Market Place: Digital Faces Tough Market for Spinoff of Altavista
By LAURENCE ZUCKERMAN
Dear Investor:
Digital Equipment Corp. cordially invites you to finance its latest marketing
campaign. In exchange, you will get to share some of the company's future
losses.
Sound like a promising invitation? That appears to be the pitch underlying
Digital Equipment's decision to spin off Altavista Internet Software Inc., the
division best known by Internet aficionados for software that uses key words
to search for information on the World Wide Web.
Last week Digital registered with the Securities and Exchange Commission to
raise as much as $50 million by selling up to 20 percent of Altavista in an
initial public offering. Digital and its lead underwriter on the deal, Lehman
Brothers, have yet to disclose how many shares Altavista plans to issue and at
what price.
But given the performance so far of the four other Internet search companies
that have gone public this year, it will not be easy for Altavista to command
a premium, analysts say.
"They are going to have a hard time generating excitement for Altavista,
because anybody who bought into the other Internet search companies doesn't
have a very good taste in their mouth," said Ryan Jacob, director of research
at IPO Value Monitor, which researches initial offerings for institutional
investors.
All four of the new Internet search companies -- Yahoo Inc., Lycos Inc.,
Infoseek Corp. and Excite Inc. -- are trading far below the peaks they reached
on their first days of trading, and, with the exception of Yahoo, at a
fraction of their offering prices.
For example, Excite, which went public on April 3 at $17 a share and traded
as high as $21.25 its first day, closed Friday at $5.75, up 25 cents. Yahoo,
which has traded as high as $43 a share since going public in April, closed
Friday at $19.625, down 12.5 cents in Nasdaq trading.
But according to several analysts who follow Digital, raising capital does
not appear to be the principal aim behind the company's decision to spin off
Altavista. Digital had $2 billion in cash at the end of July, more than enough
to fund Altavista's growth.
But Digital, which was posting an impressive turnaround in the last two
years, stumbled badly earlier this summer. In July the company announced that
it had suffered unexpectedly high losses in its personal-computer business,
forcing the resignation of the company's No. 2 executive and the announcement
of a $492 million charge to pay for the elimination of 7,000 jobs.
That hurt Digital's stock and reminded investors that the company that
dominated the market for minicomputers in the 1980s was still having trouble
making a go of it in the Internet era of the 1990s.
By floating Altavista, analysts said, Digital is hoping to receive more
recognition for developing a cutting-edge Internet technology.
That could boost sales of Digital computers much the way Sun Microsystems has
benefited from its development of the red-hot Java computer language, even
though Java itself has generated relatively little profit, and Sun has so far
announced no plans to spin it off.
"My view is that DEC is finally getting marketing religion," said Steve
Milunovich, an analyst at Morgan Stanley in New York.
Milunovich added that he expected Robert Palmer, Digital's chairman and chief
executive, to stress marketing when he discusses the company's strategy with
Wall Street analysts at a meeting scheduled for Tuesday in New York.
That means that for the foreseeable future, at least, the decision to float
Altavista appears to provide more of a benefit to Digital shareholders, which
will own 80 percent of the new company, than to investors in Altavista itself.
In addition to linking Digital's name more closely to the Internet, the
spinoff will also remove some losses from Digital's books, thereby boosting
the parent company's earnings. It also sends a message to Digital employees
that if they come up with a hot technology, they can reap the financial
benefits of an initial public offering.
The spinoff's management team, all current Digital employees led by Ilene
Lang, Altavista's president and chief executive, will receive options to buy
the new company's shares.
But Altavista itself seems like a risky investment. Like its four public
competitors, the company has been operating for only a short time, is run by
an untested management team and has substantial losses. For the fiscal year
that ended June 29, the company lost $30 million on $3.6 million in revenues
and doesn't expect to make money soon.
And though Altavista is best known for its search technology, most of the
company's revenues last year came from an unrelated program that helps people
keep unwanted intruders from penetrating their Internet sites.
Unlike its competitors, Altavista accepts no advertising on its free search
site on the World Wide Web. Instead it plans to make money by licensing its
search technology to other sites that might otherwise be competitors and to
foreign telecommunications companies that set up parallel, or so-called
mirror, search sites outside the United States.
The company has recently signed a deal with Yahoo, which is the best-known
Internet search site, to provide the underlying technology for Yahoo's
service. Altavista has also reached agreements with Telia Telecom AB of Sweden
and Telestra Corp. of Australia to set up mirror sites.
Such agreements help sell powerful Digital computers, which are needed to
handle the large amounts of data that make Altavista's search capability so
effective. But it is not yet clear how much transaction and licensing revenue
the accords will bring to the new company.
The other source of revenue is a family of Altavista products aimed at
corporate customers, including electronic mail, security and work group
software, which are not related to searching the Web but which the company
hopes will benefit from carrying the Altavista brand name.
"We have committed to, and there are high expectations from, Bob Palmer and
the Digital board that we will be financially viable," Ms. Lang said. "But we
are still in investment mode because we are a new business."
Which begs the question: Why not wait for a quarter or two of profits before
taking Altavista public?