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Britain.Com (Int'l Edition)


International -- European Cover Story

Britain.com (int'l edition)

Will Net mania set off a new phase of growth, or is it just a bubble waiting to burst?

From the outside, No. 20 Portman Square looks no different from any other Victorian townhouse on this quiet London street. But inside, the recently restored mansion is buzzing. In the ornate bar, twentysomethings talk tech into mobile phones, while Mama Love, a flamboyantly attired fortune-teller, reads palms in the corner. This is Home House, a private club favored by pop stars such as Madonna--and a microcosm of the Internet culture that's taking off in Britain. It's "a great place to eavesdrop on new Internet deals," says Tim Hammond, the 31-year-old CEO of Ideas Hub, a consultancy that helps Net startups.

Around London, similar scenes are repeated every day: Dot-com mania has hit with a vengeance. Droves of Britons, from journalists to investment bankers, are dumping their day jobs for a roll of the cyber dice. Many are hitting the jackpot. About a third of the $4.4 billion in venture capital going to European Internet companies last year went to British startups. Some 700,000 were registered last year alone. The surge in activity is transforming once downtrodden industrial neighborhoods like London's Shoreditch and Clerkenwell, which are now home to hundreds of tiny Net companies as well as chic apartments. Britain's budding Generation E is even the basis of a prime-time soap opera called The City, which will feature Netrepreneurs as the main characters.

But a debate is also raging about how deeply the Internet--and Britain's own Net companies--can change the country's economy. Some worry that Britain's sudden love affair with the Net is just the latest investment fad, yet another bubble waiting to burst. "There's far more money than sense at this early stage," frets consultant Hammond. "Companies with extremely rich valuations will have to deliver extraordinarily high rates of growth to satisfy investors," warns Morgan Stanley Dean Witter European investment banker Dhiren Shah.HIGH IMPACT. Others are convinced that the Net can tilt Britain into a new phase of economic growth, with rising productivity and scores of new jobs. Britain spent 3.5% of gross domestic product last year on information technology, compared with 2.5% in France and 2.6% in Germany. And while Sweden is more wired--it spent 4.5% of GDP on info tech--its small economy doesn't have the heft of Britain's. That's why a growing number of economists think Britain could be the first in Europe to create a U.S.-style New Economy. "In the U.S., you have seen technology-driven improvements in productivity. You will see that this year in Britain," predicts Stuart Weatherby, senior economist at WestLB Panmure Ltd. in London. He expects Britain's economy to grow at least 3.5% this year. Other forecasts range as high as 4%, vs. 3% on the Continent. "The impact will be felt first in Britain and then the rest of Europe," Weatherby adds.

Britain still lags behind the U.S. when it comes to its Net sector. So far, there's no equivalent of Yahoo! or Amazon.com to lead the pack and inspire others to innovation. But Britain hosts one company likely to be a champion in the next phase of the Internet's development--the mobile Internet. Just a few years ago, Vodafone AirTouch PLC was an upstart based in the sleepy town of Newbury, England. Now it's the world's largest mobile-phone company, and it recently sealed the biggest takeover ever by acquiring German telecom rival Mannesmann for $183 billion. The new company will have operations in Asia, the U.S., and throughout Europe, and its Internet cell phones will inspire a host of British companies to provide supporting software.

Vodafone won't be Britain's only ace. Venture capitalists are betting a number of strong regional winners--and perhaps even a few global Net powerhouses--will emerge. For now, the most popular Web site in the country, Internet service provider Freeserve, caters to a British audience (table, page 27). But other British Net companies are expanding across the continent and aim to attract users around the world. These range from well-known names such as the BBC to new companies such as QXL, a British online-auction site. Since its initial public offering in October, the company has moved quickly into other European countries and seen its market value rise to $3.6 billion. "QXL has a chance to become the eBay of Europe," says Merrill Lynch & Co. European Net analyst Peter Bradshaw.

Another attraction for investors in Britain is its strengths in media, marketing, and music. In the early days, the Internet spurred the creation of infrastructure and technology companies, many U.S.-based. These days, though, the focus is on services, content, and e-commerce, all potential outlets for Britain's creative talent. One of the more original British Net startups, for example, is Peoplesound.com, an online-music site that lets users across Europe download music from 4,000 emerging European bands for free. Other sites are quirky: Travellers can get medical information and access to a global network of doctors via Medicineplanet.com. Genealogists can trace their Scottish roots on Origins.net.

As for e-commerce, most trading is business-to-consumer through sites such as lastminute.com. It sells everything from airplane tickets to flowers to users looking for last-minute deals. Another popular site for hobby and sports enthusiasts is Magicalia.com, which sells everything from stamps to sports equipment. Merrill Lynch's Bradshaw predicts the total value of online sales in Britain will reach $47.6 billion by 2002. By then, two-thirds will come from business-to-business transactions, the backbone of the U.S. Net. "We're already seeing a move from consumer-based dot-coms to business-to-business," says Phil Rance, marketing chief for Credo, a London Net consultancy."KNOWLEDGE SOCIETY." How quickly the Net penetrates into British life could depend partly on Prime Minister Tony Blair. A self-described technophobe until late last year, he now wants to use the Net to create a kind of New Economy Albion. Blair promises to streamline regulations, create incentives, and invest government money to make Britain "the best place in the world" for electronic commerce by 2002. He has appointed the first e-commerce minister and is planning to spend $2.7 billion over the next three years in a drive to give nearly every student Internet access. "We are making a number of major changes in education that will make Britain better positioned for the knowledge society than even the U.S.," says Chancellor of the Exchequer Gordon Brown. The government is also talking about cutting its prohibitive 40% tax on capital gains to 22%, partly to bolster the IPO market.

Whether or not Blair and Brown live up to their promises, Britain has other advantages. Cambridge University and the surrounding area have become one of the most dynamic places for innovation in Europe. The Massachusetts Institute of Technology plans to establish a European enterprise institute at Cambridge that will administer a network of programs to focus on technology, entrepreneurship, and productivity.

Probably the biggest advantage for the British Net, however, is money. The City of London, long Europe's financial capital, is becoming the main channel for financing the European Internet. In the third quarter alone, British Internet outfits received $342 million in private equity investments from financial institutions, more than 20 times the amount invested during the same period in 1998. That compares with $243 million in France, $125 million in Germany, and $20 million in Sweden, according to Private Equity Research in London. "I've never seen anything like [this pace of change] in 15 years as a venture capitalist in the U.S," says Christopher Spray, a principal in the London office of U.S. venture-capital firm Atlas Venture Inc., which has backed 12 Net startups in Britain. Over the next two years, venture capitalists figure an estimated $3.5 billion will go to British Internet companies--out of $10 billion in venture capital expected to flood into Europe as a whole. "In the rest of the Continent, investors aren't as comfortable investing in New Economy-style companies," says Ellen de Kreij, a principal in the London office of Broadview International, a U.S. high-tech investment bank.

Since 1998, 50 British Internet companies have launched IPOs. A torrent of new listings is expected in the first six months of this year. Many of them are likely to receive sky-high valuations, analysts say, mainly because of the shortage of supply. The share price of JellyWorks PLC, an Internet investment company, soared 1,000% when the offering made its debut on London's high-growth stock exchange, the Alternative Investment Market (AIM) on Dec. 22, even though the company was just six weeks old. The shares of Oneview.net, a provider of Internet solutions to small businesses, are now trading at $80 on the AIM, up from an initial offering price of $1.40 a share on Oct. 1. The AIM shot up 139% for 1999, outperforming rival European exchanges.

It wasn't always this way, of course. Back in the early 1990s, Cambridge University mathematician Mike Lynch had to struggle to get backing for his software company, Autonomy, now an Internet hit on the Easdaq exchange in Brussels. Lynch had developed a sophisticated search software that relies on mathematical algorithms to scan large amounts of text and sort information according to the meaning and context of words. He couldn't get any financing at all until a wealthy eccentric, whom he met in a pub, gave him $3,000 in seed capital.

By 1996, he had built up a track record and customers, which finally enabled him to raise $15 million from venture capitalists. By the time of Autonomy's IPO in July, 1998, his customers included Reuters, Merrill Lynch, and British Aerospace, which rely on his software for their own Web sites. Autonomy now has a market cap of $5 billion, and more than half of its $30 million in sales come from the U.S., where Lynch plans a listing on Nasdaq.

Autonomy's success paved the way for others. Another British innovation helped open the floodgates. In October, 1998, four friends decided to get together on the first Tuesday of the month in the Alphabet Bar in Soho to trade advice on e-businesses. Within months, First Tuesday was born--a monthly meeting of entrepreneurs and financiers. Today, First Tuesday claims more than 12,000 members in Britain and 13,000 more in 28 European cities. "We tapped a nerve," says founding member Julie Meyer, a 33-year-old American expat who wants to turn First Tuesday into a publicly traded business-to-business portal. "It's as if Britain has fast-forwarded to Silicon Valley circa 1998," adds co-founder Nick Denton, 33, who also founded moreover.com, which collects news from more than 1,500 corporate Web sites.

The company that has really set Britain's Net wave in motion is Freeserve. The unit of consumer-electronics retailer Dixons Group PLC was the first to offer free Net access in Europe in September, 1998. Until then, Web surfers had to pay both for the phone call and a fee to America Online Inc. or other ISPs. With Freeserve, they had to pay only for the call: Freeserve makes its money from ads and profit-sharing with the phone company. Thanks to Freeserve, Net usage in Britain has taken off. With 1.7 million active subscribers, Freeserve boasts a third of the British ISP market. Its success has spawned more than 200 copycats at home and changed the rules of Net access in Europe. Last July, Freeserve went public on the LSE, soaring 37% on the first day of trading and paving the way for other high-profile IPOs.

Freeserve, with a $13 billion market cap, is the closest thing Britain has to America Online. But it doesn't expect to be profitable until 2002. Still, the name of the game is to catch the next Freeserve. These days, Net watchers have their eye on lastminute.com, a small site founded in October, 1998, by Brent Hoberman, 31, and Martha Lane Fox, 27. The idea: offer late-breaking deals online on just about everything. "We were just two nutters with a big plan and $1 million in funding" from British venture capitalists, says Lane Fox. Now the company employs 167. It sold $10 million in goods and services last year, and sales are soaring. lastminute.com claims to have more than 800,000 regular users in Britain and on the Continent. The company is planning to go public in March: Analysts are valuing it at $660 million. Lane Fox and Hoberman are not short on ambition. "We want to become one of the top three e-commerce brands in the world," he declares.REALITY CHECK. Then again, there are bound to be failures as Britain embraces the Net. One disappointment so far has been Boo.com, an online retailer of urban sportswear backed by Bernard Arnault, the Benetton family, and J.P. Morgan. They invested a total of $1.1 billion, but Boo.com missed its planned launch date twice and had numerous technical problems until it finally got going last November.

Net stocks are riding high, but one big flop could hit the whole sector. "There will be double-digit gains and losses," warns Michael Whitaker, CEO of Internet venture-capital firm New Media Spark in London. Then, many believe, reality will set in. "People's expectations and the market's response will become much more realistic," says Rob Bier, CEO of Internet incubator Antfactory.

It will take a few years to see how deeply the Net changes Britain. Although e-commerce is just taking off, some economists think it's already making a difference. Supermarkets such as Tesco have developed popular Web sites. Retail prices fell by 0.5% last year, a change from the typical 1% annual rise in Britain. By improving productivity and increasing competition, the Net "will create enormous economies of scale and cut costs," says Dresdner Kleinwort Benson economist David Owen, who estimates that as much as 40% of the industries included in the retail price index will be affected. "It's the biggest disruption to British business since the oil crisis," says Atlas Spray. And the biggest opportunity.By Kerry Capell, with Heidi Dawley, in LondonReturn to top


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