The Internet's Money Machine

By Karl Taro/Greenfeld

What's the most valuable product you can manufacture? Supercomputers? Stealth bombers? Beanie Babies? David Wetherell, 44, has figured out how to fabricate the dearest items in all the land: stock in Internet companies. As chairman and CEO of CMGI, based in Andover, Mass. Wetherell has melded together the trends and technologies of the Internet into a virtual initial-public-offering factory that analysts expect will churn out perhaps half a dozen highly lucrative offerings in the next 12 months.

There is nothing mysterious about Wetherell's business model: find promising Internet company, buy stake, fund growth, provide guidance, sell company; or take it public and pocket billions. (It's one that is also widely implemented on Sand Hill Road in Menlo Park, Calif.--the Main Street of venture capitalism.) But what has set Wetherell and CMGI apart has been his phenomenal success. His early investments in Lycos, Booklink, GeoCities, Critical Path and a slew of other Internet companies have established Wetherell as an uncanny picker of soon-to-be-ripe Internet fruit.

If you are trying to figure out how Internet companies will ultimately figure in the economy--Will they crash and burn? Or soar even higher?--CMGI is a good place to start. It is a company very much in the middle of the clash between the old and new market models, and between old and new media, that is occurring all over Wall Street. To smitten Internet investors today, profits don't matter; it's the new economic order of the future that counts. So buying a company's stock on the basis of profits is irrelevant. These investors look only to the next harvest of CMGI's hot IPOs, which is why they have driven the company's share price from $17 this past October to a high of $330 two weeks ago.

That kind of thinking has created a huge gap between the valuations of Internet stocks and the rest of the world. "It can't last forever," says Intel chairman Andy Grove, whose company owns 8.6% of CMGI. "The Web world has one set of rules and the rest of the world has another." In other words, something's got to give. Last week some of CMGI's investors took their money off the table, and CMGI traded as low as $185 before bargain hunters--and only in the Net world is $200 a share a bargain--drove it back up. It finished the week at $259.

Wetherell can't believe that anyone is questioning these never before reached values. He says that not only is the Internet not a high-risk investment, but it is also "absolutely the safest bet I know." He has been making this wager since 1994, when CMGI (then known as College Marketing Group) was still a company that hawked textbooks to college professors. He took the firm public and used the proceeds to invest in then obscure companies such as Lycos and Booklink--the latter of which he would later sell to AOL for $70 million. The soft-spoken, laid-back Connecticut native and Ohio Wesleyan University math major has never looked back, riding the trend to a personal net worth of $2.5 billion. Regrets? He passed up a chance to invest in eBay, the wildly successful Internet auction house. Wetherell figures that oversight cost him $4 billion.

Wetherell sees Net company valuations through a mathematical as much as a financial lens. He loves to cite Metcalfe's Law of Connectivity as the driving force behind his approach. The law, set down by Robert Metcalfe, founder of 3Com, states that the value of an interactive network--such as Lycos, Yahoo or AOL--is a function of the number of people attached to the network; and value increases exponentially when another person comes online. Thus a network of 10 people is at least four times as valuable as one with five. What this means is that every extra AOL subscriber is worth more than every extra cable subscriber. How much more is the umpty-billion-dollar question, because that new customer can be marketed to, advertised to, sold to, and may even be the impetus for a whole new form of commerce that will make the network more valuable still. "The growth is incredibly viral," says Wetherell, using one of his favorite words. "Online companies tend to grow along Metcalfe's Law. We have companies growing at a rate of 1% a day. The Internet is growing at a rate of 3% a day. If you can't make money in this business, then you might as well go pick oranges."

Wetherell's Internet world view is getting its fiercest test in a takeover tussle with Barry Diller--a real-economy mogul if ever there was one--who has made a bid for Lycos, the Internet portal that Wetherell financed and of which he owns 18.5%. While Diller and Wetherell agree that the partnering of Lycos' new-media assets and Diller's traditional media hodgepodge of USA Networks, Home Shopping Network and other film- and television-production interests makes strategic sense, they disagree sharply on the value Diller ascribes to Lycos.

In the world Diller comes from, you don't pay a premium for unprofitable businesses. But in the Internet economy, where almost nobody has made a profit yet (and certainly Lycos hasn't), that hasn't kept Yahoo from shelling out $4.35 billion for GeoCities, or stopped the Internet portal @Home from paying $6 billion for Excite--both deals made at hefty price premiums. Of course, they used their richly priced shares as currency. Diller's offer to merge part of his USA Networks with Lycos to form a new company, of which Lycos would own 30%, values Lycos at approximately $85 a share, substantially less than the $130 it was trading at when Diller made the offer. Wetherell, after initially supporting the bid, changed his mind, withdrew from the Lycos board and pledged to vote his shares against the deal at a shareholders' meeting next month.

Diller, who made an unsuccessful run at Paramount in 1994 using stock from the shop-at-home company QVC, has been seen by the Internet community as crashing the party with a most unwelcome piece of news: your companies aren't worth as much as you think. (And for a few wobbly days early last week, he was right.) Wetherell and his ilk are now seeking to show Diller the door. "He's Barry Diller, he's famous, he's a great dealmaker, but he may have overstepped," says Joe Butt, senior analyst at Forrester Research.

Get real, says Diller. "There has been an enormous amount of arrogance, of easy money made by people who are extraordinarily arrogant about the real world and how difficult it is to build and sustain a business," he says. He likens Internet companies to "slot machines that pay off again and again. If I was an investor, I'd be corrupted by it to some degree as well."

Valuation questions aside, old-media and new-media firms have to link up. Nearly every old-media firm needs some kind of new-media footprint to distribute its content and capitalize on the e-commerce and marketing opportunities offered by the Internet. AT&T, for instance, controls Net portal @Home and cable company TCI. Last week it made a bid for Mediaone, another cable firm with investments in entertainment. Thus AT&T wants to deliver everything to everybody--from phone service to cable TV to e-commerce--over a variety of networks.

Sooner or later an Internet company will purchase a substantial, publicly traded real-world firm, and that will finally bring about in the financial markets the sort of convergence already under way on the desktop between the television and the PC. Wetherell is a firm believer in that convergence, and he points out that the companies currently in his incubation pipeline are poised to capitalize on the expansive networking possibilities and dizzying growth that increasing interconnectivity promises. "Look, traditional media is one to many--you publish a magazine, and it goes out to many. But on the Internet you have many to many, so the possibilities are phenomenal. The numbers are what makes this case so exciting."

Even if the Lycos deal goes through as currently configured, Wetherell and CMGI stand to make close to $700 million. And with companies such as Chemdex, Silknet, Raging Bull and Medical Village preparing to go public and perhaps become the next Lycos or GeoCities, Wetherell's viral growth justifications of wild valuations will continue to be gospel in the Net economy. "David is so confident and so smart," says Bill Martin, 21, a University of Virginia dropout and one of the founders of Raging Bull, a financial Web community half-owned by CMGI. "But he's a guts guy too. When we brought him our idea, he listened, took a conference call and then came back in the room and put 2 million bucks into the company. I called the dean the next day and told her I wasn't coming back to school."

Good move. If all goes according to plan and Wetherell's valuation models continue to hold, then Raging Bull will go public in about a year, and Martin will be worth a few hundred million dollars. Those will be Internet dollars, of course--but do you think Martin really cares?