While it's too early to quit on the Internet sector, the New Economy is facing its first major hurdle. In a March 20 article, Barron's reports that more than 50 public Internet companies are expected to run out of cash within the next calendar year. The projection is based on studies by Pegasus Research International, which reviewed the companies' annual reports and current revenue projections. Gloomy predictions for firms like drkoop.com, Medscape, Newsedge and SmarterKids.com were of little surprise to industry analysts. The inclusion of heavyweights like Amazon.com and E-Loan, however, did have some raising their eyebrows -- and worse -- panicking. The Barron's piece, coupled with the monopoly ruling against Microsoft, caused a plunge in the Nasdaq and made some investors rethink their tech positions.

It's in this sunny atmosphere that Benjamin Boissevain, managing director at Agile Equity, a New York-based boutique investment bank formerly known as E-Technologies, took the stage for a New York Capital Roundtable meeting in early April. The topic -- "When Dotcom Companies Fail." Boissevain's message -- "The fun with consolidation has just begun."

Boissevain echoed a prediction, held by many Internet industry analysts, that about two-thirds of the current roster of Internet companies will fail within five years. What's left, he said will be one or two companies within each "sub-sector." (For example, only one or two online book retailers, pet supply providers, or makeup moguls will survive the great Internet purge.) On the plus side, Boissevain predicts that the remaining one-third of Internet companies will succeed beyond everybody's expectations.

Three keys to solvency
So what's an investor to do? Boissevain outlined three keys to protecting investment positions in Internet firms at risk. The first is to follow macroeconomic trends in the Internet sector to determine value. The most important trend, according to Boissevain, is the "valuation vacuum." Since the Internet sector has so little history, no one knows for sure what the value of a firm is. Boissevain spoke of an M&A colleague who visited a business-to-business portal in Atlanta that was looking to sell. The M&A advisor spent a day with the firm, observing the bare light bulbs in the ceiling, the doors being used as tables and the milk crates serving as chairs. At the end of the day, he asked the portal's CEO what he thought his firm was worth. "It starts with a 'b,'" replied the CEO, presumably with a straight face. Said Boissevain: "That's a good example of the valuation vacuum." Since there's little room for comparison, it's difficult to place a value on a company, leading to overvaluation. "It's often better to sell now for a reasonable valuation," notes Boissevain, "than to sell a year from now for a 99 percent discount."

~ Boissevain's second key is to recognize M&A processes in the Internet sector. "This sector is moving incredibly fast. Be aware of your competitors. Otherwise you run the risk of being blindsided and becoming a fire sale." He outlined the "first-mover advantage" in the Internet M&A sector and the need to create competition. He advised those on the buy-side looking to snap up Internet assets to narrow their choices to at least three. That way, if one company with bare light bulbs and milk crates starts saying "billion," the buyer can move on to a similar firm.

If the worst happens and your Internet investment goes belly-up, Boissevain spoke of extracting the maximum value from "soft assets." When old economy firms go under, there are assets to be sold that can recoup some of the investment (e.g., inventory, machinery or real estate). With many dotcoms, all that's left are computers, office equipment and soft assets: a brand, a URL, content, customer databases and what Boissevain called "wetware."

Well-known brands, content or URLs can be sold, as can a database of desirable customers. Wetware is the completely intangible assets: ideas, management and bodies. Good ideas, even if they fail initially, have value, argued Boissevain. Specifically, patented or copyrighted ideas can bring monetary returns. A well-respected management team, he continued, can be attractive to buyers, even in the worst case scenario. Finally, a talented staff is always in demand. Specifically, Boissevain noted the demand for software developers and said that it's not uncommon for firms to be purchased just to get acquire the services of technical staffers. Boissevain mentioned the use of "golden handcuffs," or stock option grants with longer vesting schedules, as a way to keep coveted staff members from jumping ship after an acquisition.

Investment paranoia
"The street is winnowing out the winners and the losers," cautioned Boissevain. "That doesn't mean the Internet sector will go away." However, like a financial Boy Scout, he warns investors to be prepared. "Be paranoid," he said. "Every company should have an M&A strategy in their back pocket."