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Search engines: Real profits, real stocks
It wasnt market insanity that sent Mamma.com and Ask Jeeves.com soaring last week. Its recognition that Internet search has become a real business on its own.
By Michael Brush
Last week, two fairly obscure dot-com stocks surged so dramatically that all of Wall Street began worrying that we had returned to the bubble days of the late 1990s.
With nary a bit of warning, Mamma.com (MAMA, news, msgs), a small Internet search company based in Montreal, jumped nearly 300% in two days. A similar buying frenzy struck Ask Jeeves.com (ASKJ, news, msgs), a larger search site. Those shares jumped more than 50% in two days.
Both stocks have calmed down, as a lot of smart money bailed out of these names as fast as possible.
The valuations have gotten much higher, and that is why we dont own the whole universe of these stocks anymore, says Paul Leung, an analyst with Sterling Johnston Capital Management in San Francisco.
Look again
But is it really 1999 all over again? Not really, say analysts who follow these stocks closely, including Leung. Sure, these stocks look a little pricey, and they could drop more from recent highs, especially if the overall tech sector continues to weaken.
But analysts say there are three underlying trends supporting the case that search engine and Internet-ad companies like Ask Jeeves, Mamma.com, FindWhat.com (FWHT, news, msgs) and 24/7 Real Media (TFSMD, news, msgs) are on more solid footing this time around.
- Theyre using technology a lot better now, and that makes Internet advertising more effective. Especially key are the sponsored links that pop up when you run a query at a search engine. Advertisers love em.
- Despite the popularity of these kinds of ads, only a small portion of overall ad budgets is spent online, meaning theres room for solid growth.
- The companies have real earnings now, so you're not paying for "eyeballs" alone, or some other nonsensical measure of worth, as in the bubble days.
"When you have a huge rally like this, it does make you wonder: Are we repeating ourselves here? says analyst Jason Schrotberger, who follows search engine companies for Turner Investments of Berwyn, Pa. But we have a number of Internet advertisers that are top holdings, and we have no plans to sell them because growth will be above what people expect.
As for the big picture: Nate Elliott of Jupiter Research estimates online advertising spending should grow about 20% a year from an estimated $7.6 billion this year to reach nearly $15 billion in 2008. Meantime, heres a closer look at the trends that should support real -- not imagined -- growth at these suddenly fashionable companies.
The lure of pinpoint accuracy
Advertisers have begun to fall in love with the sponsored links offered by search engines. Heres why:- Timing. Unlike TV ads or even the yellow pages, sponsored links get in the face of consumers at the very moment they're about to buy something, says Jonathan Cohen, of JHC Capital Management in Greenwich, Conn. A customer can even make a purchase immediately with the click of a mouse. This means advertisers can target their pitches better than ever. Its not like running a TV commercial for flowers, where you just hope someone watching is looking for flowers, says Phillip Thune, chief operating officer at FindWhat.com, based in Fort Myers, Fla. Instead, a florist can purchase listings that appear only when Web searchers type in the word "flowers" or "Valentine's Day."
- Flexibility. From an advertisers point of view, technology in place now offers more flexibility to target an ad budget where the company thinks it works best. For example, advertisers typically pay for those sponsored links in an ongoing bidding war. In short, they decide when they want to pay the most to get at the top of the list of sponsored links, say, because they are selling flowers and its Valentines Day, Thune says.
Whats more, Thune says, consumers can be tracked on the Web to see if they actually make a purchase after clicking through an ad. That means advertisers know which types of links and search-engine alliances are providing the most bang for the buck, and advertisers can adjust their spending accordingly.
FindWhat.com knows this corner of the Internet ad world well; its job is to round up advertisers looking to pay for sponsored links. Then, it hooks them up with the right Web sites. Whenever a consumer clicks on a sponsored link at a search engine and goes to an advertisers Web site, the advertiser pays FindWhat a fee, which is shared with the search engine.
Only the beginning
Blue-chip advertisers, after years of skepticism, are finally warming up to ad buys on the Internet. In 1999 and 2000, there were still a lot of blue-chip companies and executives that thought the Internet was up and coming but still not there, says Shrotberger.
Now, megabuck advertising clients such as Procter & Gamble (PG, news, msgs) advertise aggressively at Web sites like those run by iVillage (IVIL, news, msgs) as a way to reach women. And thanks in part to the growing popularity of those sponsored links, spending on online advertising should grow an estimated 20% this year to reach $7.6 billion, says Jupiter Research.
Advertisers are just now recognizing the true value of search, of having a user tell you exactly what they are looking for at the moment they are looking for it, says Steven Sordello, the chief financial officer of Ask Jeeves.
There is plenty of room for more gains in Internet ad spending, since there's an imbalance between how much time consumers spend online and how much money advertisers spend there. Consumers currently spend about 15% of their media time on the Internet, but advertisers only deploy about 2% of their ad budget there.
They have real earnings now
So what sets last weeks rally apart from the bubble of the late 1990s?
The primary difference is that all these companies are generating pretty substantial cash flow and earnings, and they are proven business models at this point, says Sterling Johnstons Leung. Back in the bubble, you were taking bets on what would happen two or three years out.
In an ironic twist, at least one company in this space has grown into the valuations investors gave it during the bubble. For example, at $19, shares of FindWhat.com trade for just a little more than what the stock went for when the bubble peaked in March 2000. But back then the company was bringing in only $250,000 per quarter in revenue. Today, we are in a quarter where we think we can do $22 million in revenue, says FindWhats Thune. We have never stopped growing because what we do works. What we do makes so much sense for anyone trying to advertise online.
Overall, the paid-search sector has grown to gross about $3 billion per year in revenue, up from $500 million in 2001, says Sordello of Ask Jeeves. The industry is still young, and it is growing really fast.
The main players
Internet search engine stocks come in three flavors. There are companies that have popular Web sites with sophisticated search engines. There are companies that specialize in rounding up advertisers. And there are those that do both.
The companies that do it all: Google, for example, ranks as the Internets top search engine, but it also has extensive relations with advertisers looking to place sponsored links. Perhaps the strongest player in this field, Google is private, but many people expect it to go public sometime this year. Like Google, Yahoo! (YHOO, news, msgs) controls one of the Internets most popular search sites, but it also rounds up and distributes sponsored-link ads through its Overture division.
Sites that draw the traffic: Ask Jeeves drums up some advertising on its own. But its mainly a search engine site that offers advertisers plenty of traffic. In a move that impressed investors last week, Ask Jeeves doubled its reach and pushed into the list of the biggest five search-engine companies with an acquisition that contributed to the frenzy in its shares last week. Ask Jeeves agreed to buy the privately-held Interactive Search Holdings, taking over that company's collection of search sites, including My Way, My Search, My Web Search, MaxOnline, iWon and Excite. Ask Jeeves gets about 67% of its ad revenue from referrals from Google -- a potentially risky concentration.
Mamma.com, another search engine site, caught fire last week when it announced impressive profitability. It was the first time the search engine reported results as a standalone company. Mamma.com still trades at a discount to competitors, says Carl Wiese, an analyst with Wall Street Associates. But it faces daunting competition from gorillas like Google, and it may be a takeover candidate someday soon. Mamma.com is mainly a search engine site now, but it plans to branch out more into advertising through acquisitions, says David Goldman, the company's chairman.
Sites that round up the advertisers: Despite its name, FindWhat.com isnt much of a search engine. Instead, it supplies search engines with sponsored-link ads and some of the technology that helps them work. FindWhat.com just struck a deal to help run the online yellow pages for Verizon (VZ, news, msgs), and it recently expanded into Europe with an acquisition.
The company 24/7 Real Media is a hybrid of sorts. It provides search-engine sites with access to an extensive network of advertisers, as well as technology that helps serve up ads and tracks how consumers use them. The company is planning a secondary offering because it will likely go on the acquisition trail soon.
Shares of LookSmart (LOOK, news, msgs) fell more than 50% in one day last fall (from $3 to $1.44) when MSN announced it would no longer take search-engine-related advertising leads from the company. (MSN's parent, Microsoft, owns MSN Money.) Despite the decline, Sterlings Leung says he wouldnt buy shares at current prices because of uncertainty about the companys future. But he does not count LookSmart out. If they sign AOL tomorrow, that problem would go away.
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