While the Internet market grows more nervous, confident young entrepreneurs refuse to cry into their cappuccinos, reports Jay Rayner
There were two very different Internet markets in Britain last week, existing a little uneasily side by side. In the first, every thing was gloom and doom. Shares in Freeserve, the United Kingdom’s largest Internet service provider which achieved a valuation in excess of 1,5-billion when it floated in July, had slipped well below the original offer price of 150p.
On its stock market debut the success of the company had been held up as proof that a much delayed Internet boom of the sort seen in the United States had finally reached the UK. In the US, companies have achieved valuations in the billions, making enormous paper profits for investors, and it was assumed that the same would happen in the UK.
Instead, thousands of Freeserve’s eager investors were now staring at heavy losses. Accordingly, financial analysts called into question the enormous valuations of Internet companies which are yet to make any profit and which, in some cases, are yet to even launch. Perhaps over-hyped Internet stocks were little more than the modern equivalent of the emperor’s new clothes, they said.
The message was compounded last week by the news that the valuation of QXL, a British online auction house due to float next month, had been halved from an estimated 500-million to little more than 200- million on theEpublication of its share issue price. As far as the Financial Times was concerned, the UK was in the grip of a ”slump in net shares”. It was assumed that all over London Internet entrepreneurs were weeping into their cappuccinos.
If so, 27-year-old Azeem Azhar hadn’t been told. He was operating inside Britain’s other Internet business, where confidence is undented and expectations remain high. Last week, Azhar was securing millions of dollars worth of private investment for his new Internet business, esouk.com.
”Freeserve was simply overvalued,” he says. ”Everybody accepts that there is an Internet bubble, but if it bursts that doesn’t mean these companies will have no value. Freeserve won’t go from being worth 2- billion to zero. It will go from, say, 2- billion to 1,1-billion. British entrepreneurs are trying to create real Internet businesses with real value.”
Azhar certainly is. He has a four-and-a- half minute pitch to describe his new business, one he’s given 35 times this week. He scribbles graphs of Internet usage against time and taps away furiously on his laptop to bring up statistics about online spending, all to support his proposition that there is room for a company like esouk.com which will be creating new e- commerce.
”Our product will be really great businesses,” he says.
Had he come across any scepticism about the viability of the Internet sector from investors? ”Absolutely not,” he says. ”If anything, the reverse is true. Bankers are desperate to get into the Internet.”
That is undoubtedly the case. At the same time as Azhar was getting his funding last week a brand new 10-million investment fund, New Media Spark, was being launched. Its chair, Thomas Teichman, is as unfazed as Azhar by the Freeserve and QXL news. ”These markets are volatile,” he says. ”I wouldn’t write them off yet.”
Or as Nick Denton, founder of $4-million British Internet start-up Moreover.com, which supplies news content to websites, says: ”What did people expect? That the boom would go in a straight line from first Web browser to world domination? Anybody who knows the history of the Internet in the US will know there are always detours. Yahoo!, which is now worth billions, stagnated at one point.”
Those detours are not dissuading the entrepreneurs. According to Teichman, the quality of ideas coming to them for investment is consistently high. ”We already get five a day, of which a couple are worth looking at. Of those, two a week will be worth pursuing. The entrepreneurs will tend to be mostly male, mostly in their late twenties and will often be slightly unusual characters. We actually look for people who are slightly different.”
The rewards for those unusual characters who get it right are potentially enormous. Tim Jackson, a former Financial Times journalist and the founder of QXL, is now only a non- executive director of the company but he still retains a 17,5% holding. Even at the very lowest end of last week’s valuation, that will give him a 35-million paper fortune once it is floated.
However, Teichman says, these huge valuations of personal wealth should not be taken too seriously. ”They are very exciting but remember the people who start these businesses can’t sell their shares.” They will be bound by golden handcuffs and even then their company will have to perform if they are to realise any wealth.
Ernesto Schmitt, president of Peoplesound.com, knows the problem. His company, which next month launches a website providing downloadable music, was set up in June with a valuation of $20-million. Since then, Schmitt says, its valuation has risen by multiples of that as new investment has come in. As a founder he owns a large stake in the company and is, in theory, worth many millions. But, he says: ”No kebab shop would give me a falafel for my paper money.”
In any case the thought of future riches is not what moves him. ”It’s the fact that I’m 28 and have 30 people working for me who are willing to follow my vision.”
It is those kinds of attitudes which are fazing the financial analysts. They are working on an old model where company valuations are calculated as a function of turnover or profit. The Internet, however, is a young market in which both are still a long way off. A year ago in Britain it was neglected. Now competing entrepreneurs are involved in what Azhar describes as a ”ferocious land grab” to carve out territory in the market place for when everybody finally gets online and is ready to spend. That in turn means pouring money into investment and foregoing revenues of any kind.
Some businesses will turn out to be duds. But there will also be huge success stories and, for the entrepreneurs who create them, huge wealth.
For the moment the massive valuations, and the assessments of personal wealth that go with them, are more a way of keeping score than any real calculation of spending power. ”Every company loses money before it makes money,” Azhar says. ”As for me, I’m in this for the fun and, of course, to get a return on my fun.”
Only a brave pundit would predict his disappointment.