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The Day Ahead: Why you shouldn't fret over ICG's bottom line

Earnings don't matter for Internet incubator ICG
Written by Larry Dignan, Contributor

Usually when a company says it will report losses in upcoming quarters, it's bad news. Unless that company is an Internet incubator, such as Internet Capital Group (ICG).

ICG shares fell in after-hours trading on Thursday after the company said it will report losses "in many quarters for the foreseeable future". In its fourth quarter, ICG lost $23.4m (£14.5m), or 9 cents (5p) a share.

Folks that bailed on ICG because of the earnings and outlook either didn't know what they owned in the first place or were just dense. In any case, traders who dumped ICG will probably regret it in a few weeks.

Earnings don't matter for ICG or CMGI, the granddaddy of Net incubators. In fact, sales don't matter much either. The only thing which does matter is that ICG and other Internet incubators continue to guess right with their venture capital and bring companies public. If you want to know how unimportant earnings are to ICG, just look at First Call's consensus estimates -- there aren't any.

There are 12 brokerages covering ICG, but not one of them ventured a guess about fourth quarter earnings. "There aren't any," said Patrick Walravens, an analyst with Lehman Brothers, when asked about ICG estimates. "There were a few that tried it before, but it didn't work." Robertson Stephens analyst, Eric Upin, also didn't bother with a projection.

To see the pitfalls of earnings estimates for Internet incubators, just look at the results from Safeguard Scientifics, ICG's parent company. Safeguard reported a fourth quarter profit of $2.09 (£1.29) a share on Thursday after it cashed in on the eMerge Interactive IPO. The consensus estimate, based on one analyst, called for a profit of 11 cents (6p) a share. Why bother guessing? We give the one analyst credit for at least trying to guess Safeguard's results, but there's no way to estimate quarterly results. You never know when these companies are going to sell stock and pad the bottom line.

When you throw out details such as top and bottom lines, ICG had a nice quarter. The company added 10 new companies to its business-to-business network. ICG also has strategic partnerships with Ford, IBM and AT&T.

The only thing that can derail ICG is a dead IPO market, or some really poor investments. There's no evidence of either one of those being possibilities, however. ICG has invested in up-and-comers such as MetalSite and eCredit.com, and it owns stake in VerticalNet, US Interactive, Breakaway and eMerge.

ICG has had big IPO hits, and has six more network companies in the pipeline to go public, said Walravens. Plus, the company has the cash to make plenty of investments. Courtesy of a secondary offering, ICG ended 1999 with $1.3bn (£80m) in cash.

The big downside to companies such as ICG is that investors have no clue how to evaluate performance without estimates. ICG and other Internet incubators are basically mutual funds for risk takers. But there are a few metrics to watch. According to Walravens, investors should watch the spread between ICG's market cap and the value of its investments. For instance, ICG's stake in its four publicly traded companies is worth about $4.2bn (£2.6bn). But ICG's market cap is $31.1bn (£19.2bn). Walravens expects that spread to close as more ICG-funded companies go public.

In addition, Walravens said investors should watch the revenue of ICG's network of companies. As ICG's network matures, revenue growth should balloon. On a pro-forma unaudited basis, the aggregate revenues of all of ICG's partner companies grew about 250 percent, from $41m (£25.4m) in the fourth quarter of 1998 to $143.5m (£88.9m) in the fourth quarter of 1999. "It's helpful to look at what's going on at all the partner companies," said Walravens. "The company is worth the sum of its parts. The key thing is that ICG makes more big investments and takes its partner companies public."

Intuit probably wishes it could sing the "earnings don't matter" tune. Shares in the company were hammered in after-hours trading after it merely met estimates with earnings of $91.4m (£56.6m), or 44 cents (27p) per share, excluding special charges, in its fiscal second quarter. Sales came in at $425.5m (£263.8m), a 14 percent gain year-over-year, but about $17m (£10.5m) short of projections. So what's the problem?

For starters, it's Intuit's biggest quarter because of tax season, and Wall Street had high hopes. In addition, folks may have also been rattled because Intuit said it had to cut the price of its TurboTax software -- the company has been trying to fend off stiff competition from Microsoft.

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