Suddenly, the Internet sector is buzzing with activity again.
After months of investors remaining indifferent to Internet-related companies beyond
bashing, Monday brought a few pieces of news that portend interesting times ahead for the sector.
confirmed it was buying search-technology contender
for $1.85 billion. And arch portal
announced it would buy social-network and photo-sharing site Flickr for an undisclosed sum that some reports pegged at around $16 million. While varying in size, both deals give some enticing insights on how Internet companies are trying to adapt to a fast-evolving industry.
Right on cue, Piper Jaffray's respected Internet analyst Safa Rashtchy issued a report entitled "It's Time to Buy the Internet Again." Rashtchy argued that advertising and search spending are ahead of expectations while valuations of many Internet properties are 20% to 25% below their levels at the beginning of the year.
"We believe investors should start actively buying the Internet sector again as several fundamental and stock performance factors clearly point to an imminent recovery in the sector," Rashtchy wrote. A key reason is that advertisers who were skeptical of the Internet's potential as a marketing venue have made a fundamental, more trusting shift in their thinking. As a result, many are giving the Internet a bigger slice of their ad-spending pie.
Internet companies are certainly acting as though they agree. IAC will issue 1.2668 shares for every Ask Jeeves share, valuing Ask Jeeves at about $28.24, or 27 times its forecast 2005 earnings and 4.8 times its forecast sales. It's also a $4-a-share premium over the stock's closing price on Friday. Ask Jeeves was trading at $28.04 in Monday trading, signaling that few investors were anticipating a bidding war from other companies in the market for a search engine.
Given the kind of optimism that analysts like Rashtchy are feeling about online advertising, Diller's grab for Jeeves makes sense. In a statement announcing the deal, IAC explained that "of the $260 billion in total U.S. advertising spend in 2004, less than $10 billion, or 4%, is online, with an expected annual growth rate of 13%." Rashtchy says that some advertisers are raising that ratio to above 10%, and Merrill Lynch forecasts search-related advertising to grow 24% a year over the next five years.
"By moving into search, Mr. Diller could not only capture some of the Internet online search advertising pie but also expand into one of the fastest growing segments for Internet companies," wrote Robert Peck, an analyst at Bear Stearns, in a Monday research note. Bear Stearns has done no underwriting business with IAC or Ask Jeeves in the past year, but it acts as a market maker.
But can Jeeves do more than add to IAC's earnings? Diller has actively resisted integrating his collection of e-commerce sites -- which range from travel site Expedia to dating site Match.com to Ticketmaster -- preferring instead to run them as an online strip-mall of specialty shops. Recently, Diller underscored that approach by splitting IAC into two entities, one housing its online travel reservation businesses, the other its remaining electronic-commerce segment.
But Diller has clearly been thinking about search as a thread tying his e-commerce empire together. In an interview in
magazine, Diller recently said, "If you define 'portal' as a search engine, then I wouldn't rule out
getting into the portal business -- though I also wouldn't want to give anyone the idea that we were planning on plunging in." (Of course not -- that would've driven up the stock price of Ask Jeeves.)
In buying Ask Jeeves, Diller is betting that search is all the glue you need to create a portal. Yahoo!'s efforts to unite disparate elements under its brand is overkill, if you take Diller's view. If the search engine in question were Google, he'd have a point. But Ask Jeeves may not have the user loyalty needed to pull off Diller's vision.
"For this deal to justify itself we think IAC will need to turn the traffic into paying customers at the other IAC brands," Michael Savner, an analyst at Bank of America Securities, wrote in a note. (BofA performed investment banking and market-making services for IAC, but not for Ask Jeeves.) "We think some investors will be concerned that Barry Diller is more focused on making deals than operating the existing businesses."
Monday's second deal is, although a hundredth of the size of the Ask Jeeves purchase, potentially as significant. Flickr, run by Vancouver-based
, took the notion of a photo-sharing site and built it into one of the most passionate online communities on the Internet. The acquisition, long anticipated among bloggers who are ardent fans of the site, comes less than week after Yahoo! announced its foray into social networking.
For Yahoo!, social-networking technology has the potential to make its site stickier -- that is, users would spent hours there, not just the few minutes it takes to check email and stock prices. Advertisers like
Procter & Gamble
and the Fox Network are lining up to put ads on MySpace, the social-network site controlled by
, because people under 30
spend up to several hours a day on the site.
But social networking has proven a hard vein to mine. Friendster, the first poster child for social networks, signed up millions of users but failed to keep their interest. Flickr has managed the trick by allowing people to share photos and search them. Many of its users upload photos daily to share developments on everything from world travels to home renovations, a degree of loyalty that Yahoo! has yet to foster in many of its online initiatives.
But in an unusual move, Yahoo! will control Flickr but it won't have access to its community of bloggers. And yet that's exactly what Yahoo! needs as it launches Yahoo360, a platform of blogs and recommendations that is its attempt to crash the social network phenomenon.
On the Flickr site where the company's executives maintain a blog, founder Caterina Fake made it clear that the two initiatives will remain separate. "Yahoo Photos will get a lot of Flickr features," Fake wrote. "Yahoo Photos and Flickr have different kinds of users with different needs, and will remain separate for the foreseeable future. Flickr would also suffer from a sudden deluge of /LOL!!!!!!!!!!!!!!! omg!/ so we're going to grow it carefully."
Both deals give a picture of the state of the Internet in March 2005: Search, with potentially explosive ad-revenue growth, is hot. Social network, with its ability to cultivate loyal and sticky audiences, is hot. But it's going to take more than old-fashioned M&A for the bigger, older Internet giants to tap into these hot trends.