Not Just Any Portal in the Storm


By David Shook Early on in the advertising market's collapse last year, Terra Lycos (TRLY) didn't appear to have much of a future. As a second-tier portal behind the Big Three -- America Online, MSN, and Yahoo! -- Terra Lycos seemed a "geographically and strategically confused portfolio of Internet assets," as one analyst opined. Another said the company was in serious trouble because 70% of its revenues came from advertising.

Today, however, Terra Lycos appears to be adjusting nicely in an otherwise dismal period for Web portals. Ad revenues still account for more than 60% of the company's sales, but cost-cutting has led to a healthier balance sheet -- even as hard times have befallen others in the industry, most notably chief competitor Yahoo.

Despite the weakness of the online-ad market, Terra Lycos' financial shape has improved markedly. That's why a few analysts believe its shares are cheap at the current price of $7.60, down from $46 a year ago.

BIG WEAPON. Buying now still has risks. Even the company's executives admit Terra Lycos remains in transition. "Certainly, I'm feeling the pressure every day," Lycos USA President Stephen Killeen admitted during a recent interview at his office in Waltham, Mass. Killeen joined the company early this year after stints at online investment site Raging Bull and Fidelity's online brokerage. "The rules," notes Killeen, "have changed in the ad market."

Terra Lycos has a big weapon on its side: A $2.2 billion cash balance it can use for acquisitions and as a cushion during the economic slump. The cash windfall came from Telefonica, the Spanish telephone giant and 38% owner of Terra Lycos. Last October, Telefonica engineered the merger of Spain-based Terra Networks and Massachusetts-based Lycos, and then made sure the combined company had plenty of cash to duke it out with larger rivals.

A major positive sign, according to analysts, is that Terra Lycos didn't burn through any of the dough in the second quarter. While Earthlink and tech-news portal CNET have been rumored targets, the company has been tight-lipped about the companies it might want to buy. For the record, Killeen says he isn't interested in Earthlink because it wouldn't provide Terra Lycos with broadband capabilities. He declines to discuss other rumored targets.

PROFITS AHEAD? Meanwhile, things are looking better at Terra Lycos than they did last January, when it didn't have a clear strategy, management turnover was heavy, and several major advertisers had defected. "Until recently, it had been difficult to assign any 'going concern' value to Terra Lycos because it was uncertain if the company would ever reach break-even," says Lisa Haas, an analyst with Wit Soundview who, in early August, upgraded the stock to buy from hold. (She had the stock rated sell in January.) The company has said it expects to break even by the second quarter of next year.

That would be quite a turnaround. Terra Lycos lost $832 million in the second quarter, but most of the red ink was due to a $677 million goodwill charge related to the merger. In the meantime, the company generated total quarterly sales of $165 million, up 34% vs. the same quarter a year ago. More than 90% of its business is done in the U.S., Spain, and Latin America.

In the U.S., which accounts for nearly half of revenues, Killeen has been moving quickly to cut the losses. He has taken down hundreds of Web sites that accounted for about 1 billion page views a year from the Lycos portal network and has cut 15% of the U.S. workforce. Overall, Terra Lycos is trimming $30 million in operating expenses this year and plans to chop as much as $150 million next year.

"MONETIZE" OR DUMP. That may sound like a retrenchment, but Killeen says page views haven't proved to be a successful method for measuring the effectiveness of advertising -- and he doesn't like Web sites that don't generate money. "Everyone in this business is marching in the same direction, to some extent, on ads," Killeen says. "But for us, we're stepping away from [measures] such as page views...because it's not clear how to 'monetize' that metric. If we can't monetize it, let's get rid of it."

The new philosophy is already paying dividends. Terra Lycos' 34% revenue hike in the second quarter occurred even though advertising sales increased a scant 4% from the same quarter a year earlier. That's largely because of Killeen's focus on only the company's best Web properties and deals -- sites such as Quote.com, Matchmaker, Raging Bull, and a longstanding music agreement with Bertelsmann.

Meanwhile, the Lycos network is seeing steady increases in traffic: Unique visitors in July jumped to 103 million, up from 94 million in January. "The company has stabilized quite a bit since early this year," says Bear, Stearns analyst Jeff Fieler, who has a strong buy rating on the stock.

ROUTING RIVALS. Terra Lycos also is holding up well when judged against its rivals -- not to mention former rivals. Consider Excite@home, a combination portal and broadband-cable ISP that still competes head-to-head with Lycos for portal ad dollars. On Aug. 20, accountants for Excite@home said its finances are in turmoil and that the enterprise may not be able to survive as a going concern for another year. That news follows Disney's move earlier this year to fold its money-losing Go.com portal, which also competed directly with Lycos.

Then there's Yahoo. As Lycos' closest competitor in the U.S., the company, which also relies heavily on ad sales, is leaning toward the development of more subscription-based services. But Yahoo's stock, which closed at $13.26 Aug. 23, trades at a premium to Lycos -- even though, as analyst Hass notes, Lycos is increasing its gross profit margins at a faster rate. Yahoo trades at more than 8 times estimated 2002 revenues, while Terra Lycos trades at roughly 3.5 times next year's projected sales, she says.

During the slump, Terra Lycos has made productivity gains against its rival. Last year, it generated less than $20,000 in sales per employee, vs. $100,000 for Yahoo. Over the past two quarters, Terra Lycos earned about $48,000 in revenues per employee, vs. approximately $55,000 at Yahoo. Says Haas: "The gap in efficiency between the two companies has recently narrowed."

MORE TO DO. Terra Lycos still has its work cut out. Cost-cutting internationally won't be easy. In the U.S., it gets most of its revenues from ads, but overseas it's a hodgepodge of mainly fee-based businesses.

The company provides Internet access to more than 7 million customers in Europe and Latin America, offering paid subscription services (and, in some cases, free Internet access) in a total of 42 countries. But competition from larger European Internet players is intensifying. And in Europe, Asia, and increasingly in Latin America, Internet technologies are being built around expensive, evolving wireless technologies. That will require huge investments if Terra Lycos is to keep up.

Wall Street still seems far from convinced that Terra Lycos can succeed. Only a few analysts even cover the stock. But the company clearly is making progress. Six months from now, investors with a taste for adventure may be happy that they jumped in when the ad market seemed to be at its most dismal. Shook covers the markets for BusinessWeek Online in New York


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