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Inktomi's A Buy Now Or Anytime

With a current market capitalization of $13.7 billion, caching server and search engine software sector leader Inktomi trades at 80x its trailing 12 months' revenue of $171 million.

By nearly anyone's measure, this means that Inktomi, like the majority of publicly traded Internet companies, is overvalued.

In most cases this is a cause for great concern among investors, and rightly so. No stock can indefinitely continue to trade far above the issuing company's real value; sooner or later share price (and thus market cap) must come into line with revenues, profits and growth rates. That's why more than half of all Internet stocks have fallen at least 50% this year; the entire sector was wildly overvalued, and all but the most delusional Internet investors knew it.

But I've long maintained that a handful of 'Net companies will eventually grow into their lofty valuations. Inktomi will be one of them.

In January, when I named Inktomi as one of my 10 stocks to watch for 2000, I noted that the company was more overvalued in terms of TTM revenues than any of my other HotWatch 2000 picks (which, despite what all evidence indicates, did NOT include Intraware ).

Back then, INKT was trading at $88.75, had a market cap of $9.8 billion and revenues of $71 million in the previously reported four quarters. That put Inktomi's valuation at 138x TTM revenues.

Today, despite a nearly 40% increase in its market cap, Inktomi's valuation as a function of TTM revenue has dropped 42%. Both trends are exactly what investors want to see.

Which is why two Wall Street brokerages, Lehman Brothers and First Union Securities, issued favorable reports on the company Wednesday.

Lehman started coverage of INKT with a "buy" rating, settting a target price of $150 (shares were trading Wednesday afternoon at $124.75) and valuing the company at 50 times its upper earnings estimate for 2001 of $383.5 million. That translates into a market cap of $19.2 billion.

First Union, meanwhile, set a 12-month price target of $145 per share for Inktomi and upgraded its rating of the stock to "buy" from "market perform."

I see two catalysts behind these reports. First, these Wall Street analysts were reacting favorably to last week's news regarding Inktomi's alliance with America Online and others to improve the delivery of content via the Internet.

Under the "Content Bridge" alliance, Inktomi will provide network infrastructure technology for delivering content. The deal is a blow to Akamai Technologies , a rival content delivery provider that has stolen much of Inktomi's spotlight this year.

Second, since plunging this spring, Inktomi shares have remained relatively stable, falling below $100 per share only once (closing at $98.31 on Aug. 1). Thanks to its 45% market share in the caching server and search engine markets, as well as two consecutive quarters of profits, Inktomi appears to have found a solid bottom.

With its discerning eye trained on the booming wireless market, a penchant for allying itself with other powerful 'Net players, dominant market share and growing profits, Inktomi remains a leading candidate to become one of the Internet's biggest winners.