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Despite downturn, online revenue gives high-tech companies cushion

Until a few weeks ago, this looked like a banner year for technology stocks. In the fall, the initial public offering of software-maker VMware rose 80 percent within the first few hours of trading. In October, Microsoft bought a 1.6 percent stake in social-networking site Facebook for $240 million.

But as stock markets worldwide churn amid concerns about subprime lending, technology stocks have taken a hit. Network-equipment maker Cisco, for example, forecast tepid performance citing a "pretty dramatic" decrease in demand from financial institutions.

So were the past few weeks a minor stumble for tech stocks? Or should investors brace for a repeat of the dot-com bust?

Though there are some skittish doubters, many financiers, entrepreneurs and analysts in high-tech point to evidence that the situation is different this time. Stocks are not trading at as high a multiple of earnings as they did seven years ago, investors are putting less money into each venture and many of the new companies have narrower ambitions focused on a practical niche.

What is fueling the boom this time around is a surge in online advertising, the release of a new generation of consumer products and rosy earnings forecasts from some of the largest Internet companies.

There are 1.3 billion people using the Internet, compared with 100 million in the late 1990s, meaning there is a base for business plans that were speculative just a few years ago, said Paul Saffo, a longtime technology forecaster. "There's none of the frothy sort of amateurish investing we had before," he said.

Shares of companies like Google, Apple and BlackBerry maker Research in Motion hit all-time highs, but stocks in the information-technology sector are trading at about 24 times their earnings, compared with 71 times earnings at the height of the tech bubble seven years ago.

"Investors have adopted more of a 'show me the money' or 'trust but verify' attitude and are not willing to go out on a limb on promised earnings," said Howard Silverblatt, senior index analyst with Standard & Poor's.

VMware, for example, is not the inexperienced dot-com of yesteryear. The Palo Alto, Calif., company, whose leadership is made up of seasoned executives in their 40s and 50s, has been profitable since 2003 and provides technology that allows computers run more than one operating system.

With its practical product, VMware represents a kind of shift in strategy for Silicon Valley, which has been about big ideas since its early days as a government-research center for radio and military electronics.

Historically, the more maverick the goal, the more scientist-entrepreneurs in the valley were willing to take part. In the 1990s, for example, nearly every plan scrawled on a white board that involved e-shopping secured funding. In part, that was what made this fertile ground for the semiconductor, the home printer, the Internet browser, and e-commerce, which were nurtured here until they were ready for the masses.

In the years since the bust, which wiped away billions of dollars in stock-market value and led to mass layoffs, the region has developed a sense of caution. Now, industry watchers say, there are fewer illusions that you must change the world to make money. Nowhere is that change more evident than among the venture-capital firms that finance companies at an early stage.

While venture capitalists continue to fund plenty of creative companies working on environmentally friendly energy, mobile services and medical devices, they are also branching out to finance more traditional business models.

In its 35-year history, venture capital firm Kleiner Perkins funded such groundbreaking companies as Genentech, Sun Microsystems, Amazon.com and Google. Investments this year include $50 million in YesPPG, a men's shirt factory in Shanghai, China. The shirt company has no high-tech dreams or breakthrough patents, but unlike many of the ventures Kleiner invested in the 1990s it is profitable.

"In China, there's a big emergent middle class and lot of clothes to be sold," Saffo said.

Likewise, Sequoia Capital, which in the past funded Cisco and Apple during their early years, just bought a $5 million stake in Noah Private Wealth Management, an independent financial advisory firm, and invested in a document-printing business.

It is significantly cheaper to operate a Web venture because many start-ups are being financed with personal credit cards or by angel investors without much cash. Online advertising services also allow Web entrepreneurs to start collecting ad revenue from day one to fund themselves.

"The really big difference between now and 10 years ago is that you can be a kid in a college dorm room and build something," said Darian Patchin, who worked through a number of start-up firms during the first tech boom. "The tools are better, there are easier ways to bring in revenues so you can stay up and running."

These days, a purchase bid from Google or Microsoft — or both — is the equivalent of an IPO. Some of the area's most innovative companies in recent years — Keyhole, for example, which developed what is now known as Google Earth — were snapped up by the larger companies before they had a chance to go public.

Part of what is driving the big buys in technology is the money flowing from private-equity firms, armed with cash from pension funds and yield-hungry university endowments. Tech firms also spent more than $70 billion in each of the past three years acquiring other companies, compared with a low of $33 billion in 2002 and a high of nearly $500 billion in 2000, Thomson Financial said.

Technology companies "are flush with cash," said Brendan Gilmartin, an analyst at Thomson. "They're using cash to fund a lot of these acquisitions, unlike the old days when they used the stock price. The metrics have changed ... they're more capable of executing a more grandiose plan, especially on the expansion front."

Some analysts warn that the caution characteristic of this boom would not insulate investors from a possible fall.

Investors had flocked to tech stocks in recent months because they were seen as largely isolated from the credit market jitters and also on the belief that they would be best positioned to take advantage of global growth in the face of a slowing domestic economy.

Now there are signs that overseas economies are weakening, such as in Europe, and some analysts question the tech sector's growth outlook. There may not be enough advertising dollars for every online company, they said, and corporations may not invest in technology in the way that networking and computer companies are forecasting.

"I don't think there's a whole lot of evidence they're doing that," said Mark Coffelt, chief investment officer of Empiric Funds, which has reduced its investment in tech stocks.

In a sign of how fragile the current tech stock levels might be, some analysts warily eye the weakness in semiconductor companies, even as software, networking and computer hardware makers have hit multiple-year highs. In late-October, for instance, shares of Texas Instruments, the world's biggest maker of mobile-phone chips, was considered a must-buy until the company surprised Wall Street with lower forecasts for the fourth quarter, causing its shares to drop more than 8 percent.

"There's a lot of assumptions in there about growth," Standard & Poor's Silverblatt said, adding that with the economy on shaky footing, it is far from clear just how this boom will play out.

In Silicon Valley, there is an agreement that possible complications, including the subprime mortgage crisis, the Iraq war and China's safety issues, are out of their control.

"The risks to the valley are all external," Saffo said. "If tech stocks crash, it's not going to be about what's happening here. It's what's happening everywhere else and the general state of the of the world. I see that everything is just pointing in a lot of different crazy directions."