This is a sample Internet Review newsletter, originally sent to subscribers on Oct. 17.I regularly look at many different sectors of the market in my job running a fund of hedge funds, as well as for my various writings. Sectors I regularly follow include alternative energy, homeland security, areas in information technology other than the Internet, nanotechnology, closed-end funds, and any deep-value stock or company with an activist following. But no sector excites me as much as the Internet. The Internet, by itself, is an emerging market, and every day there are new sources of profit that the various public companies are trying to exploit, and new private companies are getting funded every day that will get bought tomorrow by the six companies out there currently doing a landgrab -- Google ( GOOG), Yahoo! ( YHOO), InteractiveCorp ( IACI), News Corp. ( NWS), Time Warner ( TWX) and Microsoft ( MSFT). Looking at the various statistics in the Internet sector is important for unearthing where the trends in profits and M&A will take us. For instance, in an article earlier this year I outlined the demise of traditional media and pointed out that the right direction would be to look at the companies taking advantage of the 10 million (and rising) blogs out there. I identified New York Times ( NYT) as potentially losing the battle and said that whoever bought blog aggregators like weblogsinc.com or Gawker would be the potential winners.
Stat No. 1: Keyword PricesThe average price for search terms fell again: According to Fathom Online via Media Post, the average price to buy a keyword on a search engine was $1.44 in September, down from $1.50 in August, and 26% less than the 12-month high of $1.95 in April. The categories down the most were investment, down 17% to $1.46; telecom, down 15% to $1.62; and automotive, down 2% to $1.51. Just to review: if you want to sell an item (let's say, hypothetically, dogfood) you would go to a search engine (Google being the common choice) and purchase the key words "dog food" for, let's say, 50 cents per click. Whenever anyone searches on the words "dog food" your ad would appear to the right. A click on the ad would result in your account being deducted 50 cents until you hit your allotted ad budget. What does it mean that prices are declining, particularly when spending on search marketing is up 40% year over year? Gregg Steward from Fathom Online comments: "We continue to see more volume being pumped into this basic commodity market of words and, as volume increases, prices tend to stabilize." As keyword purchases become a commodity, custom-tailored search engine ad campaigns become more important as companies seek to stand out and optimize their spending online. Although these stocks are not making the recommended list at this point, I am keeping an eye on CGI Holding ( THK) and Interchange ( INCX), two companies that specialize in creating search engine marketing campaigns for customers. Of the two companies, Interchange has the better balance sheet, but I'm nervous about its business prospects, particularly the focus on its new Local.com division.
Stat No. 2: The Number of Web sitesI mentioned this in my article on Mary Meeker last Thursday, but it's important enough to mention again. The Netcraft site,
Stat No. 3: Rise in Online Mobile WorkersiGillottResearch put out a report last April stating that the U.S. mobile workforce numbered 56 million, and it will rise to 61 million by 2009. From the Austin Business Journal in April 2005: "The report says the growth in mobile workers will be driven by more job functions becoming mobile, thanks partly to the installation of more high-speed wireless networks; more workers in already mobile-friendly sectors, such as the legal profession, becoming mobile; and mobile-friendly industries adding employees." In that vein, I'm adding iPass ( IPAS) to the model portfolio as a buy today at $5.50.
Right now, with the Christmas season looming, most investors are (quite rightly) focused on retail, and in particular the further effect the Internet is going to have on retail sales given high oil prices, which make it more difficult to conduct all of your shopping in your car.However, the key to the ongoing success and analysis of the Internet and its benefits on society is the enormous increase in employee productivity that the Internet has wrought. iPass is a cornerstone of this story: It helps over 2,400 corporate customers enable their mobile employees to connect securely and seamlessly into corporate databases through the Internet. It customers are sticky because once you sign up to get your workers mobile through iPass, it's very difficult to switch. But that is not the only fundamental reason to like this stock here. iPass, which is already profitable, has $169 million in cash and cash equivalents and no debt on the balance sheet. In other words, it's likely this company is in business for many years to come. The company's $350 million market cap and $169 million in net cash put its enterprise value at $180 million. With cash flow generated from operations clocking in at $36 million in the past 12 months, that means that even in a worst-case scenario where those cash flows start to decline, the company remains a buyout candidate. Shamrock Activist Value Fund bought shares starting at $6.29 last May (the fund filed an SEC filing May 23, 2005 stating it had accumulated a 7.17% stake) and Shamrock kept on buying all the way down to $5.29. In August the firm filed again, showing an 8.68% stake in the company. Broadband revenue, which offers higher margin and growth, is starting to kick in, although it's still a small percentage of overall revenue. So why are the shares so low? The company's core business is helping workers dial up to its corporate networks through narrowband wireline as opposed to wireless or broadband, and the narrowband business is in decline. Revenue in the quarter ended June 30, 2005, went from $35 million to $33 million year-over-year, but overall revenue was boosted by a $1.6 million increase in broadband revenue. To combat this decline, the company is actively switching customers to broadband and is focusing on its software connectivity services. Finally, Merriman Curhan Ford recently rated iPass a Buy with the following comments:
"Software sales. For FY06, we are estimating that iPass will generate $25M in mobile-device security software revenue. Symantec recently paid as much as 7x revenue for Sygate, one of iPass' partners. A 7x multiple would equate to a $175M price tag for iPass' software business alone versus the current EV of only $162M. Customers and partnerships. With 2,400 enterprise customers -- including 270 of the Global 2000 -- and a platform so well suited to integrations, we can't be too far away from some big customer wins and major software-related partnerships, in our view. Any such news could quickly move iPass shares away from today's deep-value position. Unlocking the valuation. The activist fund, Shamrock, has not had a visible impact on iPass yet. This is uncharacteristic of them, which might suggest that iPass is moving in a direction that will soon begin to unleash value."