Web Pact to Shift Balance of Power, Balance Sheets

AOL, Netscape and Sun are throwing a holiday bash, but not everyone is invited. Investors in Internet stocks may want to take a good look at the guest list.

America Online’s $4.3-billion takeover of Netscape Communications, and the pair’s broad alliance with Sun Microsystems, launches a starry-eyed agenda for pervasive Internet use and electronic commerce. Should it deliver on its promises, the alliance arguably could influence the fortunes of myriad companies in an Internet-centric industry, just as Microsoft and Intel have defined the rules of the game for years.

The troika plays in virtually every node in the Internet chain. AOL is the dominant access provider, Netscape’s Navigator is the leading browser, and Sun’s servers are the hardware of choice for hosting Internet content. As owner of both AOL and Netscape’s hugely trafficked Web sites, or “portals,” the new AOL has the opportunity to serve and sell to both home and workplace users.

With Sun’s Java software, they have a development platform for cable set-top boxes and hand-held Web-access devices that could, among other things, go a long way toward fulfilling the slogan “AOL Anywhere.”

The deal has put a new spin on how investors size up the combatants in the turf wars that drive the Internet’s evolution. For some, like Microsoft, it represents a direct challenge; for others, a boon. However, if the long-term impact is likely to be large, it’s also largely unknowable. The deal demonstrates that no industry changes as fast and unpredictably as the Internet.

Among analysts interviewed, most say the group facing the clearest risk is the portals, particularly the search engines that have morphed themselves into Internet gateways providing information, advertising and services. Yet when news of the pact hit, almost all Internet stocks got a lift, including Yahoo, Excite, Lycos and Infoseek.

“There’s nothing rational to that response,” said Derek Brown, an Internet analyst with Volpe Brown Whelan & Co. in San Francisco. “The level of competition just increased dramatically.”

In the short term, the deal could drive more traffic to Redwood City, Calif.-based Excite, which is a prominent partner of Netscape’s own portal, Netcenter. But looking farther out, Excite’s place at the table may be endangered. “The opportunity for Excite to parlay its relationship with Netscape seems less likely now,” Brown said. “If I am AOL, I want to leverage Netcenter as much as I can.”

Henry Blodget of CIBC Oppenheimer in New York puts it this way: “The industry is becoming a waltz of elephants--AOL, Yahoo and Microsoft--and Excite is looking smaller and more lonely than it did a little while ago.”

On the other hand, the deal is likely to spur continued turbocharged growth for the entire business, allowing room for several portals to do well. With AOL pledging to keep its properties distinct in their appeal to different audiences, another portal might prosper by adopting a niche strategy of its own--focusing on being all things to fewer people.

Furthermore, the deal could force offline media giants to commit to acquiring the remaining independents, Excite or Lycos. That sentiment may be reflected in Excite’s stock price, a hefty $50.87 at Friday’s close. But if the terms of the AOL-Netscape, Disney-Infoseek and NBC-Snap pacts are any guide, rich premiums are not guaranteed.

If the troika makes good on its scheme for widespread Internet access via consumer devices other than PCs, Spyglass Inc. of Naperville, Ill., is positioned for sparkling growth. And analysts say it’s an idea whose time will come: International Data Corp. of Framingham, Mass., forecasts that 50 million such devices will be sold in 2002.

A few years ago, it looked as though Spyglass could have been a contender. In 1994, for $13 million, it licensed its Web browser code to Microsoft, which made the technology the basis of what became Internet Explorer. Having reinvented itself, Spyglass is now the only publicly traded specialist in non-PC Internet software and services. The two leading platforms for this not-quite-emerging market are Microsoft’s Windows CE and Sun’s Java, and Spyglass considers itself an arms supplier to both sides.

The AOL news, as well as a recently inked deal with cable set-top box designer General Instrument, whet investors’ appetite for Spyglass shares. The stock went vertical the week of Nov. 23. Even with a recent pullback to $21.75, it has quadrupled year to date in this overheated market for Internet stocks. Analysts advise caution in the near term but still describe it as a long-term buy based on the opportunities ahead.

“In the last several months, we are starting to see signs that this is a real market,” said Frank Sparacino of Barrington Research in Chicago, who expects the company to nudge into profitability this quarter. “There’s a great deal of volatility in the stock, but the market they are in is good and their clients are big, established names.”

Two software companies that enable multimedia within the browser may also be ready to ride AOL’s coattails. The familiar Shockwave from San Francisco-based Macromedia Inc. allows multimedia playback on the Web, and the company’s Flash product is used for developing and using interactive graphics. RealNetworks of Seattle distributes plug-ins that deliver “streaming media,” sound and video clips that play back immediately without having to be downloaded first. Both are free to the user (at least the lower-end versions), bringing in cash primarily through sales to content providers.

“The creators will presumably be more inclined to buy Macromedia software knowing that their content will be viewable on AOL and Netscape. It’s market development,” said software analyst Jay Vleeschhouwer of Merrill Lynch in New York. John Powers, who covers RealNetworks for BancBoston Robertson Stephens in San Francisco, concurs: “This is supportive of relationships RealNetworks already has. The core strategy is to get the players on the client machines for free everywhere and make it a no-brainer for the content deliverers to make content for it.”

This year, Macromedia rebounded from the decline of the Macintosh platform and internal marketing errors, Vleeschhouwer said. The stock started the year in the doldrums but has made a gradual ascent to $27.56 as its products gained momentum with Internet users. Vleeschhouwer rates it “accumulate”--a moderate buy signal--forecasting revenue growth approaching 30% for 1999 and 2000.

RealNetworks’ chart, on the other hand, looks like an EKG gone haywire. Much of the volatility can be linked to having Microsoft as not only a competitor but an adversary. Chief Executive Rob Glaser testified against his former employer and partner in July, and the giant of Redmond is in the process of divesting its 10% stake.

Sound scary? Not to Powers. “Never count Microsoft out, but Real is farther ahead in terms of products and partnerships than they were six months ago.”

RealNetworks has a dominant 85% market share, Powers notes. On the other hand, so did Netscape’s Navigator at one time. That doesn’t shake the analyst’s confidence. He says investors should treat RealNetworks with the same consideration they give to the industry leaders, which would imply a much higher price than Friday’s close of $34.19. “I consider it a core Internet franchise,” he said.

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Edward Silver can be reached via e-mail at [email protected].