Another huge and completely unprovoked (to say nothing of unjustified) run-up in Internet stocks today sent Amazon.com--which reports earnings on Wednesday--soaring near its 52-week high. Meanwhile erstwhile news provider CNet jumped 29 percent, purportedly because four NBC execs will be moving to CNet as a result of NBC's recent decision to take a stake in the Net company. Given the fact that NBC has spent the last week complaining about slowing revenues and the hopeless future of any medium--like broadcast television--that relies solely on advertising, one can be forgiven for wondering why the arrival of TV execs makes CNet a third more valuable, but, hey, why ask why?
Also participating in the rally, though in less impressive fashion, was Internet portal site Excite, which last week reported second-quarter losses considerably smaller than analysts' estimates. Interestingly, though, Excite traded down immediately after its numbers came out, and dropped further through the rest of the week. Today's bounceback boosted the stock, but it's still almost 15 percent below its 52-week high.
Excite fell in part because Internet companies, paradoxically, seem to do better when investors don't have too much concrete data to grind. For the first six months of 1998, after all, Excite generated just $56 million in revenues. And it's a little harder to delude yourself about how out-of-whack Internet valuations are when you have those numbers staring you in the face. But there was also a more substantial reason to doubt that Excite's performance was as strong as the headlines suggested. And curiously enough, it was hidden in plain sight.
Excite had been expected to lose 39 cents a share for the second quarter. Instead, it lost just 10 cents a share, a resounding triumph at a time when portal sites are burning cash in an attempt to gain brand recognition. As a result, Excite looked like a company that was able to expand revenues, increase "viewership," and keep expenses to a reasonable level. It'd be hard to ask for anything more in a growth company.
The only problem is that Excite actually lost $1.72 a share for the quarter, since the company dumped major expenses into the category of "one-time charges." That allowed Excite to exclude those expenses from its operating budget, so that the company's "operating loss" totaled just 10 cents.
Now, certain expenses--most notably those associated with mergers and, to a lesser extent, those associated with major restructuring plans--do belong in the "one-time charge" category. What investors are after is a sense of how the company will perform on a normal operating basis in the future, and the cost of a major merger isn't really relevant in that respect. Excite did take a one-time charge for its acquisition of a company called Thurow, which seems sensible.
But Excite's decision to take a one-time charge for the $56.8 million it spent on the major alliance it struck with Netscape in April of this year is considerably more dubious. After all, Excite has touted this alliance as central to its marketing strategy for the future. The three-year deal is supposed to drive traffic from Netscape to Excite, and as such is the kind of cross-marketing arrangement that will be central to any successful portal site in the future. This is, in other words, exactly the kind of deal that Excite needs to be striking all the time. It is a normal business expense for a media company, not an extraordinary event that will never recur. In fact, if Excite doesn't replicate the Netscape deal with other companies, it will soon be out of business.
The question, really, is this: If advertising deals aren't included in an Internet company's operating budget, what is? The portal sites don't make anything, after all. All they offer is access. It's not like Excite is spending billions on its technology. What Excite has to do is lure viewers. That's what the Netscape deal was intended to do. It was an operating expense, and should have either been charged against the operating budget this quarter or amortized over the course of the contract. In either case, it shouldn't have been a one-time charge.
Admittedly, this seems somewhat arcane. But in fact the habitual use of accounting gimmicks to make earnings look shinier than they are has played an important role in fueling the stock-market boom. And the last thing Internet stocks need is another flimsy foundation for a buying frenzy.