IP: INVESTORS' INTERNET CRAZE UPENDING BALANCE SHEETS

[Dave Farber <farber () central cis upenn edu>]

(Sent to IP with permission).


Investors' Internet Craze Upending Balance Sheets
By Lee Gomes, San Jose Mercury News, Calif. Knight-Ridder/Tribune Business News


SAN JOSE, Calif.--Dec. 4--Starwave, a popular World Wide Web site devoted to 
sports, recently started up a new section covering the NBA; in barely a week, a 
million people a day were dropping by to read about the court antics of Charles 
Barkley and Shaquille O'Neal.


Another success story for one of those red-hot Internet stocks, like Netscape 
Communications Corp., that you've been hearing about?


Well, not exactly. The software behind Starwave's ``NBA.COM'' is from a company 
that many investors seem to think doesn't even know how to spell Internet: the 
Microsoft Corp.


That many Internet investors might be surprised by that bit of news is testament
 to a pattern that is becoming increasingly apparent during the ongoing and 
utterly surreal Internet stock frenzy: While many investors have added new words
 like ``browser'' and ``URL'' to their vocabularies, there's one word they seem 
to have forgotten: ``competition.''


> From the prices they are paying for Internet stocks, investors are acting as 
though gold has been struck, but only a few prospectors are heading west to mine
 it. The fact is, though, that in nearly every Internet category -- from 
hardware to software to services -- there is already intense jockeying for 
position, with even more on the way.


Internet investors are now paying extraordinary prices for stocks and getting by
 for now only with the promise of Microsoft-style future profits. But with the 
field getting as crowded as it is, will those profits ever arrive? The blind 
spot for Microsoft, which will be discussing its Internet strategy Thursday, is 
only the most obvious example of today's market. While apparently a pariah among
 Internet investors, Microsoft has a slew of Internet products waiting in the 
wings, and it looms so large on the landscape that by the time Thursday rolls 
around, IBM, Silicon Graphics, Sun Microsystems and Netscape will all have tried
 to strike first with major Internet announcements of their own.


But questions such as whether Microsoft will beat out Netscape in the Internet 
server business are the manifestations of just one form of the competition 
expected over the Internet in coming years.


It's also likely that many categories of Internet products will quickly evolve 
into commodity, low-profit businesses -- despite the fact that on Wall Street, 
nearly every Internet issue is at a price you might expect from a drug company 
that had just discovered a patentable cure for baldness.


The best example involves providing Internet connections -- the business of such
 current Wall Street favorites as Uunet Technologies Inc., which closed at 
$76.25 on Friday, up more than 200 percent in six months, and Netcom On-Line 
Communications Services Inc., whose Friday price of $70 reflected a similar 
percentage increase over the same period.


Internet connections is a business that Pacific Bell, the three major 
long-distance companies, most of the regional Bell carriers and even low-tech 
companies like Knight-Ridder, owner of the Mercury News, all plan on getting 
into in the next few months.


``I don't think there's any question it's going to become a commodity,'' said an
 insider at one of the firms.


Even more significantly, at least in terms of current Wall Street assumptions 
about the Internet, new and very basic questions are emerging about just how 
much of a gold rush the Internet will actually become.


At the center of things, as always, is a technology question: Is the Internet 
really some fundamental new technology that will change everything, the way that
 cars and trucks changed the ground rules under which the railroads operated?


Or instead, will the Internet's essential features, such as graphical Web pages 
and standardized connections, evolve into generic capabilities for all computer 
systems, in much the same way that multimedia functions did; capabilities that 
can easily be incorporated into most existing product lines?


In the first scenario, Internet companies such as Netscape become the new 
masters of the universe. In the second, they are simply tool providers.


Wall Street is betting billions on the first, but there are indications the 
other scenario is being played out; that firms not now considered ``Internet 
companies'' are quietly evolving their product offerings to add 
``Internet-awareness'' to them.


This is especially true for companies selling to Fortune 1,000 companies,


which will be making 80 percent of all Internet-related technology purchases,


according to an estimate by Zona Research Inc. of Redwood City, Calif. While 
some of these purchases will be to put up the sorts of corporate Web pages that 
are common today, the bulk of them will be to develop private, internal 
``Intranets'' for exchanging information internally and for employee-friendly 
access to corporate information.


Edify Corp. of Santa Clara, Calif., for example, began life five years ago by 
providing the software that allows people to get information out of touch-tone 
phones, as in ``Press 2 for more options.'' It eventually grew to offer other 
business services to companies, and now is taking its ``customer self-service'' 
software to the Web.


Customers of First Union Banks in Charlotte, N.C. can use Edify's Web-related 
software to check on their 401(k) plans. They log in through a Netscape server, 
but Edify's ``Electronic Workforce'' product handles everything after that, 
including creating Web pages.


``From our perspective, the web is a perfectly natural extension of our 
business,'' said Edify's Jan Haimes. ``The speed at which it has developed has 
affected our thinking, but the transition has turned out to be incredibly 
smooth.''


Similar moves are under way at ParcPlace-Digitalk Inc. of Sunnyvale, an 
eight-year old firm that sells software development tools to corporations using 
the ``object-oriented'' programming system. The company just released an 
extension to its product line for use on the Web; already, a Palo Alto financial
 services start-up, Integral Development Corp., has used to offer a Web-based 
service that calculate the prices of ``derivatives,'' those complex financial 
instruments.


It is widely assumed that more software companies will take the approach of 
Edify and ParcPlace-Digitalk. Data base companies like Oracle Development Corp.,
 for example, are already taking steps to use Internet technology to hook up to 
their data bases.


``The Internet is complementary to what most enterprise software vendors 
currently have,'' said Henry Morris, of International Data Corp., the research 
firm. ``Changing over to Intranets wouldn't involve massive surgery for most of 
them.''


The implication: Once all the fuss dies down, the Internet, at least inside 
companies, may turn out to be but a new spurt of growth for the existing 
``enterprise software'' market -- a huge and highly profitable business, to be 
sure, but not quite the cosmic realignment many investors seem to be 
anticipating.


There are some Internet technology suppliers, most notably Sun Microsystems and 
Netscape, that paint a more dramatic picture -- that the Web, along with a Sun 
computer language known as ``Java'' -- could lead to major upheavals in the 
kinds of software that companies use to conduct their business.


Sun has been remarkably successful at marketing that idea for most of the year; 
some sort of Java connection plays a role in many recent run-ups in Internet 
stocks. In some technical quarters, though, the Java story is greeted with 
skepticism -- such as among top executives of the some of the same companies 
that, in an announcement expected today, Sun and Netscape are listing as Java 
supporters.


``People have been talking about software development for years now, and every 
couple of years, some new software fad comes along that people say will change 
everything,'' said Bernard Guidon, vice president for Hewlett-Packard's computer
 systems group. ``Before Java it was object-oriented software, and before that 
it was automated software design. You never know, but my feeling is that while 
Java will have limited use, it won't make for a revolution in software.''


These sorts of strategic questions associated with the move to the Internet 
appear to elude many investors, who seem to believe just two things: that the 
Internet is going to be big, and that they want a piece of it.


``The attitude seems to be, ``Get the troops on shore. We'll make the army 
later,'' said Peter Canoni, who directs equity investments at Aeltus Investment 
Management Inc.


The utter devotion of investors to Internet stocks has startled virtually 
everyone in the technology business -- including those at the affected 
companies. None appear to be hyping their shares in penny stock fashion; to do 
so would be both ethically and legally problematic.


Netscape Communications Corp., in fact, seems to be going out of its way to 
dampen expectations. In late October, when the company announced a small profit,
 company officials warned investors they shouldn't necessarily expect more 
profits any time soon.


Nothing, though, has yet cooled things off. And few stocks better demonstrate 
the extreme peculiarities of current Internet trading, especially the lack of 
regard for future competition, than Spyglass Inc. of Naperville,


Ill.


The stock closed Friday at $106.75, quadruple its price in the summer; the firm 
has already announced a stock split. As for its fundamentals, in its most recent
 quarter, it had profits of $1.19 million on sales of $3.3 million.


Spyglass's main business is licensing rudimentary Web browser software for other
 companies to make products out of; it also has announced a line of server 
software for the same market. Quarterdeck, for example, relies on Spyglass for 
its Web offerings.


But bare-bones browsers are not especially hard to develop; as with a simple 
word processor or spreadsheet program, any small but competent team of 
programmers could come up with one in little time.


In addition, Spyglass does not supply any of the extra features that browsers 
need these days to be commercially viable, such as security or electronic mail. 
Those must be developed by Spyglass's customers, from whom it receives royalties
 of roughly two percent of the retail price of the browser.


Who are those customers? Actually, the better question is, Who aren't they? 
Netscape, for one, isn't; it wrote its own browser from scratch. And while 
Microsoft licensed Spyglass technology, it did so by way of a one-time,


$2 million payment.


But by one estimate, 80 percent of the browsers in use today belong to those two
 companies, meaning Spyglass gets no revenue from them at all.


While Web browsers may be the most ubiquitous and high-profile categories of 
Internet software, the actual sums spent on them are expected to be relatively 
minuscule. Zona Research projects browser sales in 1998 of just $134 million -- 
less than one half of 1 percent of the $31.6 billion it is predicting will be 
spent on all Internet technology. (Nearly 70 percent of that figure will be 
spent on hardware and Internet connection costs, it says.)


Working Spyglass's arithmetic -- 2 percent royalties on a 20 percent market 
share of a $134 million market -- suggests that in 1998, the company will have 
browser-related income of $536,000. That figure is an unlikely one,


since it's actually less than the company now makes, but the overall numbers 
involved don't suggest a huge upside potential.


Spyglass, of course, could strike it big in its new server business, but there, 
too, it's up against Netscape and Microsoft, among others.


So why the attraction to investors? Spyglass spokesman Randy Pitzer, like many 
people at Internet companies these days, is in the position of being forced to 
defend his firm and its products in the face of something -- its stock price -- 
over which it has no control.


``The only logical reason we can come up with,'' he said, ``is the opportunity 
that people see out there.''


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