JOHN TOMPKINS: Booming growth on the Internet

Copyright © 1998 Nando.net

The Internet is the fastest growing industry ever. The stunning maze of networks connecting millions of computers around the world is expanding more swiftly than any communications media before it: telephone, radio, fax, television.

The Internet is luring millions of viewers from their TV sets, cutting into first class mail, eroding catalog sales, hurting telephone traffic, menacing newspapers and magazines. Growing at warp speed, the Internet may well have more effect on the world than the invention of moveable type. It took 38 years before 50 million Americans were listening to radio. Television got to that many in only 14 years. The Internet had 50 million users in four years. It's estimated that over 120 million are online now with 134 million forecast for next year -- and that's a low-ball estimate.

All the numbers connected with the Internet are astounding and usually understatements. In the first quarter, Ticketmaster sold 523,000 tickets online compared with 153,000 in the same period of 1997. Amazon.com sold $148 million worth of books last year -- nearly 10 times its 1996 volume. Dell Computer booked just under $1 million-a-day in Internet sales for January 1997. By December it was having $6 million days. The list goes on: Travel agents sold more than $800 million worth of trips last year, nearly a third more than in 1996. $40 million of insurance premiums, $600 million in stock brokerage commissions.

What happened? Sometime within the last nine or so months, the Internet began crossing the line from exotic, expensive, technical device to ordinary household necessity. It hasn't reached critical mass yet; it's not quite as common as the fax or cell phone, but it's getting there faster than its wildest fans believed possible.

In a report issued a few weeks ago Mary Meeker, Internet specialist on Morgan Stanley Dean Witter's technology team, daringly forecast that next year -- 1999 that is -- more consumers will be using personal computers in prime time than TVs. Other estimates suggest that as many as half of those PCs will be connected to the Internet. Fear is driving the established media into the 'net as fast as they can jump.

For example, NBC, a unit of General Electric Co., agreed this month to invest up to $39 million for control of Snap, a small search engine company owned by Cnet Inc., a provider of Web and cable content. As part of the deal NBC gets 5 percent of Cnet.

Walt Disney, Time Warner, and a slew of other media and entertainment companies have been thinking about buying into a similar search engine or navigation service. So the NBC deal gave a quick boost in price to some of the better known of these: Yahoo!, Lycos, Excite, and Infoseek. The excitement rubbed off on the initial public offering of Inktomi Corp. on Wednesday. Inktomi designs search engines and is best known for creating HotBot.

Inktomi was priced at $18 a share as the market opened. Underwriter Goldman Sachs had originally expected the offering range to be $12 to $14. By Wednesday, this was hiked to $16 to $18 -- and that was just the opener. An hour or two after the opening, Inktomi had soared as high as $40 and it closed at $36 a share. Inktomi is one of the most successful of recent IPOs. Since it was founded in 1996, the company has not made a profit.

The extremely high valuations of such Internet stocks may give media executives pause -- until they consider the danger of not buying in. The enemy is already pounding at the gates. According to a late Pew poll, 36 percent of Americans now look to the Internet for news compared with 14 percent three years ago. In the same time period the audience for prime time TV news has plunged from 30 percent to 15 percent. Why do people surf the Internet for news? Because they can pick and choose the stories and get all the facts rather than just those an editor thinks are important. When the president's press secretary says something unusual, TV may carry a sound bite; but the word-for-word Q and A session is easy to find on the Internet. The complex struggle for power in Moscow is on the Internet in great detail (in English) each day while our news media focus on murder cases and sex scandals. (EDITOR'S NOTE: Though not exactly unbiased, we at Nando would like to think that Tompkins is right about all this.)

The explosion of the Internet into popular consciousness came so fast and quietly that many of us didn't notice it. Yes, ads on TV and in magazines have been carrying a small print Internet address for some time, but the trend has gone far beyond. This week we saw a banner ad plastered on the side of a New York City bus. It showed an old
drawing of Queen Victoria next to a picture of an unkempt woman of today. The legend said that if you wanted the queen but got the slattern you needed Infoseek. Then the company logo: a red circle with a red lower case "I'' in the middle. No explanation. Infoseek knew that many passers-by would know about it and the Internet without having to be told.

James Preissler, Internet analyst at Paine Webber, links the sudden expansion of the Internet to the emergence of the $1,000 PC. While PC hardware manufacturers and chip companies are reporting so-so results, low-priced personal computers are selling fast, helped along by price wars. Preissler says that many buyers of cheaper PCs seem to
be first-time buyers "who are buying in many cases expressly to get online." He believes that at $1,000 and lower PCs are hitting the critical price point of the kind that suddenly created a mass markets for TV, fax machines, and cable. What's more, low-cost PCs are particularly attractive to low income households -- a segment that's relatively untouched.

There are literally hundreds and hundreds of Internet-oriented stocks, though less than a hundred are pure Internet plays. For weeks, the stocks of Internet software companies have ranked first in price performance in the Investors Business Daily list of 197 industry groups. New Internet software companies now dominate the list of initial public offerings. Half of the technology news stories reported by Bloomberg involve Internet companies.

The Internet group of stocks rocketed up and up for the first quarter and then got sandbagged by the general pullback of technology issues in the midst of the second quarter. There's been some recovery, but that bump in the road made a lot of investors more cautious and less willing to buy risky names with little liquidity.

In spite of the lightning speed of Internet growth and the spectacular performance of some Internet stocks, there are only three small mutual funds devoted to investing in the Internet. Why only three out of thousands? The reason: volatility and a thin market. Add to that the difficulty of estimating the value of a company with great expectations and no earnings and you begin to understand. A host of aggressive technology funds have a few of the bigger Internet stocks in their portfolio: Amazon.com, America Online, Cisco Systems (Internet hardware maker), and Yahoo! (hot searcher). The biggest ofthe Internet fund trio is Munder Net Fund, a member of a sizable fund family based near Detroit. Munder has about $4.5 million invested in such stocks as Microsoft, Winstar Communications (telecom, info services), Axent Technologies (info security software) and Cisco Systems.

Overall, Munder defines Internet orientation very broadly. It returned 23.2 percent for the year-to-date vs. 14.6 percent for the S&P 500. NetNet is also ranked No. 2 in three-month return on Morningstar's list of the 25 top technology funds. Ryan Jacob, who runs the $600,000 Internet Fund, firmly refuses to consider any stock
that doesn't get most of its income either on or from the Internet. This means he doesn't own the likes of Microsoft or Intel. He does hold GMG Information Services an Internet venture firm; Excite (Nasdaq: ECIT) a search engine; Amazon.com; and Sportsline, web-based sports news. He likes Egghead, a discount software retailer that
closed its stores and sells online. Jacob's tiny fund has performed well enough to triple in net asset value since the first of the year. Year-to-date return: 24.48 percent.

"I don't think anybody thinks the 'net is a fad anymore," says Jacob. "We believe the Internet is slowly becoming a mass market medium. It's not a question of if these companies will become profitable, it's a question of how profitable they will be." He agrees with Paine Webber's Preissler that one of the biggest obstacles is the fact that you have to buy a computer, and the faster PC prices drop the faster the 'net will grow.

The third Internet investor is WWW Internet Fund, out of Cincinnati. The fund has returned 11.6 percent year-to-date. Its criteria for Internet stocks is rather broad and aims for a balanced mix of large, mid, and small cap stocks. It says it invests 50 percent of its $3.1 million of assets in larger mature companies. This eliminates all the
pure Internet plays from half the portfolio. The Internet stocks are often compared to the biotech group; both are highly volatile and many sell at a multiple of sales rather than non-existent earnings.

Some of that volatility has been caused by short sellers rushing to cover their position as a stock took off. The group remains a short selling target, but prices move so fast that only a nimble trader can play that game. A year or so ago, America Online was such a managerial mess that it was near the top of the list of popular short
sales. Now AOL has achieved the status of Internet blue chip -- the favorite Internet stock of hundreds of mutual funds. Since last November, AOL shares have climbed the chart on a 45-degree angle going from 32 to 90 with very few bumps in the road.

With 12 million subscribers worldwide, AOL is not only the largest Internet service provider but also a name that's almost a synonym for the Internet. With a major presence in Europe and Asia, AOL is pursuing an ambitious expansion plan. This month, for example, it announced the acquisition of an Israeli company called Mirabilis for $287 million. Mirabilis owns ICQ (I seek You) which is the world's leading messaging platform. AOL will build ICQ into a separate Internet communications system. The bottom line: ICQ is reportedly growing faster than AOL and its users spend much more time online than AOL's.

AOL's future looks golden, but can you stand a price/earnings ratio of 260?