It's taken a while to get there, but a milestone has been reached in the coming of age of the Internet, at least on Wall Street. All of a sudden, the sector is facing the possibility of its first serious hostile-takeover fight: in this case, the struggle shaping up between Barry Diller of USA Networks (USAI) - Get Report and a chap in Boston named David Wetherell, who heads a marketing-turned-investment company called CMGI (CMGI) . The prize over which they've squared off? Control of the Lycos (LCOS) search engine company.

Here's the plot: Wetherell's company owns 20% of Lycos, which agreed back on Feb. 9 to be acquired by Diller's company, but at a price that Wetherell now says is not high enough. So he's hired the crowd over at

Morgan Stanley Dean Witter

to find someone willing to pay a higher price and has been telling people that if push comes to shove, he'll consider having his company buy Lycos outright.

This battle is instructive on several counts, most notably for the insight it provides into the way folks are thinking about Internet stock prices these days, and just how big a return they've become accustomed to expecting on their investment. And then there are the combatants themselves. In the one corner we find Wetherell, 44, a Connecticut farm boy turned computer programmer, who started what is now known as CMGI as a direct-marketing company to college professors back in the 1980s and who then was bitten by the Internet bug and has now transformed the business into a successful venture capital operation.

By all accounts, Wetherell fancies himself a cool hand at poker. But staring back at him from the other corner is arguably the coolest, smoothest cardsharp on Wall Street, Diller, who is in a game he simply can't afford to lose.

Barry Boy has certainly come in for his knocks

here at Eye to the Keyhole. But that is only because he is so unnervingly good at what he does: turning garbage into nuggets of gold. Diller's USA Networks is actually nothing more than a hodgepodge of junk, ranging from some out-of-the-way UHF TV stations to bits and pieces of the failed

Savoy Pictures

operation, parts of

Universal Studios

, cable TV's

Home Shopping Network

, the

Ticketmaster

entertainment ticketing service and a Web operation called

CitySearch

.

Yet it is certainly a testament to something -- though frankly, I'm not sure what -- that he has somehow managed to use these assets to float $5.8 billion of loans and other liabilities while at the same time goosing up the price of his stock by more than 600% in the past four years. Maybe it's because he's actually making money with USA Networks and the company seems to be erupting with cash flow in all directions.

Even his failures are impressive. Let it never be forgotten that in Barry Diller we find a man who back in 1994 actually tried and very nearly succeeded in buying Paramount Communications using stock from a cheeseball shop-at-home company (

QVC

) that he happened to own at the time.

In the very least, we may thus say that Diller is certainly a man with a long and rich experience -- and plenty of rich friends -- on Wall Street. Which leads to the corollary observation, based once again on the public record in these matters, that when it comes to takeover fights, Diller has most likely already forgotten more about the ways of Wall Street than David Wetherell will probably ever learn. It will be an interesting contest.

Lycos, as you may know, is generally regarded as one of the weaker of the four major search-engine companies (the others being

Yahoo!

(YHOO)

,

Excite

(XCIT)

and

Infoseek

(SEEK)

. It has roughly half the revenue of Yahoo! or Excite, yet during the 12-month period that ended Dec. 31, 1998, it racked up nearly seven times the losses ($121.3 million) of the rest of the group combined. Not surprisingly, Wall Street has thus given Lycos the smallest market capitalization of the four: $4.7 billion vs. $5.7 billion for Excite and nearly $35 billion for Yahoo!

As the whole world now knows, anyone who bought these stocks back when they first went public has reaped a phenomenal return since then. Adjusted for three subsequent stock splits, Yahoo! closed at 5 1/2 a share (split-adjusted) on its initial public offering date of April 12, 1996. Today the shares sell for 173 or thereabouts -- a gain of more than 3,000%. Even the worst performer of the group -- Infoseek -- has risen 691% since going public.

But having been swept up in the euphoria of a sector running free, investors have by now forgotten that for most of the past three years, these stocks proved to be very poor investments. Infoseek went public in June 1996 at 12 with its first trade in the aftermarket at 15 1/2, but the shares were still selling for barely 13 per share as recently as January 1998. Excite went public in April 1996 at 8 1/2 per share (split-adjusted) with its first aftermarket trade at 10 1/2, yet the stock was still selling for barely 11 in December 1997. Lycos also went public in April 1996 at 8 (split-adjusted) with its first aftermarket trade at about 14 5/8; by the end of the following year, the stock was still selling for barely 18. Even Yahoo! proved a flop in its first year as a public company: A year after its IPO, the shares were still selling for the same price.

What changed -- changing those stocks from dross into gold in the process -- was the frenzy of momentum-driven buying that spread throughout the entire Internet sector as 1998 progressed. Nothing fundamental transpired in 1998 to change the Internet into a more appealing investment than it had been in 1997. In fact, quite the contrary, a certain sober downscaling of expectations set in, particularly in the case of advertising revenues -- the presumed backbone of the entire Internet business model.

Nonetheless, as 1998 progressed, an absolute multitude of investors -- a growing number of them day traders -- piled into the sector, sending stocks like Yahoo! and the other search-engine companies into orbit. In one wild week alone -- from Jan. 4 to Jan. 11 of this year - Yahoo! soared 67% in value, Excite leaped 90%, Infoseek jumped 83% and Lycos, arguably the most troubled of the group, rocketed 142% in price, to 131 per share.

That 142% run-up, which lifted Lycos' stock price from 54 per share into the solid triple digits, now has Diller and Wetherell at loggerheads. That's because the run-up was caused by momentum players chasing the stock price in hopes of capitalizing on takeover rumors about Lycos that were flying everywhere at the time. Though the rumors mentioned such companies as

General Electric's

(GE) - Get Report

NBC

television network as a likely Lycos partner, Diller's USA Networks was even then secretly negotiating a deal to take over the company.

But Diller wasn't about to pay nearly $140 per share for a company that had been selling for barely $50 only a couple of weeks earlier -- which ignominy he handily avoided by the terms of the deal he wound up negotiating. USA Networks and Lycos would jointly create a new company -- to be called

USA-Lycos Interactive Networks

-- to be composed of Lycos along with USA Network's ticketing, Internet and home shopping businesses, but not including its recently acquired businesses from Universal Studios. The Diller side would wind up owning 61.5% of the resulting company, while the Lycos crowd would get 30%, with the other 8.5% going to various third-party shareholders.

Somehow Barry convinced the Lycos board that the resulting company would be valued at $22 billion (based on some pie-in-the-sky multiple of the combined revenues of the business -- roughly $1.5 billion). But the reality was no more complicated than simple arithmetic: The deal was saying, in effect, that 100% of Lycos would be worth 30% of the combined company. And since Lycos, at 131 per share, was being valued on Wall Street at $5.6 billion while USA Networks carried a $6.5 billion market cap, this meant that Diller was actually valuing Lycos at $84 per share at most (30% of $12.1 billion).

In fact, nearly half of USA Network's revenue and the great bulk of its operating profits derive from its television operations, which aren't included in the deal, suggesting that no matter how one values USA Networks, Diller in fact agreed to contribute a whole lot less than the full $6.5 billion value of media junk in his toy box to create the new company. Let's be generous and say that the Universal assets aren't worth anywhere near the $4.1 billion that he paid for them, but only $2 billion. Result? Two billion dollars has to be deducted from Diller's contribution to the new company, which brings the valuation of the Lycos shares down to about $70 each.

That's why Lycos' shares plunged from a high of 137 two days before the deal was announced to a low of 87 1/4 the day after: Investors simply realized that Diller wasn't going to pay a preposterous premium for Lycos just because some starry-eyed day traders figured he owed it to the market.

And that explains why Wetherell, whose company holds 20% of Lycos' shares, instantly began trying to talk their value back up by muttering that he wouldn't go along with the deal unless the shares rose back to 130-plus. It wasn't simply that the three-day slide lopped nearly $430 million off their value. No, the bigger and more menacing problem was that the collapse threatened to drag down the price of CMGI itself, a company that has soared by more than 6,500% since the autumn of 1995 on Internet mania and Wetherell's vaunted skill in incubating Internet initial public offering super-successes such as Lycos and

GeoCities

(GCTY)

, another of his startups. Of course, as with many other stocks in the sector, virtually the whole of the CMGI run-up has come courtesy of day traders and momentum players since the start of 1998.

Unfortunately for Wetherell, the strategy has not succeeded in lifting Lycos' price much above 109, which is why he has now resigned as a member of Lycos' board of directors and set out to derail the deal by hiring Morgan Stanley Dean Witter to find a Lycos buyer willing to pay more. If that doesn't succeed, he's even now saying he might have CMGI buy Lycos outright -- though his only reason for doing so would be to create a price-propping corner in its stock. After all, if he wanted it for any presumed synergies (which I personally think are nil), he would have bought the company back before Christmas when it was selling for barely 50 per share.

This is a high-stakes showdown, make no mistake, since one man or the other is bound to wind up with egg on his face big-time. If Wetherell succeeds, Diller will have been outsmarted by a man who talked an already overpriced stock right up and out of his grasp. But if Wetherell fails, Diller will have taken an important step toward returning pricing reason and common sense to Internet stocks.

Christopher Byron's column appears in the New York Observer, and he also writes a Wall Street and investing column for Playboy. He is the former assistant managing editor for Forbes, the Wall Street correspondent for Time and the Bottom Line columnist for New York. Byron holds no positions in any of the stocks discussed in his column. While he cannot provide investment advice or recommendations, he welcomes your feedback at

cbyron1@home.com.