A rather cynical article in TheStreet.com tonight on CMGI, DW, LYCOS & Diller. Thought you all should see (no arrows please).
Will David Wetherell Outgun Barry Diller?
By Christopher Byron
Special to TheStreet.com
03/17/99 02:14 PM ET
It's taken a while to get there, but a milestone has been reached in the
coming of age of the Internet, at least on Wall Street. All of a sudden, the
sector is facing the possibility of its first serious hostile-takeover fight: in this
case, the struggle shaping up between Barry Diller of USA Networks
(USAI:Nasdaq) and a chap in Boston named David Wetherell, who heads a
marketing-turned-investment company called CMGI (CMGI:Nasdaq). The
prize over which they've squared off? Control of the Lycos (LCOS:Nasdaq)
search engine company.
Here's the plot: Wetherell's company owns 20% of Lycos, which agreed back
on Feb. 9 to be acquired by Diller's company, but at a price that Wetherell
now says is not high enough. So he's hired the crowd over at Morgan
Stanley Dean Witter to find someone willing to pay a higher price and has
been telling people that if push comes to shove, he'll consider having his
company buy Lycos outright.
This battle is instructive on several counts, most notably for the insight it
provides into the way folks are thinking about Internet stock prices these
days, and just how big a return they've become accustomed to expecting on
their investment. And then there are the combatants themselves. In the one
corner we find Wetherell, 44, a Connecticut farm boy turned computer
programmer, who started what is now known as CMGI as a direct-marketing
company to college professors back in the 1980s and who then was bitten by
the Internet bug and has now transformed the business into a successful
venture capital operation.
By all accounts, Wetherell fancies himself a cool hand at poker. But staring
back at him from the other corner is arguably the coolest, smoothest
cardsharp on Wall Street, Diller, who is in a game he simply can't afford to
lose.
Barry Boy has certainly come in for his knocks here at Eye to the Keyhole.
But that is only because he is so unnervingly good at what he does: turning
garbage into nuggets of gold. Diller's USA Networks is actually nothing more
than a hodgepodge of junk, ranging from some out-of-the-way UHF TV
stations to bits and pieces of the failed Savoy Pictures operation, parts of
Universal Studios, cable TV's Home Shopping Network, the
Ticketmaster entertainment ticketing service and a Web operation called
CitySearch.
Yet it is certainly a testament to something -- though frankly, I'm not sure
what -- that he has somehow managed to use these assets to float $5.8
billion of loans and other liabilities while at the same time goosing up the
price of his stock by more than 600% in the past four years. Maybe it's
because he's actually making money with USA Networks and the company
seems to be erupting with cash flow in all directions.
Even his failures are impressive. Let it never be forgotten that in Barry Diller
we find a man who back in 1994 actually tried and very nearly succeeded in
buying Paramount Communications using stock from a cheeseball
shop-at-home company (QVC) that he happened to own at the time.
In the very least, we may thus say that Diller is certainly a man with a long
and rich experience -- and plenty of rich friends -- on Wall Street. Which
leads to the corollary observation, based once again on the public record in
these matters, that when it comes to takeover fights, Diller has most likely
already forgotten more about the ways of Wall Street than David Wetherell
will probably ever learn. It will be an interesting contest.
Lycos, as you may know, is generally regarded as one of the weaker of the
four major search-engine companies (the others being Yahoo!
(YHOO:Nasdaq), Excite (XCIT:Nasdaq) and Infoseek (SEEK:Nasdaq). It has
roughly half the revenue of Yahoo! or Excite, yet during the 12-month period
that ended Dec. 31, 1998, it racked up nearly seven times the losses ($121.3
million) of the rest of the group combined. Not surprisingly, Wall Street has
thus given Lycos the smallest market capitalization of the four: $4.7 billion vs.
$5.7 billion for Excite and nearly $35 billion for Yahoo!
As the whole world now knows, anyone who bought these stocks back when
they first went public has reaped a phenomenal return since then. Adjusted
for three subsequent stock splits, Yahoo! closed at 5 1/2 a share
(split-adjusted) on its initial public offering date of April 12, 1996. Today the
shares sell for 173 or thereabouts -- a gain of more than 3,000%. Even the
worst performer of the group -- Infoseek -- has risen 691% since going public.
But having been swept up in the euphoria of a sector running free, investors
have by now forgotten that for most of the past three years, these stocks
proved to be very poor investments. Infoseek went public in June 1996 at 12
with its first trade in the aftermarket at 15 1/2, but the shares were still selling
for barely 13 per share as recently as January 1998. Excite went public in
April 1996 at 8 1/2 per share (split-adjusted) with its first aftermarket trade at
10 1/2, yet the stock was still selling for barely 11 in December 1997. Lycos
also went public in April 1996 at 8 (split-adjusted) with its first aftermarket
trade at about 14 5/8; by the end of the following year, the stock was still
selling for barely 18. Even Yahoo! proved a flop in its first year as a public
company: A year after its IPO, the shares were still selling for the same
price.
What changed -- changing those stocks from dross into gold in the process --
was the frenzy of momentum-driven buying that spread throughout the entire
Internet sector as 1998 progressed. Nothing fundamental transpired in 1998
to change the Internet into a more appealing investment than it had been in
1997. In fact, quite the contrary, a certain sober downscaling of expectations
set in, particularly in the case of advertising revenues -- the presumed
backbone of the entire Internet business model.
Nonetheless, as 1998 progressed, an absolute multitude of investors -- a
growing number of them day traders -- piled into the sector, sending stocks
like Yahoo! and the other search-engine companies into orbit. In one wild
week alone -- from Jan. 4 to Jan. 11 of this year - Yahoo! soared 67% in
value, Excite leaped 90%, Infoseek jumped 83% and Lycos, arguably the
most troubled of the group, rocketed 142% in price, to 131 per share.
That 142% run-up, which lifted Lycos' stock price from 54 per share into the
solid triple digits, now has Diller and Wetherell at loggerheads. That's
because the run-up was caused by momentum players chasing the stock
price in hopes of capitalizing on takeover rumors about Lycos that were flying
everywhere at the time. Though the rumors mentioned such companies as
General Electric's (GE:NYSE) NBC television network as a likely Lycos
partner, Diller's USA Networks was even then secretly negotiating a deal to
take over the company.
But Diller wasn't about to pay nearly $140 per share for a company that had
been selling for barely $50 only a couple of weeks earlier -- which ignominy
he handily avoided by the terms of the deal he wound up negotiating. USA
Networks and Lycos would jointly create a new company -- to be called
USA-Lycos Interactive Networks -- to be composed of Lycos along with
USA Network's ticketing, Internet and home shopping businesses, but not
including its recently acquired businesses from Universal Studios. The Diller
side would wind up owning 61.5% of the resulting company, while the Lycos
crowd would get 30%, with the other 8.5% going to various third-party
shareholders.
Somehow Barry convinced the Lycos board that the resulting company would
be valued at $22 billion (based on some pie-in-the-sky multiple of the
combined revenues of the business -- roughly $1.5 billion). But the reality was
no more complicated than simple arithmetic: The deal was saying, in effect,
that 100% of Lycos would be worth 30% of the combined company. And
since Lycos, at 131 per share, was being valued on Wall Street at $5.6 billion
while USA Networks carried a $6.5 billion market cap, this meant that Diller
was actually valuing Lycos at $84 per share at most (30% of $12.1 billion).
In fact, nearly half of USA Network's revenue and the great bulk of its
operating profits derive from its television operations, which aren't included in
the deal, suggesting that no matter how one values USA Networks, Diller in
fact agreed to contribute a whole lot less than the full $6.5 billion value of
media junk in his toy box to create the new company. Let's be generous and
say that the Universal assets aren't worth anywhere near the $4.1 billion that
he paid for them, but only $2 billion. Result? Two billion dollars has to be
deducted from Diller's contribution to the new company, which brings the
valuation of the Lycos shares down to about $70 each.
That's why Lycos' shares plunged from a high of 137 two days before the deal
was announced to a low of 87 1/4 the day after: Investors simply realized that
Diller wasn't going to pay a preposterous premium for Lycos just because
some starry-eyed day traders figured he owed it to the market.
And that explains why Wetherell, whose company holds 20% of Lycos'
shares, instantly began trying to talk their value back up by muttering that he
wouldn't go along with the deal unless the shares rose back to 130-plus. It
wasn't simply that the three-day slide lopped nearly $430 million off their
value. No, the bigger and more menacing problem was that the collapse
threatened to drag down the price of CMGI itself, a company that has soared
by more than 6,500% since the autumn of 1995 on Internet mania and
Wetherell's vaunted skill in incubating Internet initial public offering
super-successes such as Lycos and GeoCities (GCTY:Nasdaq), another of
his startups. Of course, as with many other stocks in the sector, virtually the
whole of the CMGI run-up has come courtesy of day traders and momentum
players since the start of 1998.
Unfortunately for Wetherell, the strategy has not succeeded in lifting Lycos'
price much above 109, which is why he has now resigned as a member of
Lycos' board of directors and set out to derail the deal by hiring Morgan
Stanley Dean Witter to find a Lycos buyer willing to pay more. If that doesn't
succeed, he's even now saying he might have CMGI buy Lycos outright --
though his only reason for doing so would be to create a price-propping
corner in its stock. After all, if he wanted it for any presumed synergies
(which I personally think are nil), he would have bought the company back
before Christmas when it was selling for barely 50 per share.
This is a high-stakes showdown, make no mistake, since one man or the
other is bound to wind up with egg on his face big-time. If Wetherell
succeeds, Diller will have been outsmarted by a man who talked an already
overpriced stock right up and out of his grasp. But if Wetherell fails, Diller will
have taken an important step toward returning pricing reason and common
sense to Internet stocks.
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