BUSINESSWEEK ONLINE : MARCH 22, 1999 ISSUE
BUSINESS WEEK E.BIZ

What Every Investor Needs to Know about Internet Stocks
In a Q&A, the high-flying Internet Fund's Ryan Jacob shares some secrets

If you think it takes split-second trading to make money in Internet stocks, meet Ryan Jacob. As manager of Internet Fund (WWWFX), he has earned shareholders a breathtaking 308% in the past year -- mainly by buying and holding industry leaders. In 1998, when his fund was the year's top-performer, turnover was only 20%.

So far this year, when many top Internet names have fallen well below their 52-week highs, the Internet Fund is up 71%. Other Internet sector funds are available, and they have all performed well. But his two main competitors, WWW Internet Fund (WWIFX) and Munder Net Net (MNNBX), are up 31%, and 42%, respectively, this year. Assets in Internet Fund have surged tenfold from a mere $20 million last December to about $200 million currently. But since it's still a relatively small fund, Jacob says he's having no trouble handling the flood of new money.

Jacob's charter is to buy companies that make most of their money directly from the Internet -- as opposed to companies that simply have an electronic business component. In just a few years, he thinks all companies will have to use the Internet to do business. "Companies that don't will be out of business," he says.

Business Week Online Associate Editor Amey Stone talked to Jacob about his strategy for picking Net stocks and about trends investors should keep in mind if they venture into this risky, high-priced sector. He may be only 29, but in Internet terms Jacob is an old-timer, and he has a broad grasp on the industry that makes him worth listening to.

Q: Your fund is up 71% this year, after gaining 196% last year. How did you do it?
A:
We focused on investing in industry leaders and employed a buy-and-hold strategy. That counted for a large part of our gains. We've also been fairly adept at identifying up and comers and making significant investments in those companies.

Q: So you're not one of the rapid-fire Internet stock traders we keep hearing about?
A:
Hardly. As point of reference, our turnover was under 20% last year. That surprises a lot of people.


Q: Here's what I'm really wondering now: How can your fund be up so much this year when many top Internet stocks are well off their 52-week highs? For the past month Internet leaders have been recovering from a steep slide that started in mid-January. But Amazon.com (AMZN) is still about 30% off its highs, and Yahoo! (YHOO) is off nearly 20%.
A:
Last year really closed out with a bang. So near the end of '98 and early '99 we became more defensive. We let cash rise to over 30%, which is high for us. In the latter half of January we saw stock prices come in considerably. Since that point, we have been a little more aggressive. We brought cash down to about a 15% level and I anticipate it will head lower.

The very turbulent market of the fast few weeks has given us an opportunity to pick our points and build positions accordingly. We also benefited from some of our larger holdings being acquired. Both GeoCities (GCTY) and Excite (XCIT) were acquired at 50% premiums to then-current share prices. That helped.

Q: Do you think the consolidation will continue? There are rumors of more mega-mergers, including AT&T (T) merging with America Online (AOL) and Yahoo joining up with Amazon.com
A:
I think there will be a lot of new deal activities, but I don't believe those rumors. People are just speculating. I would be surprised if the Amazon and Yahoo deal happened. That is slightly more plausible than AOL and AT&T, but still highly unlikely.

Q: Do you think you can keep delivering such high returns?
A:
Obviously, this is a high-risk and high-return fund. It's been more of high-return fund lately. But at a point last year from July to October, it lost almost half its value from peak to trough. That can easily happen again, and it is impossible to predict when it can occur. Long-term we feel very comfortable.

Q: So you think Internet stocks will continue to lead the market?
A:
Over a two-year-plus time horizon, yes. Many of these companies we own are growing 30% to 50% per quarter. It's very difficult to find another area of the market that is growing that rapidly.

Q: What about valuations?
A:
Over the last week, valuations have come up quite a bit again. CMG Information Services (CMGI) and eBay (EBAY) have had tremendous runs over the past couple of weeks and require constant supervision. Now we think they are more fully priced than they were a month ago. It can change that quickly.

Q: So are you scaling back again?
A:
There are times when it pays to be aggressive and times when it pays to be conservative. Now it may pay to be a little more conservative, where a month ago it paid to be more aggressive. I'm not saying to scale back, but to be more selective.

Q: So you mean companies that lead in their business segment and stand less of a chance of posting disappointing results?
A:
Yes, although, the big risk isn't that they are going to miss a quarter. The big-picture risk is that someone will come out with a better technology, or that someone will co-op their service to render them obsolete. That is why in this sector diversification is very important.

Q: Can you suggest some names?
A:
We still think there are some leaders that are selling at an attractive price on a relative basis. Yahoo is very attractive here. Another one is Inktomi (INKT). Broadcom (BRCM ) does not seem overpriced.

Q: When will investors start caring about profits?
A:
Profits do matter to investors. What you'll see is companies able to reach profitability will enjoy a big bump up in market values. Profitable companies like Yahoo, eBay, and American Online (AOL) already enjoy much higher valuations.

Q: You've made some changes to the fund recently -- adding infrastructure plays when it used to be all Web. Why?
A:
It goes back to when valuations got on the high side in January. We tried to look for areas that we thought had been overlooked. We focused on companies that will really be the Internet networks of the next century. That's when we added Qwest Communications (QWST) and Global Crossing (GBLX), IXC Communications (IIXC), and RCN (RCNC). To be fair, they are still a small portion of fund.

Q: What do you think of the 1999 crop of IPOs?
A:
I think it is a mixed group. Some are subpar. But there are some that I think are real companies with bright prospects. iVillage and Critical Path, an E-mail outsourcer, are two examples. That doesn't mean they will come public at the right price. On a price basis, a lot of IPOs are coming to market at rich levels.

Q: Now, let's talk about some specific companies in the news lately. What do you think of Amazon.com broadening product offerings beyond books? They now have a deal with Drugstore.com that seems pretty far afield from books, CDs, and videos.
A:
It does make a lot of sense. What they are doing is extending their brand relationship with consumers to other products. People go to Amazon because they feel comfortable with the brand as a place to buy. By taking a large equity interest in Drustore.com, they have extended their brand into that property rather than doing it themselves. That may be a strategy they employ in the future.

Q: What about Lycos (LCOS)? It used to be one of your top holdings, but you sold it when it announced its controversial deal with USA Networks (USAI).
A:
We weren't comfortable with the terms of the deal. I thought it was more advantageous for USA shareholders than for Lycos shareholders. We weren't really sold on the benefits of that type of vertical integration with Home Shopping Network.

Q: Do you think CMG will buy Lycos?
A:
It is possible, but unlikely. I still think the terms of the deal could be revised, but I just didn't feel comfortable holding on.

Q: Are you concerned about the federal investigation into fraud on eBay?
A:
Not really. Clearly, there are some issues, but for the most part it has been overblown in the press.

Q: Finally, I'll ask you the question raised by our cover story. What do you think every CEO should know about electronic business?
A:
I think that the Internet will be incorporated into all businesses within the next three years. The issue is not whether they have "brochureware" on the front end of their corporate Web site. The issue is the back end -- are they incorporating the Internet into their distribution and order-processing systems. Companies that don't will be out of business.


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