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Spiderman: Inside Lycos' Exit At What Cost?

Lycos' (NASDAQ:LCOS) merger with USA Networks (NASDAQ:USAI) and Ticketmaster Online-Citysearch (NASDAQ:TMCS) left Wall Street scratching its head trying to value what happened. Here's one take.

USA Networks' Internet assets -- Ticketmaster and Internet Shopping Network/First Auction -- will be rolled into the new USA/Lycos Interactive Networks. USA Networks will also toss in its Home Shopping Network.

The combined market value of the 3 amigos was $20 billion February 8, the day before the deal. The firms themselves have said the combined value of the 3 in their minds was $22 billion. Wall Street had a different opinion. By the time investors got wind of the merger February 9 LCOS and TMCS lost about 25% each. USAI gained 9%.

The drop came as the new entity splits became known: Upon the closing of the transaction, USAI will own 61.5 percent, Lycos shareholders will own 30 percent and TMCS shareholders other than USAI will own 8.5 percent of the USA/Lycos equity (TMCS shareholders, including USAI, will receive in the aggregate approximately 19 percent of the USA/Lycos equity).

Additionally, Lycos shareholders can increase their ownership another 5 percent, to a total of 35 percent, and TMCS public shareholders can increase their ownership by 0.15 percent, to a total of 8.65 percent, should the initial USA/Lycos shares achieve an average market value of $45 billion over specified periods.

According to reports, Lycos shareholders are slated to get 1 new share in the new outfit for each LCOS share while TMCS shareholders are on tap for .4464 of the new firm's share for each TMCS share.

To be fair, LCOS shares have risen dramatically this year, largely driven on takeover talk. LCOS was up 70% since December 31, 1998. Lycos' allocated value of the $22 billion package above -- 30% or $6.6 billion -- seems in line with what @Home agreed to pay for Excite. That deal was initially valued at $6.7 billion.

We think part of the problem LCOS shareholders have is they may have wanted more of a premium past the rapid run LCOS has already had. Or they expected an NBC to cut a check. The benefit of USA Network wasn't evident, which some say makes Lycos an e-commerce powerhouse. We say not so fast.

USA Network is quick to point out its 90% broadcast reach in the U.S. and its cable carriage. But we know from having been a media financial analyst that those "homes passed" or "coverage area" percents are meaningless. The only numbers that matter are actual homes viewing USA Network programs or channels. Far less than 90% of U.S. homes tune in.

Let's focus on the $22 billion value ascribed here. If USAI owns 61% pro forma that implies $13 billion valuation for its contribution. For Internet Shopping Network/First Auction using uBID (NASDAQ:UBID), Egghead.com (NASDAQ:EGGS) and ONSALE (NASDAQ:ONSL) as comparables we come up with $565 million average. USA's stake in TMCS is about 67%. So we can get to $3.2 billion value already. That implies $10 billion value on Home Shopping Network.

The combined entity would have generated $1.5 billion in revenue, however, and the overwhelming majority of that is from Home Shopping Network. That's a 6.7x revenue multiple given to this cable property, on the high side for cable properties we'd say.

We can justify a premium though on the leverage that its revenue and cash flow brings to two smaller revenue enterprises: Lycos and Ticketmaster Online-Citysearch. LCOS generated about $25 million in revenue in its latest quarter while TMCS posted $13.6 million revenue for 1998.

Said another way, USA Networks, with its $1.5 billion revenue being thrown off, has the cash. Electronic retailing was $776 million of USA's $2 billion revenue for the nine months ending September, 1998. And the oldest rule on Wall Street is 'he who has the cash makes the rules.'

Some of the benefits of the merger center on e-commerce. Again, however, easier said than done. Lycos is not an e-commerce powerhouse now, nor is TMCS. Lycos is almost 100% ad supported, not transaction supported.

What the three can do is cross promote e-commerce across the mediums and venues, however, turn traffic into shopping.

Overall we think just as when Ticketmaster Online and Citysearch merged that there were pieces to be added to make this a complete multi-media e-tail and e-commerce experience. Lycos adds the wide Internet reach element that TMCS lacks and USA Networks never had.

Knowing USA Network chairman Barry Diller, the man who built Fox TV and invented the TV movie, the same one who wanted to acquire a Big 3 broadcast network four years ago, knowing all this, as well as the fact USA Networks sold debt recently, we could see that more acquisitions may be on tap. We think Diller could acquire a larger broadcast group or network yet, if not a movie studio along the way. That's the kind of multi-media player Diller is.

But another point not mentioned is that cable Internet services are growing. With its cable, Internet programming now at its fingertips--combined with home shopping expertise--USA/Lycos could be a programming and etail leader in this space. What they've done, more than @Home-Excite, is raise the ante between cable and Internet, broadcasters and Internet, to merge to create multi-platform commerce and content.

One last point on valuation: both Lycos' and Excite's deal values make what Disney paid for 43% of Infoseek, $430 million, seem cheaper by the minute. Was it the best deal Lycos could do? For the long term we think so.

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