Dotcom bubble goes with a bang

It seems like the new kids on the block in IT services, such as Razorfish, Pixelpark and MarchFirst, are discovering the price of being in fashion earlier in the year.

Ian Mitchell

City briefing

It seems like the new kids on the block in IT services, such as Razorfish, Pixelpark and MarchFirst, are discovering that the price of being in fashion earlier in the year is that they are being unceremoniously dumped now the new season has arrived.

Four months ago I wrote in this column about how a new breed of IT services companies was emerging to advise companies, both dotcoms and mature businesses, on their Internet strategies. These consultancies appealed to clients who wanted advice on how they could take advantage of the opportunities offered by the Web but felt that the traditional services companies lacked the entrepreneurial vision to help.

Amid projections of rocketing turnover and caught up in the Internet bubble earlier this year, valuations reached unsustainable levels. For example, at its high of nearly $57 in February, Razorfish was trading at over 1,500 times pre tax profits and 31 times sales. Compare that with Logica, which at its peak was trading on 125 times pre- tax profits and 14 times sales, and you begin to see how much expectation was built into the Razorfish share price.

Earlier in the year when share prices of Razorfish et al were soaring there were predictions that the Internet services companies would take increasing chunks of the market from the more traditional services businesses.

In July, I said that my money was on the established players, such as CMG and Logica, adding the Web consulting and design skills before the new breed of services companies could acquire expertise in system integration.

That would appear to have been the correct call as the Web services companies have issued a rash of profit warnings and poor figures in recent weeks.

Marchfirst last week became the latest to disappoint, missing analyst estimates by a mile and writing 10% of its revenues off as bad debt in addition to warning that revenue would be flat over the next six months.

The bad debt write-off is particularly worrying - if you are working for dotcoms and they go bust you are going to be at the end of a long line trying to get your fees.

In addition, those companies that did work for dotcoms in return for equity stakes are at major risk of having to write off these investments as the share price of many of them falls. Many dotcoms have lost over 90% of their stock market valuation in the last eight months or so.

It is not particularly surprising that revenue projections have cooled off either. The last year or so has seen many businesses trialing e-commerce pilot projects, seeing what works before committing to re-engineering their businesses and there have also been numerous dotcom start-ups who needed help with their strategy.

Now that the clients are moving on from pilot to implementation phase, the traditional services companies with the track record of systems integration and the skilled staff to cope are winning the contracts. In some ways the traditional services companies must have a quiet sense of satisfaction that the Internet bubble has burst and that the upstarts are having problems.

Where the new boys were lining up takeover bids for established services businesses, now the tables are turned and it would be no surprise to see a wave of consolidation in the industry.

Ian Mitchell is an IT analyst with stockbroker Beeson Gregory. His opinions should not be construed as investment advice.

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