November 8, 2005
By Will Deener

Dot-com investing is slowly working its way back into financial fashion.

A new generation of Internet companies is gaining currency and enticing investors again. Although remnants of the Internet mania of the late 1990s still litter the landscape, that debacle almost assures that today’s cyberinvestor remains grounded in reality.

“All of us took more risks [in the late 1990s] than we should have,” said Ryan Jacob, portfolio manager of the Jacob Internet fund. “Today, investors are much more scrutinizing, and it is a much more rational environment.”

That’s good because investing in dot-coms is not – and never should have been – for everybody.

The sector is volatile and no place for a retirement nest egg.

Although the number of Internet-related initial public offerings, or IPOs, is just a trickle, most financial experts predict plenty more to come.

That forecast is based primarily on the fact that private venture capital firms are starting to pour money into Internet-related companies, and that is often a precursor for them going public.

“Finally, venture capital firms feel like they can make money again on these companies,” said Michael Greeley, general partner at IDG Partners, a Boston venture capital firm.

“There’s a lot of enthusiasm for investing in these early-stage Internet companies.”

The dazzling debut of Google Inc. last year provided the backdrop for the dot-com renewal and injected some much-needed excitement into the sector.

Google shares have soared from $85 when the company went public in August 2004 to almost $400 a share now.

“Google really has shined a bright light on this area,” Mr. Greeley said.

But Google was a unique cultural and financial phenomenon. Only recently have investors considered the profit potential in other Internet companies.

Linda Killian, portfolio manager of the IPO-Plus Aftermarket fund, a mutual fund that buys shares in newly minted companies, said she’s adding some Internet companies to her portfolio.

“I have found a couple Internet companies I like,” Ms. Killian said. “But I remain very wary of the space; I am extremely selective; and I want to see profits in these companies.”

Her fund now owns shares of WebMD Health Corp., which runs the health care portal WebMD .com. The company went public in late September at $17.50 a share and promptly spiked to about $24, where it currently trades.

WebMD is an excellent template for potential Internet investors. It is a well-managed company, profitable and a leader in its niche, financial experts said. These traits were lacking in many of the first-generation Internet companies.

“There’s a lot of substance to this company,” Ms. Killian said. “Most of the revenue comes from companies looking for an effective way to target-advertise.”

Someone who clicks on WebMD for information about a particular disease will also see ads from pharmaceutical companies selling drugs to treat it. Traffic on the site has increased 41 percent in the last three years.

So far this year, only four out of the 158 IPOs have been Internet-related companies, according to Renaissance Capital’s IPOhome .com. But there are at least that many more in the IPO pipeline. (The financial services industry produced 28 IPOs, the most of any sector.)

‘User-generated’

One of the hottest Internet sectors and the area where more public companies may emerge involves “user-generated” Web sites, such as MySpace.com and TheFaceBook .com, Mr. Jacob said.

These sites allow young people – particularly college students – to post personal information and keep in touch with friends.

In fact, even traditional media companies are buying these types of Internet companies. For example, this year media giant News Corp. bought Intermix, which owned MySpace.

“The big media companies kind of abandoned their Internet efforts a few years ago, but they are ramping up now,” Mr. Jacob said. “News Corp. is shooting for that younger demographic.”

Dow Jones & Co. and New York Times Co. also purchased Internet companies this year to beef up their cybertraffic, he said. Interestingly, some of the most promising Internet companies are being picked off by larger companies even before they can go public.

The best example of that was the News Corp. purchase of IGN Entertainment Inc., which provides games and other data for mobile devices, after IGN had announced it would go public.

“These larger media companies are nervous,” Mr. Jacob said. “They understand the strategic importance of the Internet.”

Baidu bubble

Although shares of WebMD, Google and a few others have done well, there have been some notable Internet IPO swoons this year. In fact, the stock price behavior earlier this year of Baidu.com Inc. was reminiscent of the silliness of the late 1990s.

Baidu, a Beijing-based Internet search engine, mesmerized Wall Street with its chest-pounding comparisons to Google. Its shares skyrocketed from $27 to $122 during the first day of trading Aug. 5 – one of the biggest one-day gains ever.

That gave the company a market value of $4 billion even though it was barely profitable, earning just $1.8 million during the first six months of the year. Not surprisingly, the air has since been let out of that bubble, and Baidu shares currently trade at about $70. The company now sports a more reasonable market value of $1.6 billion.

Karen Dolan, mutual fund analyst at Morningstar in Chicago, said this kind of volatility should be a reminder that Internet investing is still treacherous. A safer alternative for those who can’t resist is investing in an Internet-focused mutual fund, she said.

Currently, there are seven Internet funds, down from 44 during the 2000 heyday. All seven are down slightly year-to-date, but the annual return over the last three years is 30 percent, Morningstar reports.

“But even these funds are risky because it’s sort of niche investing,” Ms. Dolan said. “People may want to consider a more diversified growth-oriented mutual fund that has some Internet exposure.”

Straying from herd

Mr. Greeley of IDG Partners said he’s a little fearful that the herd mentality of the venture capital firms might overheat the Internet space again and make it difficult for him to find and invest in modestly priced Internet companies.

“Sometimes you will see 700 venture capital firms get excited about something, and they all want to have investments in the same companies,” Mr. Greeley said.

The money spigot certainly has been turned on again. The average size of a venture capital Internet deal topped $14 million in the third quarter, or about double the $7.4 million size of the other types of deals, Mr. Greeley said.

If the trend continues, venture capital firms will invest about $3 billion in about 400 Internet-related companies this year, compared with $2.7 billion last year and $2.5 billion in 2003.

Still, the amount of money being thrown at Internet companies is dramatically lower than it was during the bubble years.

In 2000, for example, venture capital companies invested $44 billion in 3,000 Internet companies.

“I think average investors are still very cautious about the Internet,” Mr. Greeley said. “They want to see companies of a certain size and maturity before they invest. I don’t think there will be a bubble again.”