How to spot dotcom stock duds

Retired teacher David Lim knows zilch about technology or the Internet. But his ignorance about anything technology-related has not prevented him from hitching a costly ride on the latest play on the Kuala Lumpur Stock Exchange (KLSE)...

Retired teacher David Lim knows zilch about technology or the Internet. But his ignorance about anything technology-related has not prevented him from hitching a costly ride on the latest play on the Kuala Lumpur Stock Exchange (KLSE), punting on so-called technology stocks.

Since the start of the year, Lim noticed that each time a listed company announced some proposed Internet-related venture, their share prices rose sharply. So he decided to buy into Pica (M) Corp Bhd whose share price had more than doubled from RM2 in February, on the back of its proposed Internet ventures.

After he bought the shares in mid-March, Pica's stock price took a pounding when the company aborted its planned purchase of a 10 percent stake in Internet firm Kalan Gold Corp. Pica fell 11.7 percent to a two-month low of RM4.46. By April 20, it had dropped further to RM3.54. A shell-shocked Lim lost several thousand ringgits on the deal.

While riding the dotcom bandwagon can be highly rewarding for the astute investor, the Pica debacle also highlights the dangers inherent in Internet plays. The Pica affair, along with several similar cases, has given a bad name to the dotcom industry.

After lagging behind Singapore, Hong Kong and Japan, corporate Malaysia only recently awoke to the riches promised by the Internet boom. From a trickle, this is now threatening to become a torrent. Over 30 listed companies in the country have so far announced plans to invest in Internet-related ventures. While several are well received by analysts, many have raised their eyebrows. "Some companies just do nothing but announce possible Internet ventures," noted a Kuala Lumpur-based technology analyst. The more cynical analysts say these announcements are often nothing more than a ploy to prop up a company's share price. Old tricks replayed

All these appear to be a replay of corporate tricks from years gone by: share prices jacked up through announcements and signing of memorandums of understanding (MOUs) for contracts in China; timber concessions; and privatization projects. Many of these MOUs ended up in the trash can several months later, an analyst reminisced. Now it appears the current dotcom frenzy has become the new playing field for unethical businessman.

Regardless, having an Internet "strategy" has benefited many companies which have decided to add a dotcom annex to their bricks-and-mortar businesses. An analysis of recent Internet deals revealed that hype can be a valuable commodity.

Take the announcement by Dai-Ichi Industries Bhd on its proposed acquisition of a 25 percent stake in OzSearch Internet Guide Pty for RM800,000 (S$358,947). OzSearch is Australia's second-largest search directory. The day after the announcement in late March, the audio speaker manufacturer's market capitalization rose by RM58 million (S$26.02 million) as its share price increase hit an intra-day high of 24 percent.

An analysts with a bank-owned research house questioned: "If a small investment in OzSearch can boost Dai-Ichi's market capitalization so dramatically, Ozsearch must be a fantastic company. How do you justify such a price increase?"

Dai-Ichi was one of the best performers on the KLSE Second Board during the first quarter. Its share price rose 716.46 percent on talks of its involvement in various Internet deals. But Dai-ichi was eclipsed by Dijaya Enterprise Bhd whose share price shot up by 990.9 percent over the same period.

Linked to local tycoon Vincent Tan, the staid fluorescent lamp manufacturer has reinvented itself into an Internet player of sorts. It recently paid RM35 million (S$15.7 million) to buy majority stakes in Asia Web Direct (HK) Ltd and, oddly, World of Feng Shui Sdn Bhd.

Bursting the bubble

But the recent plunge in Nasdaq has put the brakes on Internet plays in Malaysia and other Asian markets. Even before that occurred, Malaysia's leaders had warned investors of a brewing dotcom bubble. In a hard-hitting comment, Prime Minister Mahathir Mohamad said bubble dotcom companies were formed to push up share prices. Many of these Internet-related companies "had no real industries to back them up". Malaysia, said Mahathir, wanted "real companies" which could continue to make money long after the dotcom companies had burst their bubble.

The regulators must have heeded the warnings. KLSE swung into action by issuing new guidelines, effective April 1, to increase the level of transparency for companies venturing into Internet-related businesses. Information which must be disclosed are the dotcom's business model, stage of development, description of the risk and rewards, the technical capability and the competence of key personnel. The company has to spell out the venture's potential financial effects such as when it expects to generate revenue.

However, some analysts feel the guidelines are not comprehensive or stringent enough to deter future dotcom shenanigans or prevent the build-up of a dotcom bubble. "You can come up with guidelines but the problem lies in enforcing these and preventing companies from announcing fake deals. Will KLSE come down hard on such companies?" wonders a KL-based analyst.

A technology analyst suggested that KLSE has to come up with regulations that limit companies from misleading investors (with their Internet deals). "KLSE should also find a way to track the development of these dotcom ventures, their financials and performance," he added.

Avoiding the dudcoms

Given that a majority of Internet startups will eventually end up as road kill, how does an investor spot whether a listed company is buying into a dudcom or dotcom? The plethora of companies jumping onto the Internet bandwagon means a shake-out will happen sooner rather than later. "Just how many localized search portals or financial portals can a small country with 22 million people support?" a technology analyst asked.

The U.S., home of the dotcom revolution, emphasizes the point that markets will eventually sift the wheat from the chaff. Nasdaq's plunge in the last month has seen a large number of Internet shares tumbling to penny stock status. Out of 318 dotcom stocks listed since the beginning of 1998, 55 or more than 17 percent are now trading for US$5 (S$8.53) or less, according to Thomson Financial/Securities Data. Some16 percent are trading for between US$5 and US$10 (S$17.05).

In fact, many investors now doubt whether most of these companies, previously flying high despite lackluster revenues, can even stay in business. Auditors of well-known Web companies such as Drkoop.com and Value America warned recently that these companies' survival is in "substantial doubt".

Nearer home, the plight of Japan's Hikari Tsushin, a cellular phone company that has modeled itself as another Softbank, offers valuable lessons not only to Asian-listed companies but also individual investors. In the Internet realm, it just takes several weeks of volatility for gold to turn into clay. At its peak in February, Hikari had a massive market capitalization of about US$76 billion and a dizzying share price of 246,000 yen (US$2,329). But by early April, the tide had turned, with Hikari's share price plummeting almost 90 percent.

Before the crash, Hikari's stock kept surging as the company regularly unveiled new Internet-related investments. Enamoured investors lapped it up. They did not realize or bother that Hikari's core cellular phone business was facing problems. The Hikari debacle is a lesson to all: even in the Internet economy when concepts and future prospects loom large, it pays to stick with fundamentals.

Back to fundamentals

OCBC Securities Franklin Tan concurred: "Fundamentals still matter."

"Investors must look at the company's shareholders, the management, their competencies, existing businesses and their profitability. Can the dotcom's business model generate profits?" asks Tan who is head of research at the Malaysian branch.

On the generally high valuations of technology stocks a research analyst said that over the longer term prices will come down to "sane levels". This will happen as the dotcom novelty wears off and Internet companies begin to start showing results, he added.

A recent OCBC Securities report also suggested that investments in Internet ventures are long term and favored promoters with deep pockets. The report advised investors who want a less direct entry into the Internet boom to consider local semiconductor-related stocks such as Malaysian Pacific Industries Bhd (MPI) and Unisem (M) Bhd. The research house called for a buy on the two stocks given their solid earnings record and the global trend of rising semiconductor sales.

Nasdaq's recent correction and its seismic effect on technology stocks throughout Asia may have a silver lining. It has temporarily dampened the Internet mania that has gripped not only small investors like Lim but also listed companies.

Since getting his fingers burnt in the Pica affair, Lim has been licking his wounds. Eventually, he plans to buy technology stocks again. "But I'll be more thorough and selective this time," he promised. It sounds like very good advice, not only for small-time investor but also the big corporations seeking to stake their claims for a piece of Malaysia's Internet El Dorado.