The rise and fall of collaboration and communication stocks - E-Finance

T+D, April, 2002 by Peter L. Martin

Here's a step-by-step review of the rise and recent fall of collaboration (knowledge-sharing) and communication stocks since 9/11. Our simple case study focuses on that group's market psychology and sentiment, which created volatility in recent performance.

Step 1: Event drives ignition. Following 9/11, Wall Street looked at many industry sectors to assess which would suffer or benefit. Collaboration was identified as a primary benefactor due to reduction in travel. That prompted aggressive buying of collaboration and communication stocks (such as videoconferencing providers) by portfolio managers on 9/17, the day the market reopened.

Step 2: Momentum builds. Third-quarter reports reflected improved operating metrics, showing a little boost from 9/11. That implied a potentially tremendous upside to future earnings reports as 9/11 interest would be monetized, heightening interest in the collaboration segment.

Step 3: Rollover happens. Strong interest by institutional and individual investors pushed most stocks in this segment up more than 100 percent since 9/17, which in our minds was too far, too fast. At that point, the stocks were trading on earnings revenue expectations that are unattainable in a reasonable timeframe, which created the perfect rollover. A rollover is when demand starts to stall--stock prices peak and then "roll over" as investors rake profits, pulling the plug on the support needed to sustain high trading levels.

Step 4: Negative information goes front and center. Just as investors made money on the way up, short sellers made money on the way down by selling the stock at high prices, buying it back at lower prices, and capturing the spread for profits. With demand waning, short sellers began an information campaign--touting competitive threats (Microsoft), pricing pressure (Genesys), and customer dissatisfaction (WebEx). The effect of those stories was to change investor sentiment from positive to negative, sending the stocks downward. Once negative psychology is created, it's almost impossible to stop.

Step 5: Confusion and expectations fuel the fire. Confusion regarding pricing, competition, and 4Q earnings expectations were aided by accounting concerns generated by the fall of Enron. Those dynamics, when mixed, created the combustion that caused the group to decline 27 percent during February.

Step 6: The aftermath arrives. Investors are left dazed and confused to assess the stock group's future. Typically, a negative cloud will loom waiting for the next catalyst to brighten the outlook. It's in such times that smart investors do diligence to determine the truth. In our experience, unjustified declines create the best investment opportunities.

Not only did this group make a round trip in terms of stock performance from 9/11/01 to 2/11/02, but also the stocks fell an additional 30 percent as negative sentiment overwhelmed the market. It was a dramatic case of momentum investing--and an excellent case of the power of market psychology and investor sentiment. We believe the sector has been tremendously oversold relative to reasonable growth expectations going forward. That presents a nice buying opportunity.

February performance for the overall corporate sector suffered from Enronitis. The sector as a whole was down 13.4 percent for the month as market worries about accounting put tremendous pressure on the group. The S&P 500 and NASDAQ fell 2.5 percent and 10.9 percent, as a nervous psychology continued to plague the market. Corporate segments heaviest hit by the selloffs were collaboration and communication, off 27 percent; content management, down 14.9 percent; and content providers, declining 14.6 percent.

We think that some of the selloff is justified, as our due diligence is showing that first-quarter earnings will be poor for several of the public providers in the infrastructure and content segments (SkillSoft and Click2learn excluded). Collaboration and communication, which was battered by rumors of price erosion and competitive threats by Microsoft and Oracle, should rebound nicely as evidence to the contrary reveals continued demand and margin improvement.

Leading providers WebEx (-49.4 percent) and Raindance (-43.7 percent), hit hard in the month of February, should continue to post solid growth year over year as well as sequentially, given that 4Q demand was muted by the holidays. Other high-profile declines during February include DigitalThink (off 51.7 percent); Docent (down 36.5 percent); and Stellent (sliding 41.5 percent).

Outperformers included Click2learn, which reported positive sales momentum on its quarterly conference call and solid evidence that it will be cash-flow breakeven in 1Q 2002 and EPS positive in 2Q 2002, which cannot be said of its competitors.

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