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At GoTo.com, Trying to Shed the Portal Baggage

GoTo.com's (GOTO) business concept makes it one of the more intriguing stories among Internet stocks. Unfortunately, few investors have been hanging around to notice.

The company crosses a search engine with online advertising -- two businesses that haven't been thrilling Wall Street, unless they belong to America Online (AOL) or Yahoo! (YHOO). Shares in GoTo.com, which spiked as high as 114 1/2 last November, have drifted downward this year. The stock was trading at 15 5/8 Monday, following a bounce back from its 52-week low of 10 in early July.

But the market's distaste for GoTo.com masks a palatable story, as far as Internet stocks go. The company reported positive cash flow from operations in its latest quarter (thanks to settlement of a lawsuit against Disney (DIS)), it has nearly $100 million in the bank and analysts' predictions that the company will be regularly cash-flow positive by early 2002 don't appear to be a stretch. In the second quarter ended June 30, the company reported an operating loss of $43.3 million -- $30.6 million of that in the form of noncash amortization charges -- compared to an operating loss of $8 million one year earlier.

A Different Plan

GoTo.com's business proposition is that capitalism makes for a half-decent search engine. Whatever you search for on GoTo.com, the listings you see are from the sites that are paying the most to be seen: They're listed in order of the amount of money each site has agreed to pay GoTo.com each time an Internet user clicks on that listing to go to the company's site. (Companies bid for top placement through ongoing, automated auctions of the search terms they're interested in.) As an entertaining feature of the site, users can see how much companies are paying each time users click on their GoTo.com listing.

Road to Nowhere?
Tracking GoTo.com's steep slide

Source: BigCharts

So if you were to type "Web site hosting" in GoTo.com's search box on a recent day, the first link would be to www.webforminformation.com, which has paid $4.63 per click to be the top listing. Type in "Happy Meals" (as in the kids' meals sold at McDonald's (MCD)), and you can see that a toy store has paid a penny a listing for a top spot.

The pay-for-placement suits the tens of thousands of affiliates that GoTo.com says have incorporated the search engine into their sites. They get a cut of the revenue that GoTo.com generates from searches initiated on their home turf.

Advertisers who want to target their pitches to an attentive audience like the payment arrangement, too. But does the payment system come up with results users find useful? In theory, yes. It's in companies' best interests to be relevant to people searching for a particular term; why would a company pay for users to come to its site if the users don't want to be there?

In practice, user satisfaction is harder to gauge. It would be enlightening to see statistics covering whether, and how often, GoTo.com users reuse the site. But the company says it can't track repeat business at its affiliate sites, which account for 90% of the search engine's traffic. And it doesn't disclose repeat-usage statistics for the GoTo.com stand-alone site.

But the statistics the company is publicizing are moving in the right direction. Revenue for the second quarter was $21 million, up 22% from the immediately prior quarter and nearly six times the year earlier figure. Paid clicks grew from 88 million in the first quarter to 93 million in the second. And the average price that advertisers paid per click in the second quarter was 21 cents, up from 19 cents in the first quarter and 11 cents last year.

You Can Do Magic

One fan of the stock is Ethan McAfee, Internet analyst at T. Rowe Price. GoTo.com, says McAfee, "grows faster than the Internet." The company's revenue, he points out, is determined by the number of searches on the site, the percentage of searches that yield a paid click and the average price per click. "Any incremental small changes in any one of them," he says, "yield huge changes in incremental revenue." At GoTo.com's current price, he says, "It's one of my favorites in the small-cap/mid-cap space." T. Rowe Price bought into the stock at an average price of about 16, he says, mostly in the past three months.

Darren Chervitz, senior analyst at the (JAMFX) Jacob Internet Fund , another shareholder, says GoTo.com's business model is "obviously very impressive. ... When it reaches a magical point of inflection, it's going to be very profitable." But, he says, he'd like to see the company's revenue growing at a faster pace, something he's hopeful will result from moves like recent affiliation deals with Microsoft's (MSFT) bCentral small business portal and AOL's CompuServe service, as well as recent expansions into shopping and auction searches. McAfee says his only significant complaint about the company is that it could do a better job of managing Wall Street's expectations.

In addition to investors' distaste for unprofitable Internet companies, GoTo.com chairman Jeffrey Brewer says GoTo.com's stock is suffering because of investor bias. One problem is that the company is perceived as a second-tier portal when it's not a portal at all, he says, but an e-commerce enabler designed to be a part of many sites.

The second problem, says Brewer, is that Internet advertising is a bad business right now. But Brewer argues that the GoTo.com model, which gives advertisers a very clear picture of how much it costs to acquire a customer, works well in this time of limited ad budgets and skepticism about online advertising efficacy. "In an environment where Internet advertising has to work, and it has to be cost-effective, we win," he says.

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