Internet start-up's stock crash called sobering reminder

Drkoop.com's woes show why traders should do homework, analysts say As young Internet companies start baring financial details in their annual reports this spring, investors

Monday, April 3rd 2000, 12:00 am

By: News On 6

Drkoop.com's woes show why traders should do homework, analysts say

As young Internet companies start baring financial details in their annual reports this spring, investors are learning that accountants can quickly dash a dot.com's dreams.

Shareholders on Friday stampeded from Austin's drkoop.com Inc. upon learning that independent auditors of the health-care site expressed "substantial doubt" about its future financial health. The day before, investors sold off shares of CDNow Inc. of San Francisco on a similar caveat.

A turnabout in the fortunes of these companies is a reminder, analysts and other experts say, that guesswork can't outperform homework when it comes to picking stocks in the Internet age.

"You have got to ask yourself, do you think long-term that this company has a chance?" said Mark Mulcahy, who follows drkoop.com for Pacific Growth Equities in San Francisco. He has been in the minority among analysts in not recommending drkoop.com to investors.

Although it was a bad day for some Internet companies, the exchange where most of them find a market recovered. The Nasdaq's composite index opened higher after registering its fifth-largest drop ever on Thursday. In early after-hours trading, the index held onto a gain of 114.94 points at a value of 4572.83.

Shares of drkoop.com, co-founded by former U.S. Surgeon General C. Everett Koop, spiraled down 43 percent at one point in trading Friday to $3.56. The company went public last June at $9 a share.

In its audit of the company filed Thursday with the Securities and Exchange Commission, PricewaterhouseCoopers said "sustained losses and negative cash flows" at drkoop.com raised serious doubts about its ability to continue as what auditors call a "going concern," or an enterprise that can pay its bills.

Officials from drkoop.com didn't return calls requesting comment.

CDNow's woes

In similar language on Wednesday, Arthur Andersen accountants said CDNow had sustained recurring losses from operations, throwing into question its "ability to continue as a going concern."

And online grocer Peapod Inc. said it is looking for takeover offers in light of a cash-flow problem. Shares were down 19 percent to about $2 in midafternoon trading Friday. Barry Stouffer, an analyst at J.C. Bradford & Co., said that without an injection of cash or a buyout soon, Peapod could "disappear" in a week or two.

Wayne Shaw, accounting professor at Southern Methodist University, said a host of Internet companies that went public around the same time in the last year have burned through their cash. Investors willing to pony up the next round of financing, he said, will take a closer look at profit-and-loss statements, cash flow and balance sheets.

"People are going to be much more cognizant of what companies are reporting, and they are going to insist on earnings, not just revenues," Dr. Shaw said.

A March 20 report in Barron's may have foretold the sell-off in Internet companies with too much lift in their stock prices. The investment newsweekly reported a study by Pegasus Research International of New York that concluded that some 50 companies are likely to find themselves awash in red ink within the next year.

Although some questioned the firm's methodology - Pegasus assumed the companies would take in and spend the same amount of money they had in the fourth quarter last year - Mr. Mulcahy said the conclusion was on target. "The trend they spotted is correct," he said.

A 'tougher' market

Venture capital firms betting big on the Internet could pull back on future commitments to start-ups. "I think the stock market is being much tougher on these companies, and you'll see the private markets begin to do the same," said Brian Goffman, principal with Austin Ventures.

Business-to-business Internet companies weren't immune from the new investor skepticism toward business-to-consumer companies. Shares of i2 Technologies Inc., Commerce One Inc. and Ariba Inc. - which all make software for Internet commerce - softened on worries that their sales will be hurt by competition. Farmers Branch-based i2 Technologies was down 5.33 percent to $122.12 by the end of regular-hours trading.

Dr. Shaw said both types of companies - "B2B" and "B2C" - can be expected to face more scrutiny from the SEC and the Financial Accounting Standards Board, which defines accounting rules, such as when a company can book a sale as actual revenue.

No more barter bucks

Counting "barter revenue" as cash will no longer pass muster, he said. For example, some Internet companies trade advertising space on one another's Web sites and account for it as revenue from ad sales. "There's not going to be anymore of this, 'You advertise on me and I'll advertise on you,' " he said.

Some self-styled chat room analysts were tossing around the theory that Internet companies might be copying the wrong business model.

For example, American Online Inc. attracts millions of viewers. That audience in turn draws in merchants willing to pay AOL to advertise on its site. But smaller, specialized retail sites can't deliver a big enough audience to attract ad revenue.

Mr. Mulcahy thinks it's a valid point. "Not everybody can be an AOL," he said.