Investment overview, April 1999

As the investment market at large begins to get the picture about the rapid growth of internet access and opportunities, many of the small cap UK listed internet stocks are gaining rapidly on investor excitement.

One of the best performers of the week was Affinity Internet Holdings, the AIM listed parent of Virtual Internet Partners, the specialist in own brand free ISP services. The company, which went public on the AIM market in April, has risen from its debut close of 142.5p to 242p - a rise of 69.8% in a couple of weeks. VIP provides an outsourced portal and free ISP service for major brands, and Egg is one of theirs. Egg is the Prudential's direct banking arm, which announced earlier this week that it will only allow new customers to join up online. VIP will provide Egg with free access and e-mail as part of Egg's complete on-line package to its existing 500,000 subscribers, of which about 30% are already estimated to have internet access. The deal was very high profile for Affinity, adding another major brand to a roster which already includes Arsenal Football Club, Toys "R" Us, Tiny Online, the University of Lancaster and Reed Business Information.

Virtualinternet.net, the domain name and hosting company which went public on AIM earlier this year, is showing signs of returning to its valuation at its debut in February. The company closed the week ahead 13.8% at 267.5p. VI recently announced the purchase of NetSearchers, which combined with VI's win of the right to issue domain name registrations in the US has obviously impressed the market. The company is also solidifying its position in the French market, as it announced it is to exercise its option to acquire the outstanding 66% of the issued share capital of Virtual Internet SARL. The deal was satisfied by the issue of 250,000 shares in VI at 200p. Of the shares issued, 72,500 ordinary shares were placed with private investors at 200p per share. Virtual Internet SARL holds exclusive French contracts with AOL and Compuserve for domain names, web site hosting and e-mail services. Dealings in the new shares are expected to begin on 10 May. While there are issues that a domain registrar may not have a clearly defensible business model, the move into intellectual property protection with the purchase of NetSearchers and the move into the French market both look like moves in the right direction.

AIM listed On-line, the online gaming company, also managed a strong performance over the week, ahead 16% at 162.5p. This was on the back of some strong interim results to 31 December 1998, and news of accelerated internet product development. The company reported turnover up 5% to 0.3m while pre-tax losses were reduced by 5% to 0.09m. The Iron Wolves publisher is working on a number of different products, including a 3D stock market visualisation product, a soccer game Canal+ is nearing completion, and is set to begin development on games for Nintendo Colour Game Boy. One of the more interesting moves is a deal with US based ISP Netserve to develop a UK portal site (and believes the deal may lead to further arrangements in Europe and the Far East). Due to the nearly 1m raised as demand for the shares grew in January, the company has reviewed its strategy and may well accelerate through development and acquisition in relevant areas. It is also continuing to develop its online games porfolio, with a licence to develop SCi Entertainment's Carmageddon online.

However, there is still a lot to prove. Given that the profile of the sector has risen so greatly in the last few months, it is the next set of results that will prove whether On-line will live up to its present valuation. Products and strategies which are still in development need to be turned into revenues. The company has accepted that the last few months have seen a major turning point on the internet, but now it needs to prove its position. Hodges said in a statement, "Finally the internet has begun to sweep the UK and with it our fortunes have turned." By anyone's standards those are fighting words.

But across the board, the big issue of the week had to be free internet access. And it wasn't the internet stocks which were making the news, as the free internet access model was extended by a number of new launches as well as the launch of a free phone call offer in addition.

The Mirror Group officially launched its own free ISP and portal site, www.ic24.net, on Friday. The company reported it has secured over 1m in advertising revenues, and hit 50,000 customers already. The site includes access to BT Wireplay, the online games network, message boards, live news updates and access to the BOL (Bertelsmann Online) bookselling site. Although it is a new (and late) entrant in the free ISP market and the service was overwhelmed at times with new registrants, the general market response was positive. The launch sees the newspaper group join rivals The Sun (which has already launched its own free service, CurrantBun), and The Express, which launched its service earlier in the week. The interesting thing to watch will be whether or not The Sun's approach (a closed service, making the Sun available online only to its own ISP subscribers) will beat the open portal approach of its rivals.

It's not just newspaper groups getting in on the act. More retailers have followed Dixon's into the market. WH Smith launched a free service at the beginning of the week, promoting its own portal service. WH Smith claims that its service is different, aiming at the educational market, with content from MSN and Hutchinson Encyclopaedia's. WH Smith bought a good deal of content when it purchased small internet publisher Helicon Publishing earlier this year. WH Smith bought Helicon in January for 5.6m - a 48% premium to its share price at the time.

Retail group Kingfisher is also making a play, although from a slightly different angle. The group owns French electrical retailer Darty, which has announced a joint venture with Group Arnault of France to provide a free ISP service in France. The new venture will be called Libertysurf, and both Kingfisher and Group Arnault will own 40% each, with the remaining 20% being owned by technical support operator Softway and management partner Pierre Besnanou, the management partner. Kingfisher jumped 5.5% on the news, as launching in France may well provide a solid springboard into the rest of Europe.

Electrical retailer Tempo launch a free internet access service called screaming.net, which is also to offer free phone calls to encourage home usage. All calls made from a modem will be free during the off-peak hours, provided that partner Localtel (a BT reseller) gets the call traffic. This adds an interesting new twist to the tale. While the offer of free calls for modem access during off-peak hours may well encourage more home usage, which is great for the market as a whole, the cost will be astronomical. Unless Tempo can poach a large number of existing free subscribers and a large proportion of new users, it seems unlikely that the group will be able to attract sufficient advertising to support the growth of the service. However, the fall in charges may well encourage even more new users online. The present rate of growth is said to be that around 11,000 users sign up to the internet everyday. This may well be the first attempt to grow using the US approach - damn the losses, just get big fast!

The free ISP model is beginning to look threatened, at least for the smaller players. If free phone calls for internet use are the future, then while it may be good for the consumer in the short run, there is a possibility that only the giants will be able to afford to offer a free service. But whatever happens, internet companies in the UK and Europe are presently still valued far below that of the US. And with reports that a couple of major US players are looking acquisitively to the UK, it looks as though there may still be lot to play for in the market.