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To: Glenn D. Rudolph who wrote (28454)	11/29/1998 4:21:00 PM
From: Glenn D. Rudolph	Respond to of 164687

Internet Software & Services – 23 November 1998 2 Internet stocks last week staged a remarkable and difficult to explain rally, with the three largest (market-capitalization) names — AOL, Yahoo! and Amazon.com — reaching new all-time highs. We note that those three companies now have a combined market cap of approximately $66.0 billion. Moreover, the recent rally has not been confined to the large-caps: a simple average (equally-weighted) of the share prices of 18 of the most visible Internet stocks shows a 30-day gain of approximately 76.5%. The question has clearly become: What Next? Valuations across the Internet space have always been enormously volatile. We are now concerned that they have become driven almost entirely by momentum and short-term trading considerations. On that basis, we feel compelled to caution investors against viewing any Internet stock in the same context as they would other investments. Specifically, and given recent levels of volatility, we would suggest that investors need for the moment to view almost all public Internet stocks as trading-oriented (as opposed to investment-oriented) vehicles. At the same time, we continue to believe that there exist companies with hugely compelling business models which take fundamental advantage of the Internet's unique structure. We think that the propagation of Internet connectivity, and the benefits which will accrue from it will span a 15-20 year event horizon. Given the profound benefits of a ubiquitous global data network (most of which have yet to even be conceived ), it seems reasonable to expect that the Internet as a medium for investment should remain at the forefront for at least the next 5-10 years. Our advice to investors is to focus on those public companies which have demonstrated an ability to generate profitability and which trade at valuations which bear at least some resemblance to their likely future operating results. Into that category we would place America Online, Lycos and 24/7 Media (each of which we maintain Buy/Buy ratings on). Addressing the broader issue of valuations across the Internet space, we believe that there exists a severe imbalance between the supply of and the demand for public Internet stocks. We expect that that imbalance will be at least partially addressed during the first half of calendar 1999. With the benefit of an open window for Internet IPOs, and with a substantial backlog of companies eager (and overeager) to access the public equity market, the number of public companies will probably go from about 20 now to closer to 30 fairly soon (we note that we define “Internet companies” more rigorously than many others do). In terms of the ultimate success or failure of individual companies within this space, we continue to take a relatively conservative outlook. We believe that the various component enterprises across the Internet (including companies engaged in commerce, content creation and distribution, community sites and Internet-based functionality) still look very much like early-stage operating businesses: they are only just beginning to be sufficiently mature where there individual strengths can be evaluated. We continue to focus intently on the ability of Internet companies to generate a meaningful return on their invested capital. We expect that those companies which are unable to meet that basic requirement will see the violent erosion of their market values concurrent with that realization by the market. In fact, the broad-based destruction of Internet equity valuations has occurred once before: from December 1995 through December 1996, most of the first-generation Internet companies lost at least 60% of their market values. Significantly, that period corresponded with disappointing operating results from both connectivity providers and Internet software companies. It is worth noting that the current generation of public Internet companies are focused primarily on building either proprietary content (occasionally original, but more frequently aggregated) or online consumer traffic upon which advertising revenues can be generated. Furthermore, while stand-alone ISPs, Internet Software companies, Portals, Internet Content companies, etc. have each been affected by the equity market's changing sense of Internet fashion over the past 2 years, there have only been two major fundamental trends during the life cycle of public Internet companies: - Stage 1: Text only. Leader — U.S. Government. Consumer Access — None. - Stage 2: Text only. Leaders — U.S. Government and Academia. Consumer Access — None. - Stage 3: Text with graphics. Leaders — AOL, Prodigy and CompuServe. Consumer Access — Limited. - Stage 4: Graphics with very limited video and sound, communication (e-mail)-centric. Leaders — AOL and Netscape. Consumer Access — Becoming more common in U.S. - Stage 5 (Present): Limited (improved) video and sound, commerce, text- and image-based communication, community, content, entertainment, computational (early-stage), etc. Leaders — AOL and Yahoo!. Consumer Access — The leading reason for new PC sales. - Stages 6/7/8: Full-motion video and high-quality (16-bit red book or better) sound. Ubiquitous consumer and corporate connectivity with high-bandwidth (over 1-meg/sec.). Our point here is that while things like aggregation and disintermediation are mechanisms capable of generating substantial results (and financial returns) over some period of time, their practitioners tend to be dislocated by shifts in either technology or market conditions. Our specific worry is that the next several stages of the Internet's inevitable maturation will produce such a violent