Net2Phone-A Budding Broadband Star? April 2, 1999By Matthew W. Ragas, Editor
Ragas Speaks for the Week
NET2PHONE - A BUDDING BROADBAND STAR?
What do Switchboard.com, CBS's (CBS) Web properties,
NBC's (GE) Web properties and Alta Vista have in
common?
Their parent companies have each expressed an interest in
spinning-off their Web assets and filing for IPOs.
Who can blame them? Wall Street and the investment
community at large continues its love affair with Internet
stocks, and these spin-off IPOs would allow investors to
get a shot at "pure play" Internet companies liberated from
their hulking parents.
Case in point: this Tuesday, computer publishing giant
Ziff-Davis (ZD) successfully launched initial public sales
of "tracking" shares in its online publishing unit, ZD Net
(ZDZ). As of yesterday's closing bell, ZD Net sports a
market cap of $3.48 billion.
The kicker? The Street currently values parent company
Ziff-Davis at only $2.27 billion. Clearly investors have no
appetite for ZD's slow-growing pulp and ink business.
WHO'S NEXT?
The recent maneuvers made by international long distance
company IDT (IDTC) suggest they are taking the
necessary steps to launch the next explosive Internet
spin-off IPO. Net2Phone, their Internet phone group,
should file to go public within the next three weeks.
Net2Phone offers a variety of Internet telephony products,
including Net2Phone Direct, Net2Fax, and Click2Talk.
In December of 1998, IDT announced that it was
reviewing strategic options for Net2Phone, including a
spin-off IPO of its Internet services group. The company
then went mum on its future plans for Net2Phone until
earlier this week.
On Monday, IDT announced plans to buy back $100
million in bonds from existing investors. This move will
allow the company to pursue other forms of financing for
Net2Phone. IDT also reported that it had arranged a $150
million credit facility from CIBC Oppenheimer, Banker's
Trust and Lehman Commercial Paper Inc. to purchase
the bond notes. (I would be surprised if some of these
investment banks don't turn out to be the underwriters on
a Net2Phone IPO).
IDT's Monday press release notes that the company is
taking these steps "primarily for the purpose of enabling
IDT to effect one or more possible financing transactions
involving Net2Phone, Inc." The release further notes that
"Net2Phone has executed a term sheet with significant
strategic investors relating to an investment in
Net2Phone's equity securities."
If that is not pre-IPO maneuvering, then I don't know what
is.
UNDERSTANDING IDT'S SPIN-OFF MOTIVATIONS
IDT's primary businesses are the following: 1) Internet
service 2) International and domestic long distance 3)
Prepaid calling cards 4) ezsurf.com - a shopping portal
powered by Internet telephony - and 5) Net2Phone, the
company's Internet telephony group.
Emerging international carrier IDT has been a pioneer in a
process known as "callback" or "re-origination" - an
arbitrage opportunity that allows IDT customers
worldwide to get outbound U.S. rates. The company is
also aggressively building private IP telephony networks
in which voice traffic runs over data networks based on
the Internet protocol.
Last year, these four businesses racked up sales of $335
million and inspired a growth rate of almost 150% for the
company and founder and CEO, Howard Jonas.
However, pricing pressure in the wholesale long distance
market and increased competition among distributors in
the pre-paid calling card business have hindered earnings
and pulled IDT's stock from a 52 week high of 38 1/2 to
Thursday's close at 17 7/8.
NET2PHONE'S GROWTH PROSPECTS
Meanwhile, the potentially lucrative Net2Phone remains
trapped inside IDT. Last quarter, the Internet division
racked up sales of $7.2 million - a 167% gain in revenue
over last year's comparable period - and IDT currently
claims a customer base of over 1.25 million Net2Phone
users. Last quarter total Net2Phone usage minutes grew to
53 million, a 54% increase over the previous quarter's 34.5
million minutes. The company was also awarded the 1998
Product of the Year award by Internet Telephony
magazine.
And there is more to come. Internet telephony will be one
of the next great waves of growth on the Internet and
Net2Phone is positioned to be one of the primary
providers. Voice quality for Net-based phone calls will
continue to improve as broadband (and the "always on"
nature of broadband connections) makes Internet-based
calls a natural extension of Web use.
To wit, as part of its acquisition of cable giant TCI, AT&T
(T) is already beginning moving its cable-based local
telephone services toward packet-switched Internet
protocols. Without even realizing it, most consumers will
eventually end up using voice-over-I.P. technology for
their phone calls.
Further, Cisco Systems (CSCO) CEO, John Chambers,
has stated that he wants his company to begin deploying
phone systems based on Internet technology by next year.
This is yet another positive sign for Internet telephony firm
Net2Phone with its installed base of over 1.25 million
users.
ICQ+NET2PHONE?
As noted in last week's report, I believe future versions of
Internet messaging devices will incorporate online music
services similar to Imagine Radio or Spinner.com.
Beyond that, I also believe AOL's (AOL) Instant
Messenger and ICQ will eventually incorporate Internet
telephony packages like Net2Phone into their instant
messaging interfaces.
Millions of Web users now spend hundreds of minutes
each month chatting via services like AOL's Instant
Messenger and ICQ - frantically typing away on their
keyboards. The natural next step is for users to have the
ability to place an instant Web-based call by simply by
clicking a button on their instant messaging device.
It makes perfect sense for users and, importantly, it allows
companies like Yahoo! (YHOO) and America Online to
squeeze a reliable revenue stream out of their chat
applications.
This development would be a huge win for IP software
players like Net2Phone. Under this scenario, telephony
providers could cut revenue-sharing deals with instant
messaging players like AOL, Excite (XCIT), Yahoo and
others. A distribution deal with ICQ alone would reach
over 30 million chat users.
SPEAKING OF DISTRIBUTION, HELLO NETSCAPE!
The wild card that Net2Phone critics underestimate is the
vast distribution deal that IDT unveiled with Netscape
(NSCP) a few weeks ago. The multi-year agreement calls
for Net2Phone's software to be exclusively bundled with
the upcoming version of the Netscape Communicator
browser to be released this summer. It also provides
Net2Phone with its own button on the Netscape browser's
personal toolbar.
This distribution coup means Net2Phone's software will
eventually be distributed to 50 million Web users -
roughly 46% of the Web browser market. In addition,
since Netscape is now a wholly owned subsidiary of AOL,
Net2Phone will likely hammer-out a similar deal targeting
AOL service and browser users.
Other Net2Phone marketing and distribution deals include
broadcast.com (BCST), NEC Packard Bell, GeoCities
(GCTY), Yahoo!, IBM (IBM), and Excite among others.
The key to Net2Phone's long term success is in achieving
wide-ranging distribution of their software to stimulate
trial usage. They are now executing nicely in this arena.
POSSIBLE NET2PHONE INVESTORS
One question remains. Who are the two investors with
whom IDT has executed a term sheet for an investment in
Net2Phone? After piecing together various bits of
information, I believe the two investors will turn out to be
online giant AOL and frequent Internet investor Softbank.
This is pure speculation on my part, but here is the
reasoning. Why would Netscape, a division of AOL, give
such a sweetheart distribution deal to Net2Phone without
taking an equity stake in the company? Getting a piece of
the action from their online partners has always been in
AOL's blood.
Softbank is a likely candidate because in December of
1998, IDT announced that it was in discussions with a
"major media conglomerate with extensive holdings in
leading Internet companies." With ownership in Ziff Davis
and investments in over 60 Internet companies (including
Yahoo!, GeoCities, and E*TRADE) Softbank could
definitely be our silent benefactor.
To add more grist to the rumor mill, a Briefing.com article
re-capping the mid-January DLJ Internet conference
noted that a Softbank partner sitting on a venture capital
panel quipped that his company had "invested in an
Internet phone company who will shortly be doing a
major IPO." Could it be Net2Phone? (Remember that
Softbank portfolio companies GeoCities and Yahoo!
already have distribution deals with Net2Phone.)
NET2PHONE: THE NEXT FEW WEEKS
Shortly after the holiday, the suspense around IDT's plans
for Net2Phone should break. The mystery investors will be
unveiled and plans for a Net2Phone IPO will be
announced at the same time.
The Yahoo! buy-out of broadcast.com for $5.7 billion may
have come at a particularly opportune time for IDT chief
Howard Jonas. Yahoo!'s acquisition price values each
broadcast.com user at roughly $640. Using that valuation
metric, Net2Phone's 1.25 million users make IDT's
Internet telephony division worth roughly $800 million.
Is that an overly optimistic valuation? Probably. Jonas
would be thrilled if the market valued Net2Phone at half of
that. But be that as it may, rest assured, there is a lot of
interesting math going on in the Jonas household this
holiday weekend.
|
