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Web portals buy to survive

In the frenetic race to capture eyeballs and wallets, the goal of Web portals continues to be buy or die--even if it means acquiring a company with negligible revenue.

In the frenetic race to capture eyeballs and wallets, the goal of Web portals continues to be buy or die--even if it means acquiring a company with negligible revenue.

This week the trend continued when Excite@Home said it would acquire Blue Mountain Arts, whose popular site creates online gift cards, for $780 million cash and stock. Excite@Home will pay an extra $270 million in stock to the company if it achieves strong traffic, reach, and "performance targets," the company added.

Excite@Home said the company isn't addicted to takeovers. "Acquisitions are only one part of the mechanism to grow traffic," said Mark Stevens, executive vice president of corporate development at Excite@Home. "We are much more aggressively moving on the marketing front."

Still, the gap between Excite and front-runner Yahoo has been widening month after month, leading some analysts to question the company's ability to generate traffic organically. In February, Excite had 18.1 million unique visitors to its site, according to Media Metrix. In September, that number had fallen to 15.3 million.

"The only way these guys are going to be competitive and catch up [with portal leaders] is through acquisitions," said Jilani Zeribi, an analyst at market research firm Current Analysis.

Internet companies with soaring share prices have typically viewed acquisitions through stock-swaps as a cheap way to stay on the growth curve. But those deals also have blurred the price of takeovers by removing standard measures of value. Profitability was long ago discounted. Now, with deals like Blue Mountain, the assumption appears to be that revenues don't matter either.

Blue Mountain, which is a private company, has not disclosed its financials. But an Excite@Home spokesman said the company posted "little or negligible" revenue last year.

The purchase could become a major test of relatively recent ways developed to value Net companies--in particular, metrics such as the number of unique visitors, or "eyeballs," that a site attracts. In the case of Blue Mountain, financial analysts calculate that Excite@Home paid $87 for each unique visitor to the site during the last month.

It hasn't yet been proven whether that figure is cheap or expensive. By any measure, however, spending potentially $1 billion to boost traffic is a risky way to remain competitive. Although Excite's traffic will rise as a result of the deal, there is still uncertainty about the loyalty of these users and how much money the company can expect to make from them.

Another missing piece of the puzzle is what Excite@Home can do with these visitors--assuming it can retain them. As it stands, the acquisition gives Excite 9 million unique users. Excite@Home plans to integrate Blue Mountain's service into its other applications, such as its online calendar and shopping services. The company also hopes it can transform these new Blue Mountain users into subscribers to its broadband service.

The company's track record gives few hints of whether it will be able to pull it all off.

Just three months ago, for example, Excite paid $425 million for online shopping site iMall--a deal that some say has yet to prove its worth.

"In the past three months, Excite@Home has spent over $1 billion on stuff that has not demonstrated it can generate any significant revenue," said David Simons, managing director of research firm Digital Video Investments.

Adding to the uncertainty, the Blue Mountain acquisition comes as red flags have gone up over the growth prospects for Web traffic in general. Last week, Web audience measurement firm Media Metrix reported a month-to-month Web traffic decline or stagnancy among the biggest portals, including America Online, Yahoo, and MSN.

"I think it's safe to say that growth rates in the U.S. are not as robust as they were a year ago," said Derek Brown, an equity analyst at Volpe Brown Whelen.

Internet math
The Blue Mountain acquisition brings to light a phenomenon unique to the Internet: Big companies are willing to spend hundreds of millions--sometimes billions--of dollars for a smaller company without a clear business plan or strong revenue.

The classic example is ICQ, the Israeli-based instant messaging firm that AOL acquired for close to $300 million in 1997. AOL made the acquisition because of the sheer number of people using ICQ and its ability to market itself by word of mouth and email.

Although ICQ's user growth since the acquisition has satisfied AOL's ambitions, blossoming from 12 million when the deal was announced to 38 million now, the company has yet to figure out how to make money with it, analysts say. So far, AOL has tried selling advertising on the Web site and wants to create more e-commerce opportunities on the site.

But AOL has had to tread lightly with ICQ. The service has traditionally been free of advertising, and its user base is more Internet-savvy and international than that of AOL's proprietary service. AOL has not disclosed results for the service.

Excite@Home faces a similar balancing act over its plans to introduce the first advertisements onto Blue Mountain--only the ramifications could be even more serious than with ICQ. For one, ICQ is software that rests on a desktop that has to be uninstalled to disappear. With Blue Mountain, a competitor such as Egreetings is one click away.

"Part of [Blue Mountain's] appeal is its home-grown Ben & Jerry's flavor," said Digital Video Investments' Simons. "If Excite comes along larding advertising on it, it risks damaging its appeal."

Portals bruised but not broken
Despite brief glimpses of slowdown from the Media Metrix report, the Web remains a growth sector, analysts say. Wall Street does not pin all its judgments on the results of one metering firm. In most cases, analysts examine top-line revenue across many companies to determine the market's health.

David Levy, an equity analyst at Hambrecht & Quist, said he has seen "absolutely zero evidence for slow growth or contraction of business" in the Internet sector. Analysts usually caution people from making generalizations about the industry when Media Metrix releases its monthly traffic reports because of its small sample size and possible seasonal effects.

Nonetheless, Levy expects the portal Monopoly game to continue at its pace. The pattern will continue as Web companies use their stock as money to buy companies that can give them more reach.

"It can continue for a long time," Levy said about companies using acquisitions to boost traffic.