Going Wild Over The Web

Just ask executives at Ancestry.com. Since its inception 10 years ago, the company has become a leader in online genealogy -- helping people trace their origins on the Internet with a personal computer.

Ancestry sells its service by subscription. Consumers pay up to $155.40 a year to access U.S. records and $299.90 for international records. The bulk of Ancestry's revenue is from subscriptions.

So far this year Generations Networks, Ancestry's parent, has collected 900,000 subscribers to either Ancestry or three other related services. It ended 2006 with 830,000 subscribers.

Tim Sullivan, chief executive of Generations, scoffs at critics who say consumers won't shell out for online content.

"This content has real value to people and our belief is that we will continue to have a very profitable and growing subscription business," he said.

Advertisers are paying, too. Companies spent nearly $10 billion in the first half of the year, most of that in search and display ads.

Investors are bidding up stocks in IBD's Internet content group, which has climbed to No. 4 among IBD's 197 industry group categories, up from 157 six months ago.

1. Business

Internet content companies make money in two ways: ads and subscriptions.

Some, such as Web portal Yahoo (NasdaqGS: - ) and sports site ESPN.com, do both.

In recent years search giant Google (NasdaqGS: - ), Yahoo and others have cashed in on advertisers chasing the growing numbers of consumers who spend more time online than anywhere else.

With so many advertisers coming online, CBS (NYSE: - ) stopped requiring consumers last year to pay to watch the live games from the National Collegiate Athletic Association's men's basketball college tournament online.

Newspapers including the New York Times Co. (NYSE: - ) have also backed away from charging consumers for some articles on its Web site.

The growing online audience means that consumers can expect that most of the online content in the future will be backed by ads instead of fees, says Gene Munster, senior analyst for Piper Jaffray & Co.

"Ad-supported content is bigger because people's usage of the Internet is growing, and advertisers are beginning to exchange the dollar business they have been doing on TV with the nickel business on the Internet," he said, referring to the high cost of television spots vs. the cheaper, more targeted ads of the Internet.

2. Market

The Internet ad market shows no signs of slowing.

By 2011, sales of online ads in the U.S. will reach $42 billion, up from $16.9 billion last year, says eMarketer, a research firm.

The Internet is becoming consumers' primary source of content whether it's ad-supported or subscription-based, says Bob Davis, managing general partner for Highland Capital Partners, a venture fund.

"Internet content is mainstream and it's not going to change," he said. "The Internet is now where we go for sports, weather, news and financial information -- it's the first line of information for everything."

Paid search -- text-based ads that show up near search results -- is the biggest driver of online ads. It accounts for 40% of the market. Display ads are next with about 20%, says eMarketer.

Investors seem to be getting the message. Stocks for leading Internet content companies have been soaring.

Shares for Google, which lives on paid search, reached an all-time high of 678 a share on Oct. 25.

Baidu.com (NasdaqGS: - ), China's top Web search service, continues to lead the sector.

Six of the top 10 performers in the sector are based in China, including China Finance Online Co. (NasdaqGM: - ), Shanda Interactive Entertainment Ltd. (NasdaqGS: - ) and Sina (NasdaqGS: - ).

Investors are buying the growth potential in China, Munster says.

"The fundamentals are much better there than they are here, and the potential is so big that people get carried away at times," he said. "These companies are growing at 50% to 100% a year, and that gets people's attention."

3. Climate

China is largely an untapped market. Only 162 million of the 1.3 billion residents are online, says Piper Jaffray.

Google, Yahoo and others are also competing there. And venture capital is also trying to get a piece of the potentially huge market.

In the first half of the year, venture funds poured over $620 million into Internet content-related firms. That's more than in any two consecutive quarters in the last five years, according to PricewaterhouseCoopers.

Because many Internet content companies are supported by ads, a growing ad market is welcome news for venture funds, says Tracy Lefteroff, global managing partner of venture capital industry services for PricewaterhouseCoopers.

"They are starting to make money again. And as long as the returns are there, the capital is going to follow," he said. Interest abounds in the sector.

One of the hottest segments of the Internet market involves so-called Web 2.0 companies. The term refers to sites that make it easy for users to connect and share information in a variety of ways.

Case in point: Microsoft (NasdaqGS: - ) paid $240 million this month for a sliver of social networking site Facebook in a deal that values the startup at $15 billion. The amount drew a quip from Rupert Murdoch, who surprised many observers two years ago when his News Corp. (NYSE: - ) paid $580 million for MySpace, Facebook's main rival.

"What (the Facebook deal) really tells you is that News Corp. is totally underpriced," the executive said during a question-and-answer session at the recent Web 2.0 summit in San Francisco.

On Oct. 15 Discovery Communications paid a reported $250 million for HowStuffWorks.com. The company, which provides information on everything from health issues to recipes, raised $75 million of private funding in April.

In April, Google earmarked $3.1 billion to acquire DoubleClick, an ad services company. The deal is under government review. Microsoft spent $6 billion to acquire DoubleClick rival aQuantive. Yahoo bought Rivals.com, a sports site, and BlueLithium, an ad services company.

Despite the buying activity, IPOs of content-oriented companies have been few and far between, says Paul Ward, analyst for Renaissance Capital, a research firm.

"We haven't seen that big bellwether social-content IPO," he said. "Most of it has been bigger companies like Google or Microsoft trying to get a stake."

4. Technology

Yahoo and Microsoft have both launched new versions of their search services to better compete with Google.

Video is another battlefield. The challenges are who can deliver it faster and profit the most. Google is launching a program to allow Web sites to carry videos from its sister site, YouTube, with ads. Google will split the ad revenue with the sites and the video creators.

Another battlefield is mobile. Google, Yahoo and others are already working on adapting search and related services to mobile devices.

Conducting a Web search for local businesses on a mobile phone while standing on a street corner will be the next breakthrough, Munster says.

"I should be able to type in a cross street in a city and see what stores are around -- and that concept of local search hasn't even begun to tap into its potential," he said.

5. Outlook

The business of Internet content is in its early stages. Companies are still working on video and mobile programs.

Upside: There's plenty of room for more ad growth in Internet content, Munster says.

"In the U.S. about 7% of advertising is done online but 25% of people's free time is spent online," he said.

But not all companies will rely on ads, says Renaissance Capital's Ward.

"You are probably going to see some that have a combination of subscriptions and ads," he said.

More social networking companies such as Going are following the success of MySpace.com and Facebook that have become leading online communities for Web surfers. Earlier this month Yahoo launched its own social networking site called Yahoo Mash.

Social networking could be the next Internet content king, says Lefteroff.

"It's one area that continues to do well even though you have to ask yourself whether it's a sustainable business model, but so far it is," he said.

Highland Capital Partners' Davis, former CEO of Web portal Lycos, sees little downside.

"If you are talking about the sector broadly, I don't think there is any risk," he said. "I think it's just a question of how rapidly it grows."

But as the rise and fall of his former company proves, audiences can be fickle. The Web is littered with Internet also-rans.

Risks: While the group as a whole should grow steadily, picking the right stocks may be tricky.

Low barriers of entry mean there's always another challenger working to woo away an incumbent's audience -- and the ad dollars that follow.

Web portals like Yahoo could be at risk as Internet content becomes more specialized.

In the future more consumers might go directly to specialized sports or real estate Web sites than portal branded areas such as Yahoo Sports or Yahoo Real Estate.