Terra Lycos bets on portal power

Although Web portals are feeling the pinch of a severe advertising downturn, the company is sticking to its story: It offers unique strengths that will carry it through the storm.

Jim Hu Staff Writer, CNET News.com
Jim Hu
covers home broadband services and the Net's portal giants.
Jim Hu
7 min read
Spanish Internet service provider Terra Networks promised a rare success story when it signed up with Web portal Lycos last fall, but troubles at the combined company show it has yet to distance itself from battered rivals Yahoo and Walt Disney's Go.com.

Although Web portals are feeling the pinch of a severe advertising downturn, Terra Lycos is sticking to its story: It offers many unique strengths that will carry it prosperously through the storm. This week, the chairman of Telefonica, which owns a 37 percent stake in the company, told Spanish reporters that Terra Lycos would break even or post positive returns in its operating results for the year.

Those are bold words for a company that has faced a rash of executive defections, racked up hundreds of millions of dollars in losses last year, and remains saddled with a business model that many analysts believe may be fatally flawed.

"We definitely are negative on them," said Lisa Haas, an equity analyst at Wit SoundView, who has a "sell" rating on Terra Lycos and a price target of $9 a share. "When you see everyone falling off the cliff, I don't see how this company can be immune to that."

Terra Lycos' optimism comes as rivals such as Yahoo, Excite@Home, Go.com and General Electric's NBCi are reassessing their immediate prospects in the face of declining ad spending by dot-coms.

Just last week, Yahoo dropped a bomb on Wall Street when it revised its earnings for the coming quarter and said Chief Executive Tim Koogle would step aside. Many analysts viewed the announcement from the Internet bellwether as a bad sign for companies dependent on online advertising.

"When you see Yahoo show sequential decline in the first quarter...I don't know how (Terra Lycos) is going to get there," Haas said.

This climate raises the question of just how different Terra Lycos really is. Like Yahoo and most other Web portals, Terra Lycos relies on advertising for the bulk of its revenue. But the merger has aligned its business model more closely with Net access services such as AOL Time Warner's America Online, Microsoft's MSN and Excite@Home.

Stripping away these differences, Terra Lycos is primarily banking on its international presence to give it a competitive edge--something analysts say may be overstated.

The company already has a presence in 41 countries, and its relationship with Telefonica is considered key to its international strategy. The telecommunications giant has 60 million phone and 20 million wireless subscribers around the world. Terra Lycos expects to develop ways to serve advertising and market to Telefonica's cell phone customers.

But analysts say the jury's still out over how much growth the company can tap overseas, and some expect the advertising slowdown in the United States to affect markets worldwide--possibly limiting Terra Lycos' revenue options.

Looking into the numbers
Unlike AOL Time Warner, whose AOL subsidiary generates billions in subscription revenue every year and has been pegged as the company's primary growth engine, Terra Lycos cannot rely on its ISP business to buttress itself in times of trouble.

The lion's share of its revenue growth relies on advertising. In 2000, the company reported about $398 million in pro forma revenue from advertising on the portal and from its ad-supported free ISP. The company generated an additional $128 million from paid ISP subscriptions.

see special coverage: Lycos bought in billion-dollar deal For the fourth quarter, Terra Lycos reported a loss of 17 cents a share on sales of $164 million. Wall Street had expected a loss of 22 cents a share on $151 million in revenue.

"To the extent that the ISP itself is EBITDA (earnings before interest, taxation, depreciation and amortization) negative, I don't think it puts it in a better position for 2001," said Jeffrey Fieler, an equity analyst at Bear Stearns. "In the longer term, it is a diversified revenue stream, but it does not carry the same long-term margins that a portal does in an advertising perspective."

When the quarterly results were announced, executives were mum about projected earnings for 2001. But Cesar Alierta, the chairman of Telefonica, told a Spanish newspaper this week that Terra Lycos would break even for operating results for the year, according to Reuters. That's in spite of a loss of $348 million EBITDA in 2000.

Wit SoundView's Haas expressed a heavy dose of skepticism over the break-even projections. Despite management's guidance, she expects Terra Lycos to report an EBITDA loss of $280 million.

Cash in hand
Most analysts agree, however, that Lycos is better off as Terra Lycos. Lycos.com ranks in the top five most trafficked sites among U.S. consumers, according to Media Metrix. The company also offers Internet access through Terra Networks, both in an ad-supported format and as paid monthly subscriptions. It has 6.1 million paid and free ISP customers.

The biggest plus from the merger was the $2 billion in cash that Telefonica infused into the company in September and the five-year, $1 billion advertising commitment from German media giant Bertelsmann.

It's not the access revenue that will keep Terra Lycos standing--it's the cash: $2.4 billion as of Dec. 31, 2000. That will keep the company around for a while and give it the freedom to acquire smaller companies to bolster its online services.

"You can hunker down and pull the sheets over your head and hope it goes away," said Stephen Killeen, the recently appointed head of Terra Lycos' U.S. operations. "But the other alternative is to be aggressive and to create new models."

Killeen, less than two weeks on the job, said the company has many areas to explore in terms of tapping new revenue and growing its advertising base.

Overcoming history
Still, combining Internet access with a Web portal has not proved to be a winning strategy.

Deals such as the ones between Excite.com and @Home or InfoSpace and Go2Net were inked to create new companies that could tap monthly subscription revenue and advertising revenue. Giving consumers access to the Internet was thought to make them loyal customers who would use the portal as their default start page. And in the same way that AOL has offered Internet access with content on its online service, new tie-ins between access and content could potentially reap the same benefits.

The end result has not been pretty.

Excite.com was acquired by cable ISP @Home in 1998 for $7.2 billion in overvalued stock. Today, the deal looks like an expensive flop that has resulted in billions in paper losses for the company now that online advertising dollars have begun to slow. Few executives from the original companies remain, and current Chief Executive George Bell plans to leave.

The situation was ugly at InfoSpace as well. The company, which develops Internet infrastructure for wireless services and Web sites, said last July that it would acquire Web content network Go2Net. InfoSpace wanted to deliver content and shopping services through Go2Net's sites as a way to grow its own business.

Just three months after the deal officially closed, trouble began to brew. CEO Arun Sarin, Chief Financial Officer Rand Rosenberg and Chief Operating Officer Russell Horowitz resigned in January for different reasons. InfoSpace later announced it would retreat from many of the businesses that it acquired from Go2Net and soon afterward laid off 21 percent of its work force.

Jumping out of the attic
Terra Lycos has also struggled to unite its portal and Net access services. The short history of the company has already been marred by key executive departures and management shake-ups that may have been a major hindrance to jump-starting the company.

In February, Terra Lycos CEO Bob Davis resigned from his post. He is believed to have resigned because of differences with Executive Chairman Joachim Agut, and he admitted to reporters that having two top executives did not work. Agut has assumed the role of CEO since Davis' departure.

On the same day, Davis' right-hand man, Chief Financial Officer Ted Philip, stepped down from his role to become vice president of strategic planning and mergers and acquisitions. Elias Rodriguez-Vina replaced Philip as CFO. Later that month, Abel Linares, chief executive of Terra Networks, resigned from the company.

The head of U.S. operations, Ron Sege, left to become CEO of Ellacoya Networks, a start-up networking company based in Merrimack, N.H. Terra Lycos filled Sege's vacancy with Killeen, the former CEO of financial site Raging Bull.

"This raises a lot of question marks for investors to who is going to drive the business," said Bear Stearns' Fieler.

South of the border
Investors are less likely to question where Terra Lycos will push its services. The Latin American market is especially important given the company's presence and the area's robust growth projections. According to Jupiter Research, the population of Internet users in Latin America will reach 86 million by the end of 2006, from 21 million at the end of 2000.

On paper, these projections highlight a healthy, growing market. But even though an area may show promise, companies still face the challenge of making a profit off these consumers. The two don't always come hand in hand--especially when advertising spending is on a decline.

"We're talking about an intensely competitive landscape where too many companies are going after an online ad market that's too small," said Lucas Graves, a Jupiter Research analyst.

Competition is rife in Latin America. The biggest players, including AOL, Yahoo and MSN, have made significant inroads. Local players with telecommunications partners have been especially successful in individual countries.

In the end, it won't be about whether people want to get online; it will be a question of whether companies such as Terra Lycos can make money off of them.

Compared with the United States, many countries don't spend as many marketing dollars. Lower purchasing power in developing countries means less money spent to reach consumers--and less room for e-commerce growth.

"I think there's still a lot of growth opportunities there because Internet penetration is small relative to where it is in the U.S.," said John Corcoran, an equity analyst at CIBC World Markets. "But we're in an environment where everyone's slowing down. What we see in the U.S. we see it first, then we see it in other markets after a lag."