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  1. MJR
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    The Silk Road Weekly:
    The Internet and The New Economy
    by U.S. Bancorp Piper Jaffray
    March 17, 2003 | Volume 4, Number 11

    Safa Rashtchy 650-838-1347

    The Silk Road Weekly is our universe publication that covers key Internet stocks and general industry themes. Our goal is to provide weekly updates on what drives these key stocks, upcoming catalysts or warnings to watch for, as well as to address our current investment thesis and valuation analysis.

    This report should be read in conjunction with important disclosure information found at the following site: http://www.piperjaffray.com/disclosures

    Risks : As with any growth industry, the risks for the Internet industry are significant. Among these are: 1) a slowdown in advertising spending, 2) slower-than-expected migration to e-commerce, 3) failure to monetize users, and 4) operating losses. Consolidation and vertical integration among the key players can also add to volatility of the stocks involved. Finally, we note that a big risk to the Internet stocks, many of which have very high valuations, is the potential of valuation multiple contraction, if the expected high growth rates don't materialize or are seen to be in jeopardy.


    In This Week's Silk Road Weekly:
    1. Industry Commentary - Thoughts on the Search Market Ahead of the Symposium
    2. Company Previews for Search Symposium (March 18, New York Palace)
    3. Universe Company Reviews

    Key Metrics Top

    Summary of Internet
    Activity In the U.S. (MM) February
    2003 January
    2003 M/M%
    Change Y/Y%
    Total Active Users 131.3 133.6 -1.8% 10.5%
    Average Sessions/Day 1.3 1.4 -4.9% 18.2%
    Average Time Spent/Day 42 46 -7.5% 14.1%

    Source: Nielsen NetRatings (Home and Work Panel)

    Traffic To Selected
    Categories (U.S.) MM Week of
    3/9/03 % Chg
    W/W February
    2003 January
    2003 Y/Y%
    Change M/M%
    Portals and Destinations 77.6 0.4% 116.4 118.7 4.5% -1.9%
    Search Sites 44.4 -0.2% 91.3 92.9 8.3% -1.8%
    e-Commerce 29.0 -2.1% 74.8 77.5 11.5% -3.5%
    Travel 13.5 1.0% 49.9 52.1 8.8% -4.3%

    Traffic To Selected
    Networks (U.S.) MM Week ending
    3/9/03 % Chg
    prev. Week February
    2003 January
    2003 Y/Y%
    Change M/M%
    AOL Time Warner (#) 50.5 -0.1% 79.1 83.2 -2.4% -4.9%
    Yahoo! (#=) 39.8 -0.5% 79.9 80.2 7.2% -0.5%
    Microsoft Network (#) 37.4 -0.4% 71.5 73.5 12.7% -2.7%
    Amazon (#) 9.1 -1.4% 35.3 38.8 12.7% -8.9%
    USA Interactive (#) 6.7 -3.2% 28.0 29.1 27.2% -3.5%
    eBay (#) 12.5 -1.9% 35.6 38.7 42.4% -7.9%
    CNET Networks (#>) 4.0 -1.2% 11.3 19.4 -39.3% -41.9%

    Source: Nielsen NetRatings (Unique Visitors Home and Work Panel; Home only for weekly data)
    Weekly data includes Internet applications

    1. Industry Commentary Top

    Thoughts on the Search Market Ahead of the Symposium. With our upcoming Search Symposium only a day away, we devote this issue of the Silk Road to a preview of key events for the major search players and list what to expect from each of the participating search companies. During the last week, the volatility of the search stocks continued, particularly for Overture (OVER) and LookSmart (LOOK). We maintain our belief that the search market is facing a very big opportunity and it is still in the early stages. As such, we think it is likely that most of the companies will be benefiting, as they have for the past year or so, rather than some benefit at the expense of the others. The search market is too young yet to have distinct winners and losers; and the early tide, at least in 2003, is likely to raise most of the players. Because of the limited number of public companies in the search space (and only a few more private ones), there is not much competition for the market to only select the strongest.

    To be sure, long-term investors must invest in the sustainable business models and the industry leaders but beyond the industry leaders, we believe other players with possibly weaker positions, but yet having some valuable asset, are likely to be absorbed by others. The portals that are going to vertically integrate are likely to go after the industry leaders first -- but there are only a few of those left so any consolidation trend is likely to impact most of the players.

    It is difficult to anticipate the outcome of our Search Symposium on the individual stocks because of the unusual format we have selected for the symposium. Rather than standard Company presentations, we will have four panel discussions with multiple companies at each panel. While this format makes the outcome more unpredictable, we expect that the industry leaders are likely to be the biggest beneficiaries, with potential downside for the weakest players.

    In the section below, we review the latest developments for each of the participating companies and also discuss potential questions or issues that may be discussed at the Symposium for each company. If you have not yet registered for the Symposium, please check with your U.S. Bancorp Piper Jaffray sales representative to check for availability (we have limited capacity for this Symposium). Also please note that we keep the most up-to-date schedule with the latest changes on the Symposium's website, www.gotoanalyst.com/ss.

    2. Company Previews for Search Symposium: 2003 and Beyond - March 18, New York Palace, NY Top

    Current Events: We expect the acquisition of Inktomi to close within the next week.
    Financial Status: In 2002, Yahoo had $140m of global sponsored search revenues, while the Company expects between $205m-$220m in revenue in 2003. In addition, Yahoo expects its 2-4 year CAGR range (from 2002) for global-sponsored search revenue to be between 40%-60%.
    Potential Symposium Questions: We believe most of the questions will revolve around increasing the monetization of search globally and around Company's different verticals, including local listings; the Company's plan's for paid inclusion; plans to gain market share; and, of course, competition from Google.

    Current Events: On February 18, the Company announced its intention to acquire AltaVista for $140m ($80m stock, $60m cash). U.S. Bancorp Piper Jaffray's Investment Banking department advised AltaVista on this transaction. On February 25, Overture announced its intention to acquire the web search division of Fast Search and Transfer for $70m in cash (with the potential for another $30m earnout).
    Financial Status: The Company expects consolidated revenue for 2003 of more than $1b, with between $125m-$135m in International revenues, Traffic acquisition costs (TAC) to be in the 62%-64% range, and EPS between $0.60-$0.70.
    Potential Symposium Questions: The integration of the recent acquisitions and why OVER needed two search companies; plans for paid inclusion; why will TAC stay in the guidance range; International trends; and the issues involved in owning a destination site

    Current Events: On March 10, the Company announced it will provide several Disney properties, including go.com, with search technology and sponsored links. On March 4, Google announced it reached more than 100,000 advertisers worldwide and the introduction of its content targeted advertising solution.
    Financial Status: Based on our analysis of the search market, we believe Google had 2002 revenues of $200-$300m and was highly profitable.
    Potential Symposium Questions: How will the highly successful Google brand be best leveraged? the competition between the partner strategy and the destination strategy; composition of the 100,000 advertisers and the current rate of growth; Average click charges compared to competition and the industry; and maintaining market share gains in the face of the potential of escalating marketing wars from the portals.

    Financial Status: We estimate Lycos (U.S. properties only) generated more than $40m-$60m in search revenue in 2003.
    Potential Symposium Questions: Will Lycos continue its relationship with FindWhat and Overture; in the face of intense competition, how will Lycos compete with the larger portals; does the Fast acquisition strengthen the relationship with Overture.

    Ask Jeeves
    Current Events: On March 4, Ask Jeeves announced the addition of new partners in the site submit paid inclusion program. On January 23, the Company announced its first profitable quarter, reporting web properties revenues of $19m, total revenues of $22.7m, and GAAP EPS of $0.05.
    Financial Status: Ask Jeeves reported Q4 web properties revenue of $19m, of which 53% was paid listings, 44% was branded advertising and 3% was paid inclusion. We are modeling for 2003 revenues of $100.2m, of which $85.9m is made up of web properties revenue and $14.3m is made up of Jeeves Solutions revenue.
    Potential Symposium Questions: Strategy for maintaining market share and search traffic, considering the competition for searchers from the major portals; when will Teoma index size ramp up, similar to that of the other leading players; will Ask Jeeves keep paid inclusion in-house or will it outsource that solution; how is Ask Jeeves international properties trending.

    Current Events: On March 6, the Company renewed its multi-year search agreement with Roadrunner. On January 28, the Company announced revenues of $31.2m, of which $27.3m was from listings.
    Financial Status: LookSmart reported Q4 listings revenue of $27.3m and total revenues of $31.3m, while reporting EBITDA of $6.0m. For 2003, we are modeling for revenues of $140.2m of which $126.2m is from the listings business, and full year EBITDA of $24.7m.
    Potential Symposium Questions: The potential impact of Overture's recent acquisitions on MSN contract renewal this year; pricing trends in paid inclusion - when will it start improving?; is there a sustainable advantage in having an editorial directory vs. an algorithmic one; how much margin erosion can we expect with the introduction of more aggressive and effective paid inclusion players.

    Current Events: On February 4, the Company announced Q4 revenues of $13.4m with EPS of $0.19. For 2003, the Company expects revenues of $60m and EPS of $0.40.
    Financial Status: FirstCall consensus for 2003 are for revenues of $60.8 million and EPS of $0.42.
    Potential Symposium Questions: Strategy for sustaining revenue base in the face of the continued loss of share by the smaller search players to the bigger portals? trends in the revenue share levels (currently at 55%)?; how has the private label partnership with Lycos worked?; is there an International strategy for expansion?

    Current Events: On March 4, All The Web, Fast's search destination, announced a new user interface. On February 25, Fast announced the sale of its web search division to Overture for $70m in cash, with the potential for an additional $30m if certain performance criteria are met.
    Financial Status: For the fiscal year ended December 31, 2002 Fast reported total revenues of $45.5m, of which $36m were Enterprise revenues, $8.8m were web search revenues and $0.7m were content services. Total company operating income for 2002 was $0.4m, comprised of $6.3m contribution from the Enterprise unit, ($4.0)m from the web search unit and ($1.9)m from the content services business unit.
    Key Symposium Questions:What differentiates Fast Web search from the other algorithmic search providers; how quickly can Fast scale its paid inclusion revenue stream; and how will Fast integrate with AltaVista.
    Current Events: On January 15, Fast and eSpotting announced a European search distribution agreement. We note that this announcement was made prior to the announcement of Overture's intent to acquire Fast's Web search. Financial Status. We estimate 2003 revenues of approximately $40m-$60m.
    Key Symposium Questions: Where is the European market, relative to the U.S. market in terms of advertiser demand, pricing, etc.; is the Yahoo relationship a sustainable one considering the significant resources Espotting's competitors have and Yahoo's focus on search; how will Overture's relationship with Fast affect eSpotting's relationship with major European players including Tiscali (which uses Fast's Web search technology).

    3. Universe Company Reviews Top

    eBay (EBAY, $83.91, MP) This quarter is tracking ahead of our estimates, and there is no major visible risk to the assumed growth rate; valuation (past year NTM P/E ratio) is creeping up to the historical average, but remains well above the industry and continues to make us nervous. Likely to see minimal impact from a potential war.

    USA Interactive (USAI, $24.99, OP) Expedia's upbeat analyst day takes some pressure off of USAI shares; We believe valuation of less than 9x 2004 attributable EBITDA is compelling for this growth story; we expect further expansion this year with additional acquisitions; concentration in the travel sector remains a negative at this point, given the war-related uncertainty in that sector; we expect 2004 will be the year of integration and loyalty programs helping drive incremental margin improvements.

    Yahoo (YHOO, $20.69, OP) Continues to be in driver's seat. Despite the recent stock appreciation, Yahoo remains one of our top picks; we believe consistent EBITDA and EPS upside through 2003 is likely to be driven by search and paid services. Any advertising growth will be a bonus and the Company continues to be best positioned for an ad recovery. Rumblings surrounding the introduction of its paid video service could provide a catalyst for the stock.

    Amazon (AMZN, $24.71, MP) Recent increase in price puts valuation at concerning levels; Company is trading at a 2003 EBITDA multiple of over 30x -- the highest among all e-commerce names and we believe investors should consider profit taking. While we believe Amazon's low price and free-delivery strategy are the right long-term business decisions, those initiatives will likely hold the stock back in the face of flat or even declining margins. The stock may be under pressure over the coming weeks due to concerns regarding Internet sales tax, although we don't expect that to be a major business issue going forward. War impact likely to be minimal unless transportation systems are affected.

    Expedia (EXPE, $37.14, OP) Upbeat analyst day provided comfort for investors, if little new information, especially in the face of preannouncements from Sabre and Delta Airlines. Meaningful appreciation is likely capped in the face of a potential war. We believe the corporate travel initiatives could provide a catalyst, especially in light of the compelling cost savings it offers corporate travel departments in a cost-conscious time. We believe travel purchases will continue to shift to the Internet. In our opinion, the Company's primary differentiator remains its technology platform and its ability to dynamically price inventory, which will be the key driver of longer-term growth, as its technology platform provides value to suppliers and consumers alike.

    Hotels.com (ROOM, $48.15, MP) We expect ROOM to beat our revenue estimate for this quarter, as we are modeling for a sequential decrease in room nights sold, a very conservative assumption. Despite our belief in Q1 upside, we believe shares will likely trade flat in the face of a potential war; packaging business rollout could provide next catalyst.

    Overture Services (OVER, $14.19, SB) Stock price took a significant hit on press rumors that Yahoo may be acquiring a competitor to Overture (eSpotting). The acquisitions of AltaVista and Fast added significantly to the already confusing short-term issues this year, but we believe the Company is on the right track and is positioned for faster growth next year. We believe the acquisitions are strategically correct and important at this stage, but Overture remains a 2004 story for now.

    DoubleClick (DCLK, $7.16, MP) Despite an attractive valuation, we remain cautious on DoubleClick until we see more aggressive strategic moves to expand product and services. The Company's existing lines are either commoditized and under pricing pressure or represent relatively slow growth areas.

    NetFlix (NFLX, $16.55, OP) The Company continues to outperform our expectations despite competition, benefiting from a solid business model and the growing DVD market. NetFlix's brand, first-mover advantage, and its critical technology and infrastructure are its key competitive advantages.

    InfoSpace (INSP, $9.36, MP) Search is becoming more central to InfoSpace, but we remain cautious on the stock until we see evidence of strategic restructuring, a hope which may finally come true with the appointment of a new CEO. It is not clear if current business units are sustainable in the long term, but the Company does have some key assets, including substantial cash that can be redeployed. Announcement of lawsuit against its former CEO and current director suggest the Company is still recovering from past issues.

    Ask Jeeves (ASKJ, $6.87, OP) Despite the recent pullback, the stock's rapid gain in the past month or so is likely to cap the upside in the near term. Risk and challenge remains the market share gain (or maintenance) in the face of bigger push by the Big Four (Google, Yahoo, MSN, and AOL).

    LookSmart (LOOK, $2.15, OP) Concerns regarding the entry of Overture and potential loss of MSN, the Company's largest affiliate are overblown. Attractive valuation of 12x this years earnings, puts the risk/reward level at compelling levels.

    CNET (CNET, $1.75, MP) The outperformance in Q4 was promising and a hopeful sign, but we remain cautious until there is noticeable sign of recovery in the tech sector and/or CNET's story becomes more focused, with the current business model changes taking shape and becoming significant.

    CMGI (CMGI, $0.73, MP) With the announcements of the divestiture of AltaVista, Tallinn, Yes Mail and the announced sale of bid, the Company's clean up work is close to over. We remain cautious until we see more visibility in the supply chain management business.

    GSI Commerce (GSIC, $1.87, UP) We remain very cautious as the losses have been expanding and there is little visibility for 2004 or the remainder of 2003.

    Homestore (HOMS, $0.59, MP) We remain cautious, since the Company still faces significant legal battles and operating losses. However, after decent fourth quarter results, and further visibility behind what the cash burn will likely be in 2003, combined with the Company's leading position in the online real estate market and its ability to retain significant revenues despite going through major upheaval are promising and hopeful signs.

    Jupitermedia (JUPM, $2.78, MP) Similar to CNET, the Company needs a recovery in tech advertising, but the diversification into the events business may provide faster relief.

    Digital Impact (DIGI, $1.32, MP) The Company has sustained itself in the face of a tough email market, but growth prospects are still limited. We believe the Company remains a potential acquisition candidate.

    U.S. Bancorp Piper Jaffray Internet Media & Marketing Indices
    Relative Price Performance - Year To Date

    About The Silk Road Weekly Top

    The Silk Road Weekly is our universe publication that covers key Internet stocks and general industry themes. Our goal is to provide weekly updates on what drives these key stocks, upcoming catalysts or warnings to watch for, as well as to address our current investment thesis and valuation analysis.
    Why the Silk Road? During the 2nd and 1st Century B.C., a crucial 7000-mile route was developed that created a vibrant and dynamic trade between China and the Roman Empire, linked through the Persian Empire and Northern India. The development of this road had a huge social and economic significance for both East and West as well as for the points in between that acted as the infrastructure for this trading space. We believe the ultimate potential of the Internet would be a similar role but multi faceted, linking the traditional economy with the potential of a richer new economy (higher profitability and margins), and also linking the less developed economies of the world with the advanced trading venues, enabling them to close the gap with the developed economies. In other words, the Internet is not the end in itself but a potential Silk Road that will help transform our global economy.

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