Telefonica's Bid To Be A Cyberstar

Buying Lycos for $12.5 billion makes it a global player

The setting was New York, but the tone Spanish. On May 16, Telefonica CEO Juan Villalonga, Bertelsmann chief Thomas Middelhoff, and Lycos leader Robert J. Davis gathered at the Equitable Building auditorium on West 50th Street to announce a bold deal. Telefonica's Internet unit, Terra Networks, was taking over Lycos, based in Waltham, Mass., for stock then valued at $12.5 billion. As part of the deal, the German media giant agreed to buy $1 billion in services from Terra Lycos over the next five years and will provide content to its global Web sites. Asked where the new company would be based, Davis--named CEO of the combined Terra Lycos--began to answer. "Just a minute Bob," Villalonga interrupted. "I am where the business is."

Villalonga will need all the Latin bravado he can muster to achieve his goal of challenging America's Big Three --American Online, Yahoo! and Microsoft--for the global Internet audience. True, the Spaniard's bold move, modeled on the AOL and Time Warner pairing, brings together content and access spanning much of the globe. Terra Lycos could dominate Latin America, be a strong player in Europe, and grab a nice slice of the U.S. Hispanic market while bolstering Lycos' market share with greater investments in the brand. "Our goal is very soon to be No. 1 because the market rewards only the winner," said Villalonga.

But a lot will have to go right to turn this collection of disparate assets into a truly top-tier player. In the U.S. the Terra Lycos combo remains well behind the market leaders. And even in Europe and Latin America, where Terra Lycos is a pacesetter, a tough struggle is under way to control global media, telecommunications, and the Internet. Indeed, on the day after the deal, enthusiastic investors seemed to be having second thoughts: Lycos shares sank 21%, to $57.60, while Terra's American depositary receipts slid 12%. "Terra Lycos has a long way to go before seriously taking on AOL Time Warner," says James MacAonghus, analyst at Jupiter Communications in London.

Still, Villalonga's ambitious bid spotlights the Net's rapidly changing rules. Until now, the fiercest contest pitted American companies battling for U.S. eyeballs in the world's largest Internet market. But as the battlefield moves abroad, they face new competition. "The Internet economy is shifting away from a U.S. center of gravity to a truly international arena," says MacAonghus.

A key weapon in the coming battle will be stock currency. Despite a recent downturn, European Internet valuations have remained high, opening a window of opportunity for a few Old World players to grab American assets. Before the deal, Terra enjoyed a $15 billion market capitalization compared to Lycos' $6 billion even though it posted only $33 million in revenues last year--less than half Lycos' $68 million. "There's not a ton of Internet stocks in Europe" worth playing, says Lanny Baker, a Salomon Smith Barney analyst.

But an inflated stock price is a fragile basis on which to build a 21st-century global Internet powerhouse. With both Terra and Lycos shares falling hard the day after the all-stock purchase was announced, the deal is hardly risk-free. "The market is indicating that Terra should be priced much lower," says Jordan Rohan, media analyst at Wit Capital in Boston. Still, analysts figure the deal will pass muster with shareholders. Even if Terra falls to $25, Lycos shareholders will still realize a premium over the mid-30s value of their shares just weeks ago

Presuming they get the deal done, the combined pair won't face easy sledding in many of the world's major markets. Telefonica's profit-generating telephone services give Lycos a deep-pocketed partner able to boost advertising and Terra's two million subscribers could make Lycos Latin America's leading portal. But in the U.S., Terra only has a site directed at American Hispanics, while Lycos trails far behind AOL, Yahoo! and Microsoft among English speakers.

In Europe, too, Terra Lycos faces a tough task overtaking the number one player, Yahoo, not to mention local giants such as Germany's T-Online and France's Wanadoo. Terra plans to use its combined strengths--it dominates in Spain while Lycos is number three in viewership in Germany--to catapult further ahead. To do that, the new company will need more acquisitions. "Job No. 1 is building market share," says Lycos' Davis, who says he is near finalizing new purchases.

Even in Terra's Latin American stronghold, competition is fierce. Free Internet services are sprouting. Terra recently slipped to No. 3 in page views in Brazil, and Microsoft's T1MSN has 1.8 million users per month, well ahead of Terra, in Mexico. "I have a much stronger brand," insists Joseph P. Doran, MSN's international product manager.

The key to Terra Lycos' strategy is to localize content better than the American giants. Bertelsmann's content--which appeals to a young, global, Net-savvy audience--will help, too. The German media giant, which owns Random House, BMG Entertainment, and various European magazines, publishers and book clubs, long has been linked with AOL in Europe. But when AOL chose to merge with Time Warner in January, it sold its stake and was left with a 27.3% stake in Lycos Europe. "Bertelsmann needs to get into the Internet market with its content and Terra Lycos gives it a foothold," says Rebecca Ulph, media analyst at Forrester Research Inc. in London. Still, Bertelsmann is not taking an equity stake--and it could continue to supply rival AOL. "This is complementary," says Bertelsmann CEO Thomas Middelhoff.

Another huge wild card will be managing a complicated Spanish-American merger. The 47-year-old Villalonga, who will become chairman of Terra Lycos, is known for his firecracker personality and penchant for micromanaging. Now the blunt Spaniard must find a way to work with the hard-driving Davis, who comes from a working-class neighborhood in Boston. CEO Davis, who will be running the merged companies day-to-day, does not speak Spanish. When they met in New York, Davis offered Villalonga an American handshake and the Spaniard surprised him with a warm embrace. The unlikely duo now will have to tango to hold the floor with AOL and Yahoo.

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