Investment Overview, 25 June 1999

Recent reports that AOL is looking closely at offering a free internet access service caused a dip in Dixon's share price, with fears of the impact this might have on the Freeserve service causing the fall.

However, last week's Fletcher Report showed that Freeserve has by far the greatest share of the UK market. Its number of active UK subscribers far outstrips those of AOL (1.25m against around 600,000 for AOL UK and around 400,000 for Compuserve), The problem is that the majority of investors still fail to understand that in the internet they are not only dealing with a new form of media and business channel, but also with a business area where the boundaries are constantly shifting, pricing models may just last weeks and only those companies which can evolve rapidly will be able to win. On a regular basis commentators will declaim that it is time for the internet bubble to burst. Similarities with the South Sea bubble a couple of hundred years ago, or the biotech industry in the eighties are sited, but there are some serious differences.

At the moment, the internet is reported to have around 100m users worldwide. It is gaining over 80,000 new users per day and is predicted to hit 200m users in 2002. That means that it will double its reach in less that two years. The figure that is often quoted to explain the speed of that growth is that while radio took 38 years to reach an audience of 50m, and television took only 13 years, the internet took only four years before it hit the 50m point. And this is during a period where the predominant form of access is through the personal computer. Given the work done in interactive television, in access through mobile phones, PDA's, the falling price of high quality access and the development of technologies to ease connectivity, the speed of take up is only likely to increase. Research from Nokia suggests that mobile internet access may lead to around 900m user access points by 2002. In many ways, the majority of people who have gone online in the last few years have been those who don't expect it all to work perfectly. The advent of the free service appealed to the mass market as it meant that users were not having to pay for a service which doesn't always connect, which can be slow to access, and which can even crash a computer.

The rapidly increasing size of the internet market is something which we have never experienced before. It is also a media\um where users tend to increase their usage as its utility becomes ever clearer. And this growth, and increased user time online, translates into rapid growth for internet businesses. Some internet businesses in the US justify their enormous valuations on the basis of enormous revenue growth. Now it is pretty obvious that some of these will prove unjustified, but it seems equally obvious that those companies will create a leading position for themselves within the internet economy and be able to leverage that position for further growth. Amazon for instance, is no longer just a retailer of books. While its decision to build a physical distribution infrastructure has worried a number of commentators, its investment in a number of different businesses looks shrewd. Its latest investment, into Sotheby's, shows just how far the company is prepared to go in order to ensure that it stays ahead of its competition.

One of the biggest problems that the traditional market faces when looking at internet companies is the fact that many of these companies don't make profits. In fact, many of them don't plan to make profits for quite some time. This is for obvious reasons to those in the industry - the most important issue is to gain as much market and mind share as possible, as fast as possible, and leverage it later. But the noise level is now so great that marketing expenses have gone from high to astronomical. And these costs are charged immediately, leaving internet companies with very high costs, usually a relatively poor cashflow (or none for start-ups), and little to no asset value. In all honesty, it's not hard to see why a company of this ilk might frighten off a traditional investor.

But the business being done online is not just techies exchanging software, or people enjoying pornography in the privacy of their own homes, this is real people doing real business. And that business is set to increase rapidly as users get more comfortable and more and more individuals have access. The internet is used to exchange information, do our banking, buy our mortgages, music, books even houses. We can take a holiday, go to school, even stay in touch with work when we're on holiday (although that is not to be recommended). Intel's Craig Barrett said that in 1999 the company expects sell $15bn worth through e-commerce this year, suggesting that the research of established industry commentators such as IDC and Forrester Research on the levels of online commerce this year are likely to prove a serious underestimation.

In essence, much of the problem appears to be an issue of education and communication. On the one hand you have a nervous investment community (with a few honourable exceptions) combined with an industry which, at least in Europe, is still coming to terms with the demands of investors. The communication of the needs and expectations of these two groups has to be made if we are to move beyond our present stage. Within Europe at the moment, it is still headline news every time a start-up raises a couple of million pounds. It is only recently that we have begun to see start-ups raising eight figure sums. A slightly more risk capital orientated form of investment has begun to flower in Europe, and much of it is focusing on technology.

However the market is definitely shifting. More and more networking groups are springing up, both virtual and actual. It is not uncommon to bump into the same person during one week, with that person being from a country outside your own, and with the meeting place being in a third country! European internet companies are learning to work together, even it their main target market remains the US. While Europe's secondary markets still leave a good deal to be desired, the capital markets are improving across Europe, and the internet IPO may soon be common news. Good ideas for companies are ten a penny, its getting it developed and to market which is the issue. That being the case, my advice to anyone reading this, is go and find a great idea, a good management team and start banging on doors. You never know, you could well turn out to be the next internet billionaire.