Internet market is consolidating rapidly

The Internet market is consolidating rapidly, with nearly double the mergers and acquisitions (M&A) activity taking place in the US market in January as it did in the whole of 1998. And analysts expect the takeover trend to expand into Europe.

According to a study by Internet consulting firm, New Media Resources, 11 transactions took place at a value of more than $11.5 billion in January - or close to double the $6 billion spent in the whole of 1998.

And the study showed there were 45 Web mergers and acquisitions totaling $12.9 billion in the first quarter of this year compared to $250 million in the first quarter of 1998.

Tim Miller, New Media Resources' president, says: "As long as the currency of Internet stocks are fully valued, these deals will continue."

He adds that two huge acquisitions in January this year - the $6.7 billion acquisition of Excite by @Home Corporation and the $4.6 billion acquisition of GeoCities by Yahoo! - fueled the high spending increase.

"I expect the number of acquisitions to grow in Europe. A general rule of thumb has been that Europe generally lagged behind the US by about 18 months, so I expect the number of acquisitions to increase over there in that same time period. We should expect the increase in M&A's in Europe in the first quarter 2001 if that rule applies," he explains.

He adds that it would be useful to watch where venture capital money is deployed "because the rate of international venture capital spending is picking up in Europe". In fact, nearly $50 million was spent on M&A activity in the region during the 15 month period, which ended in the first quarter of 1999.

Miller believes that the surge in M&A activity also indicates that Internet companies are increasingly voting to buy rather than build.

"The Internet market is developing with such velocity that in most cases it makes sense to buy a property, even if it means paying a premium. The time and energy involved to recruit and organise a team to build is so great that a company is almost certain to fall behind if it takes that route," he explains.

The report also indicates, however, that during the past five quarters, it is Internet "portal" or would be portal companies that are using their richly valued stock to head the buying binge. Nearly two thirds of all M&A related expenditure in that period came from @Home, Yahoo, Microsoft, Excite and Lycos. The five paid a total of $11.4 billion to buy 18 Web properties.

But mainstream content sites like Excite, Wired Digital and Netscape's Netcenter accounted for 57 per cent of the spending in the 15 month period, while community oriented sites such as GeoCities, Tripod and Silicon Investor made up another 26 per cent.

Ecommerce sites ranging from eToys.com and Buydirect.com accounted for only 12 per cent of the total, while five other categories comprised the other 5 per cent.

But the much hyped online retailer, Amazon.com, is also starting to make inroads into Europe, Miller says. "On the same day in April last year, Amazon.com acquired Telebook GmbH and Bookpages Limited, the UK's largest online bookstore," he explains.

Amazon.com has also just agreed to buy Alexa Internet, Exchange.com and Accept.com in three separate deals worth $645 million, and Derek Brown, a financial analyst at Volpe Brown Whelan suggests it will use the technology to monitor its customers as they surf the Web.

But it appears that buyers were willing to spend the biggest bucks on companies that could add new kinds of content and services to their own and the average price for such a purchase was $350 million.

Some 87 per cent of the total spend went on such Internet "line extensions", while a mere five per cent was spent on adding similar or identical content to buyers' existing sites.

"In coming years, we will see increasing numbers of smaller, specialised sites come into play as the Web, the narrowest of all narrowcast channels, begins to segment even more finely," Miller predicts.

"Never before has there been such a great opportunity for motivated individuals to have the potential of turning their passions into profits. And given that the Internet is inherently "virtual", there's nothing to prevent flourishing Web businesses to sprout in any location in the world," he claims.

According to his report, however, California was the most popular place to go to make a purchase. Organisations spent about $16 billion or 87 per cent of the total expenditure to buy more than 60 California Web based companies, accounting for between 35-40 per cent of the total deals done.

They spent only two per cent of their cash on international firms though, which represented only six per cent of the total deals.

"The Web site marketplace entered the early stages of consolidation in 1998 and heated up in the first quarter of 1999. Buyers paid and overpaid to grab position in the market before their competitors did and, in the case of publicly traded Internet companies, to buy while their securities were amply valued," Miller says.

"We can expect continued, and even accelerated, Web M&A activity in several areas. For one, there will be continued consolidation of power among an oligarchy of portals. Lycos, for example, is still prime picking for any number of applicants to that exclusive club," he continues. "Also, as the business to business market evolves, expect a great deal more activity among sites that appeal to business and professional markets," he adds.

Miller predicts that, after firms in the consumer and general interest markets are gobbled up, a flurry of deals is likely to take place in highly specialised industry sectors that appeal to small consumer and business niches.

But his report was further backed by industry heavyweight, Pricewaterhouse Coopers, whose Money Tree Survey indicated that venture capital (VC) investments in the first quarter of 1999 exceeded all previous levels, growing 41 per cent over the same quarter last year to $4.29 billion.

James Atwell, managing partner of Pricewaterhouse Coopers' VC Practice in the Global Technology Industry Group, says: "For all intents and purposes, the phrase 'venture capital investing' has become synonymous with 'technology investing. Technology companies alone received more funding in the first quarter of 1999 than the total investments in all industries in the first quarter of 1998."

Internet related companies, which include those across all standard industry classifications, more than tripled their funding to $1.84 billion from $501 million in the first quarter of 1998.

This represents a 218 per cent increase in dollar terms and a 105 per cent increase in the number of deals undertaken over a three year period. The number of Internet companies receiving funding also more than doubled to 236 from 114.

Atwell says: "The fact that the Internet is growing across all categories comes as no surprise. The shocking factor is the pace at which it grows. The Internet has grown at a faster rate than any sector we have ever tracked in the survey. Technology companies in general and Internet companies in particular continue to demonstrate immense business potential."

According to the survey, the number of start-up and early stage investment deals in 1998 was double that of expansion stage deals in the previous year, at 323 to 166.

However, the total amount of dollars that expansion and late stage deals drew was slightly higher than that poured into startup deals at $1.314 billion versus $1.313 billion respectively.

But as returns on investment into Internet startups continue to skyrocket, venture capitalists are now no longer the only investors willing to take a bet on high risk technology investments, with competition increasing from angels, corporate investors and entrepreneurs.

Jim Breyer of VC firm, Accel Partner, explains: "Valuations are doubling, tripling even and there's an influx of angels and everyone wanting to get in on deals."

Other venture capitalists agree. Rich Shapero of Crosspoint Venture Partners indicates there has been an increase in entrepreneurs matching VC investments in their portfolio companies.

"Angels and entrepreneurs are becoming more active in first rounds, and corporate investors, with promises of distribution and OEM deals, are moving into second rounds," he says.

Despite the increased competition, however, some feel that venture capitalists are offering less value than in the past. A surge of capital flowing into the VC business has led to an increase in the number of deals per firm, without a corresponding increase in the number of partners to sit on boards and work closely with entrepreneurs.

Accel Partners' Breyer says: "We are all really stretched. Some venture capitalists are on too many boards and not doing a good enough job helping portfolio companies."

Yet investors are not complaining - more than $15 billion flowed into the business in 1998 and that figure is expected to grow in 1999.

Crosspoint Venture Partners' Shapero exults: "We are celebrating the insanity. Yes, we're having to pay higher valuations, but we want to. We're running like hell to make hay while the sun shines."

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