LONDON -- Freeserve (FREE) is falling. The question for investors is whether the company's shares -- the value of which has been cut in half over the past month -- are falling for the right reasons.

Shoving the shares of the U.K.'s largest Internet companies off its 52-week high seen in early March was a move toward unmetered Internet access by rivals

Alta Vista

and cable company

NTL

(NTLI)

.

Freeserve, one of the first Internet service providers to drop subscription fees in the U.K., still collects a cut from the revenue on metered calls to the Internet. Matching its competitors, Freeserve said that it too would offer unmetered access, a move that the brokerage

Cazenove & Co.

believes could eliminate three-quarters of revenue on metered calls by 2002.

That change in strategy was unveiled just weeks before Internet stocks around the world began plunging from their lofty valuations as investors rediscovered their fondness for old-world profits. Furthering the dot-com malaise were several high-profile European IPOs that flopped, such as

Lastminute.com

and

World Online

. On Wednesday, Freeserve shares closed down 44 pence, or 10.2%, at 388.

Never mind that Freeserve is neither a pure e-commerce company like Lastminute.com, nor a vanilla ISP like World Online, investors still seem bent on pigeonholing Freeserve as the latter despite all the evidence to the contrary.

When Peter Misek, an analyst with

Chase H&Q

, compared Freeserve to other media and portal companies in a March research note, his clients chastised him. "Investors told me that everyone values Freeserve as an ISP and so should I," Misek says.

Nomura

analyst Daniel Bieler says much the same. "The market perceives

Internet companies as all the same, there is still a bit of ignorance as to what Freeserve is doing."

So what exactly is Freeserve doing?

ISP to Portal

In anticipation of flat-rate Internet access, Freeserve began lessening its dependence on connection fees and transforming itself into a portal. For the third quarter ended Feb. 5, 55% of the company's 5.1 million pounds ($8.1 million) in revenue came from advertising and e-commerce.

Misek expects those activities to account for 70% of Freeserve's revenue for the year ending April 2001, more than compensating for the decline in connection fees. Misek rates Freeserve a buy, and his firm hasn't performed underwriting for the company.

Moreover, Misek argues that Freeserve's "hidden gems" warrant a stock price near its 52-week high of 930 pence. Freeserve's reported revenues from online advertising and e-commerce understate the company's potential, Misek says, because they don't reflect minority interests in

iCircle

, a portal for women;

GlobalNet Financial.com

, an online news provider and

TelePost

, a business communications provider. Adding to its basket of investments, Freeserve last week announced a joint venture with

Barclays Bank

(BCS) - Get Report

to form a small-business portal.

Nomura's Bieler says Freeserve's focus on niche portals, like iCircle and the Barclay's joint venture, stand a good chance of generating profits, because these targeted sites command higher advertising rates than general portals do.

Additional revenue should flow from

Marketplace

, a service for small retailers that want to sell online, but lack technical capabilities. For a fee, Freeserve will set small retailers up with credit card processing and list them in a search engine. Then there's a deal with

Sports Internet

, which gives Freeserve a slice of the lucrative online betting market. Moreover,

Camelot

, the national lottery incumbent, has chosen Freeserve as its online partner, should it win the new license, results of which will be announced in June.

Yet, even investors who've come to grips with Freeserve's changing identity remain unconvinced that the company can succeed to any great degree. And that leaves some with lingering doubts as to whether Freeserve should enjoy the rich multiples that other portals carry. Freeserve is currently trading around 258 times trailing 12-month revenue, compared with

Yahoo!

(YHOO)

, which is trading at 149 times.

Challenges Ahead

"Certainly, Freeserve has some claim to portal status," says David Donnelly, who runs the

Optimal Fund

, a U.K.-based hedge fund with 20 million euros under management. "I'd need more evidence that they're achieving their model to become a real business before I'd get interested."

Among the challenges: Portals tend to make money, and Freeserve is expected to remain loss-making for the next two years. Moreover, a portal's value is pegged to the number of users it attracts. While Freeserve is dominant in the U.K., it has no presence in the U.S. or the rest of Europe, where the potential for advertising revenue and e-commerce is much greater.

Advertisers are expected to spend $177 million online in the U.K. this year, compared with $621 million in Europe and $5.4 billion in the U.S., according to the new media consultancy

Fletcher Research

. Likewise, U.K. consumers will spend a fraction online this year ($1.5 million), compared with their European ($8.2 million) and U.S. ($38.8 million) counterparts.

Actually, the real value in Freeserve may lie in its attractiveness as a takeover candidate. "Freeserve has missed the boat to enter Europe," Bieler argues and its domestic dominance makes it attractive to any company wanting an immediate presence in the U.K.

Freeserve didn't return a call seeking comment.

Whatever investors eventually conclude regarding Freeserve's prospects, at the very least, they should understand what type of business they are buying.

"Freeserve is moving from an ISP to a portal to a marketing platform," Bieler says. "That's something the investment community must get

its head around."