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Where the Real Internet Money Is Made

Sooner or later, advertisers had to figure out the Internet. Here was a medium that was reaching into nearly every office in America. And at home, it was wresting millions of eyes away from the TV. It could even count mouse clicks. Today, Net advertisers are finally hitting their stride.

It started with advertising on search engines, such as Google Inc. (GOOG), which collectively grew in five years from near zero to a $3.9 billion chunk of the online ad industry. Now companies are rushing to promote their brands with ever more banner ads, skyscrapers that crawl up the pages, and full-motion videos. Internet advertising should reach $9.4 billion in 2004, according to Kagan Research LLC. And with continued double-digit growth, it's on pace to surpass magazine advertising in about two years, adds Kagan.

Right now, excitement about online advertising is behind a wave of industry consolidation. AOL (TWX) dished out $435 million for in June. In mid-November, Dow Jones & Co. (DJ) agreed to buy CBS Marketwatch (MKTW) for $515 million, a rich 30 times next year's estimated cash flow. Analysts believe that Dow Jones, whose is available to subscribers only, is looking to tap the bounty of advertising that a free site can attract because it draws more visitors than paid-for competitors. The current fever has a hint of the dot-com craze, but there's one vital difference: While the advertising stars are still spinning bold visions of the online future, they're measuring their progress with profits every step of the way.


How can investors make money on this trend? Lots of ways. Beneath the twin peaks of Yahoo! Inc. (YHOO) and Google -- both pricey after sharp runups during the past year -- a prosperous industry is taking shape.

In the thick of the surge are ad agencies that specialize in online business. They are pulling advertisers to the Web by providing technology that enables them to measure precisely the impact of any given ad. Or they can follow up with customers who respond to ads. Consider fast-growing aQuantive Inc. (AQNT). The Seattle agency not only helps design campaigns for big-name clients such as Microsoft Corp. (MSFT) and Verizon Communications Co. (VZ) but is also the leader in managing advertising campaigns on search engines. Using automated technology, it bids on behalf of its customers for millions of search keywords, which are critical to getting ads seen on search sites. That's because each keyword positions a customer's ad next to the results from a specific search, whether the hunt is for can openers or Costa Rica vacations. This is a booming business for aQuantive, fueling projected triple-digit revenue growth, to $152 million, with earnings expected to grow from $11.8 million to $39 million. Says aQuantive Chief Executive Brian P. McAndrews: "We expect advertisers to keep following the eyeballs [to the Internet]."

Despite aQuantive's success, the stock has been a wallflower. Its $160 million acquisition of ad agency Razorfish in June took longer to digest than expected. The company fell short of Wall Street's estimates of third-quarter earnings. As a result the stock, at $8.38, is trading at 30 times projected 2005 earnings -- less than half of Yahoo's price-earnings ratio. Thomas Weisel Partners analyst Christa Sober Quarles says the hiccup offers investors a chance to snap up discounted shares. "As online marketing becomes more complicated, it becomes more important to bring in someone like aQuantive."

ValueClick Inc. (VCLK) is riding the same growth wave. The agency, based in Los Angeles, boasts a broad offering of services, from delivering online ads to monitoring their effectiveness and scoping out the best deals. Unlike aQuantive, ValueClick has not stumbled after doing deals. In fact, it has completed three in the past year without missing a beat. "They have an awesome record of strategic and financial acquisitions," says analyst Stewart Barry of ThinkEquity Partners LLC, a San Francisco investment bank.

The explosion of Internet ad prices -- the daily price of a banner ad on marquee sites such as the Yahoo or MSN homepage has doubled in the past year, to $300,000 -- is driving yet more advertisers to ValueClick. Its Commission Junction unit places ads on a vast network of Web pages for advertisers. Here, they are charged one-third the price per customer that they would pay on a premier site, according to Barry. Other ValueClick businesses range from search to e-mail marketing. Bolstered by acquisitions, revenue is on track to grow this year by 146%, to $162 million. Profits are expected to reach $41 million, with sales growing 31% next year, to $212 million. The bad news? The stock has doubled since August, and it's now trading at 35 times next year's estimated earnings -- pricier than aQuantive.

The Net's ad growth is benefiting online publishers every bit as much as the agencies. The trick, say analysts, is to find sites that reach a well-defined demographic. Here investors might take a look at iVillage Inc. (IVIL), the top-rated women's site. While men are easy to find at the financial, sports, and tech sites that they troll, women are far harder to locate online. With its attention to everything from child care and dieting to personal finance and astrology, iVillage receives more than 15 million unique visitors a month, nearly all of them women, according to comScore Media Metrix. IVillage leads the industry, with some 14% of U.S. women over 18 years old visiting the site. Says CEO Douglas W. McCormick: "We're a mini Yahoo for women."


The upward tilt on iVillage's stock chart looks every bit as steep as Yahoo's -- even though the numbers are far smaller. The stock, a former highflier from the dot-com days, was trading below $2 in 2003, before McCormick's advertising strategy got going. For 2004 the company figures that revenue will grow by 15%, to $66.6 million, and that it will eke out a profit of $3 million, marking its first year in the black in its nine-year history.

The stock now trades around $5.90, and analyst Youssef H. Squali of Jefferies & Co. (JEF) sees plenty of room for it to rise. The key, he says, is that iVillage is revamping the site to roll out more video -- both for ads and editorial features. "Advertisers are willing to pay 100% more for video than traditional banner ads," he says. And iVillage will create more video programming to accompany the ads, which he says may well attract more visitors to the site. "That could give them two engines of growth," he says.

As Internet ad sales mount, lots of companies are quickly steering their businesses toward the bonanza. InfoSpace Inc., the Bellevue (Wash.) company, has made its name selling ringtones for cell phones, but it also has a fast-growing directory business, including Yellow Pages. Ads now account for 60% of revenues. Analysts say the company is well positioned for the widely anticipated growth in local Internet ads.

For investors seeking a restructuring play, DoubleClick Inc. (DCLK) merits a look. The onetime titan of Internet advertising, it stumbled through the tech bust. Revenue dived from $506 million in 2000 to an estimated $290 million in 2004. While the company is still in the black, it's losing share to the likes of aQuantive and ValueClick. In November, DoubleClick hired investment bank Lazard LLC to explore its options, including a possible sale of all or part of the company. Since then, DoubleClick CEO Kevin A. Ryan says he has been fielding calls from prospective buyers.

No surprise there. The company still boasts solid technology to deliver ads and monitor and fine-tune their performance. These are tools the industry is hungry for. What's more, even after spending $100 million buying back shares over the past year, DoubleClick is still sitting on $389 million in cash -- 40% of its market cap and equal to $3.10 a share.

Investors can gamble on a possible takeover target or place their bets on a predator. Either way, Internet advertising promises a breathless ride in 2005.

By Stephen Baker

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