Net Stocks Could Soon Hit Warp Speed

The initial offering of Britain's Freeserve may start a rush

Britain's largest Internet service provider, Freeserve, began last summer as a bunch of profit calculations hastily scribbled on a British Rail napkin. But just 10 months after its launch by British electronics retailer Dixons Group PLC, Freeserve is being hailed as Britain's answer to U.S. Internet kings America Online Inc. and Yahoo! Inc. By scrapping user fees, Freeserve has captured 28% of the British Internet market and spawned more than 100 copycats in Britain. Even AOL caved in and abandoned its monthly fee in Britain. Web surfers have fallen in love with Freeserve.

Now, the company hopes investors will fall in love with it, too. On July 26, Freeserve will float 18.25% of its shares on the London Stock Exchange and NASDAQ--Europe's first initial public offering of a major Internet company. Freeserve's IPO will serve as a barometer of European market reaction. A hit offering will signal that Europe is likely to catch Internet fever. In the U.S., most Internet shares rise 30% to 100% shortly after the IPO. If that happens with Freeserve, more venture capitalists will back the Continent's Internet startups. And Europe's telephone companies and cable operators such as Deutsche Telekom and Britain's Telewest may spin off their Internet-related businesses in IPOs.

Investors seem hungry for Freeserve shares. Freeserve has received more than 114,000 applications online for its prospectus. The bankers now value the company at $2.1 billion to $2.4 billion. That far exceeds the current market capitalization of the only two British Net companies whose shares trade in London, Easynet and Internet Technology Group, valued at $205 million and $116 million, respectively.

That valuation for Freeserve is still only one-third of what many analysts expected. But the company's bankers are conservative by design. By setting a value well below market expectations, they hope to ensure a successful flotation and pave the way for the dozen or so European Internet companies set to go public in the next year (table). "There is enough demand for Internet stocks to boost the first few that come to market," says Neil Bradford, director of Fletcher Research, a London-based Internet consulting firm.

The key to Freeserve's long-term success depends on how quickly Europeans embrace the Internet. Europe's Net use lags behind the U.S.'s by three years. Yet the advent of digital technology, high-speed Internet connections, and free access is likely to result in the Internet taking off at a faster rate in Europe than it did in the U.S. The number of European Internet users, now 34 million, compared with 64 million in the U.S., is expected to more than triple by 2003, according to Morgan Stanley Dean Witter.

Rapid growth in Internet usage coupled with a shortage of viable investments means that those European Net companies that do make it to market will trade at a premium, at least initially. "The biggest question is how sustainable these valuations are, given all the likely new entrants," says Dhiren Shah, head of Morgan Stanley's European technology group. Predicts Merrill Lynch & Co.'s European Internet analyst Peter Bradshaw: "A lot of companies will fall by the wayside, but the eventual winners will be goliaths."

Dixon expects to raise as much as $400 million from the IPO, half of which will go to Freeserve. The company spent a mere $1.6 million to launch Freeserve, which expects to break even in three years based on revenues from advertising, E-commerce, and a cut of phone charges. It plans to offer online trading in September and recently acquired, an Internet site for parents. On July 12, Freeserve CEO John Pluthero announced the launch of a credit card with U.S.-based HFC Bank.

TELCO CONNECTION. Many of Europe's first Internet companies will be backed by deep-pocketed parents such as Dixons or the telcos. The clout of the venture-capital funds devoted to European startups is growing, but it is still much less than in the U.S. This should change with the maturing of Europe's high-tech stock exchanges, such as Germany's Neuer Markt and France's Nouveau Marche.

As Europe's capital markets mature, the number of viable Internet plays will grow. Until then, the danger is that investors will indiscriminately value any company that puts "" after its name as the next Microsoft.

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