My Netmares

By Daniel Kadlec

We all know the Internet is cool, fun and convenient--and fast becoming indispensable. What we don't know is whether Internet companies are worth the stratospheric prices they command in the stock market. That's the big risk you take in owning high flyers such as eBay and iVillage. Sure, they keep going up. But with little or no earnings, it's tough to gauge their ultimate value--and, possibly, not since William Henry Seward paid the Russians 2[cents] an acre for Alaska has a population (Internet junkies, in this case) been so thoroughly taken to the cleaners.

"Possibly" is the key word because for now, dreamy values for Internet companies persist. The jig isn't up, and it may be that this isn't a jig at all. AOL, which has risen from $86 to $164 in the past five weeks, may indeed be the most profitable company in the U.S. some years from now, though last year it strained to make $92 million. It's certainly priced for success. With a market value of $166 billion, it's already more than two times as expensive as Ford, the reigning profits champ last year at $22 billion. Another of the more interesting examples of com mania is a tiny online auction site called eCom eCom.com which on the strength of three coms in its name jumped 440% in two days last week.

Don't think Wall Street hasn't struggled with the value problem. Four years after Netscape rang the bell for Net mania with an initial public offering at $28 a share that soared to $58 in a day, underwriters remain skeptical and resist pricing Internet IPOs anywhere near where the market does. Last week Rhythms Netconnections was listed at $21 and closed the day at $69. Two weeks ago, Priceline.com started at $16 and shot to $69. If anything, the pricing of Net stocks is growing more off kilter. The average first-day gain for an Internet IPO has swelled from 30% early last year to 153% the first three months of this year, Commscan reports. Meanwhile, first-day gains in non-Net IPOs generally have been 10% to 20%, in line with historical averages. The gross underpricing of Internet IPOs this deep into a trend should tell you something: those closest to the companies don't believe the valuations are sustainable. Companies, underwriters and maybe 200 institutions first in line for IPOs set prices using a discipline based on some multiple of revenue, hits or subscribers that compares with similar companies in the market. But then individuals storm into the stocks at any price, resetting the value and raising the multiples for future Internet IPOs.

Underwriters have started capturing more of the initial value of Internet companies. It's an indication that the pros are grudgingly conceding that Internet companies may be worth more than they first thought. Online firms like Eoffering and Hambrecht & Co., which marked up its first IPO last week, are proving it by going straight to retail and garnering higher prices for their wares. That and the fact that some Internet companies have begun to make real money have prompted firms like Morgan Stanley and Goldman Sachs to begin raising initial prices on their deals as well. In the first quarter, 24 of 25 Internet IPOs were priced above the initial target.

But if it took the pros years to catch on, maybe these companies are more valuable than the revised opinions as well. I wouldn't get carried away with this logic. EBay at 7,600 times earnings a share (market average: 28) is a huge leap. There are good reasons to hop the Internet rocket. But do it on pullbacks, with a fund or basket of stocks--and money you can afford to lose.

See time.com/personal for more on IPOs. E-mail Dan at kadlec@time.com And see him on CNNfn Tuesdays at 12:45 p.m. E.T.