Internet Phone Stocks Soar

Two of the fastest-rising Internet stocks in the past week belong to
companies using different strategies to unite the Internet and

Both companies are coming off recent successful IPOs and each has
generated a buzz among investors with news of key partnerships and

But both Net2Phone (NTOP) and (PHCM) are in markets – Internet telephony and
wireless Internet access via phone, respectively – that are in a very
early stage of development. And that means higher risks.

I’ll discuss Net2Phone in this column, and on Friday.

If I were giving out a stock of the week award, the hands-down winner
would be Net2Phone, which more than doubled its share price from $25.81
on Aug. 18 to $53.13 on Wednesday. That’s a 106% gain, and an all-time
high stock price for the IDT spinoff. (The second-best performer in that
time frame was e-tailer Alloy Online, whose shares rose 49.8%.)

Net2Phone is the market leader in Internet telephony, with an estimated
30% share according to the last figures I could find. The company
provides software that enables consumers with a PC-connected microphone
to make calls on their computer to either a regular telephone or another
computer with Net2Phone software. Revenue is derived through the
telephony service on a cents-per-minute call basis.

In the nine months ended April 30, Net2Phone had $22.3 million in
revenue, a 179% increase over the $8.0 million generated in the same
period a year earlier.

Even before going public on July 29, Net2Phone was attracting attention
and building brand name by cutting agreements with Netscape and America Online Inc. (AOL) to integrate the company’s telephony software into their Internet products.

This week’s surge can be credited in large part to two more deals. On
Wednesday, Net2Phone announced that Sprint would test its service for
international telephony calls in the Asian market. And Tuesday, PC maker
Compaq said it will provide a button on its Presario computers sold in
Canada, Latin America and Asia that would lead users to a Web site with
Net2Phone software downloads and service information.

The attraction of Internet telephony certainly isn’t quality, though
that will improve over time. It’s price: Having your call jump onto the
Internet, travel great distances and then get back onto the public phone
network, saves you money, perhaps 50% or more.

There are a number of extravagant projections about the Internet
telephony market. One, from International Data Corp., forecasts the
telephony market will grow from $1.1 billion in 1998 to $23.4 billion in

That means the race has barely begun, which is good and bad for
Net2Phone. Good because until now competition has come primarily from
VocalTec, QuarterDeck and Microsoft (MSFT); bad because telco and hardware
giants such as Alcatel, Cisco Systems, Intel (through its Dialogic
acquisition) and Lucent are planning telephony offerings.

With a market cap of $2.5 billion, Net2Phone is valued at about 80 times
earnings. Pretty pricey, but the company has done a lot in recent months
to solidify its position as telephony market leader. I see a lot of
upside here, despite the entry of larger vendors into the market.

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