're
spending is not the same as a burn rate. They can cut it down any time they
want, and they don't have to do anything dramatic to do that. They just make
less investments in the quarter."

True, that is one way that ICG could cut down its spending. But it's primary
business is investing cash, not sitting on it.

ICG's Cash: In One Door, Out the Other Quarter
                           Cash & equivalents at Cash deployed in
                           close of quarter start-ups
Q2 1999 $26 million $96 million
Q3 1999 $186 million $29 million
Q4 1999 $1.34 billion $412 million

Ken Fox, co-founder and managing director at ICG, concedes that the company
is planning on spending a lot of money -- but only because the opportunities in
B2B now are better than ever. In that sense, he says, a temporary shutdown of
the B2B IPO window could be a good thing for the company.

"Right now, this is the window of opportunity for us," Fox says. "If the [IPO]
window were to stay closed for six to eight months, that will be even better,
because it will give us a better opportunity to invest in companies at a lower

Fox says that ICG's burn rate for operations is only $15 million per quarter.
(Analysts put it between $20 million and $25 million.) He also noted that ICG's
operations in Asia, which it gained by buying a toy company and turning it into a
B2B firm, currently hold about $200 million in additional cash, and that the
company has a $250 million line of credit.

"The important thing to understand is that our $200 million burn rate is like a
faucet," Fox says. "It is an effect of our acquisition and investment pace, and we
have complete control over it." He added that if ICG did slow its cash
deployment, it could concentrate on spurring business among its portfolio

Though miles below its December high, ICG's market cap still sits neatly at $10
billion dollars, or about 550 times its trailing 12-month sales. That's either a
pretty good endorsement or a giant leap of faith by investors, who are ultimately
betting ICG's investments will pay off.

But people who deal with the company's debt say the bond market is sending a
much different message about ICG. In December, ICG issued $566.3 million in
convertible bonds with a five-year maturity and a yield of 5.5%. Convertible bonds
typically trade in some correlation with their underlying stock, and ICG's bonds
have followed its stock price down.

Of course, as the price of a bond goes down, its yield goes up. With ICG's
convertibles falling with its stock price, the bonds are now priced at 66.55 and
yielding 16.2%, according to Morgan Stanley Dean Witter's
ConvertBond.com Web site. That places the company firmly within the
junk-bond realm, and on the edge of what debt investors consider "distressed."

A New York-based hedge-fund manager who holds those convertibles -- but is
short ICG's stock -- says the high yield clearly reflects the high risk the debt
market is assigning to the company. He bought the bonds in April at 57, when
they were yielding over 20%.

"A 20% yield to maturity is the kind of yield that gets attached to very speculative
credit," the hedge-fund manager says. "The convertible-bond community seems
to be coming up with a verdict that this is a distressed security, which is very
different from what the equity community is saying with its $10 billion market
cap: that this is one of the Internet blue-chips and one of the stocks you have to

By comparison, another out-of-favor Internet company that issued convertible
bonds, Amazon.com (AMZN:Nasdaq - news - boards), is faring better with its
debt. Currently, its 2009 converts, sold at 4.75%, are yielding a less out-of-whack

Especially disconcerting, the hedge-fund manager says, is that ICG's current
cash position is more than enough to cover its debt.

"The concern is that they're going to spend all this money and end up with
nothing. They're going to plow all that cash into new investments and never get
any return on those companies they're invested in," because the IPO window is
closed, the manager says.

 ICG's Fox disagrees.

"I would say the excitement over B2B in the last eight months has actually been
an underestimate relative to the impact on the global economy that the Internet is
going to have on business," Fox says. "No one is going to debate today that the
theme has shifted to those companies that can execute. We believe many of
ICG's companies are those companies."

He says the junk status of ICG's bonds shouldn't be construed as a sign that the
future is less than bright for the company.

"Like so many great businesses that have accessed the debt market, that yield
does trade highly," Fox says.

Fair enough. But when a company's high-risk debt starts looking more attractive
than its stock, investors might want to reconsider the price they'll pay to get into
the B2B game

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