Terra Firma?

Lycos's deal with Terra Networks is its second bid to become an Internet powerhouse. Could it unravel?

Next month, shareholders of Lycos Inc. will decide if they want to join forces with the leading Spanish Internet service provider, Terra Networks SA. Terra who, you ask? Terra is the offspring of Telefonica SA, Spain’s privatized phone utility, and its stock was trading around $150 last winter. U.S.-based Internet portals such as Lycos are increasingly looking abroad for growth, and here a Spanish player with an expanding presence in Latin America came to Lycos with a hefty offer. Now Lycos management, for the second time in two years, is enticing shareholders with a fascinating, but risky, deal. And if shareholders say no, it will send Lycos back to the drawing board to keep pace with its Internet peers.

It’s been difficult for Lycos to keep up with the likes of America Online and Yahoo. It consistently ranks fourth in total U.S. Web traffic (after AOL, Microsoft’s sites, and Yahoo). All the same, its announcement in May that it would be acquired by Terra Networks came out of left field. The offer–$97.55 worth of Terra’s shares, based on its stock price at the time of $56–was a lush premium for Lycos, which was trading at about $60 at the time. For Terra, the deal represented the crowning achievement of an aggressive worldwide expansion program that included acquisitions in Mexico, Brazil, and Chile. For Lycos, whose merger with USA Networks fizzled amidst shareholder skepticism, the new deal was heralded as a bold move onto the international stage. “Overnight, in one fell swoop, this company has jumped from strong Internet competitor to a global powerhouse,” claimed Lycos CEO Bob Davis at the time of the deal.

But the deal only served to confuse many investors. It was the world’s first international portal acquisition, and the acquirer was a relative unknown. In addition, Terra’s stock has slumped more than 20 points since the announcement, and analysts caution that the deal is not a certainty, especially if that trend continues. Ted Philip, Lycos’s chief operating officer and CFO insists, of course, that he “sees nothing that keeps this deal from closing.” Still, the investor reaction underscores risks associated with cross- border deals when a foreign acquirer is using an inflated stock price to make an acquisition.

“It’s risky to the Lycos management from the standpoint that they’re putting all their cards on the table and assuming this deal will go through, when the reality is that if Terra’s price gets too weak, there won’t be a real takeover premium for shareholders,” notes Frederick Moran, head of Internet research at Jefferies & Co., in New York. As European Internet shares falter like their U.S. counterparts, shareholders may have to choose between the longer-term strategic sense of the deal and the desire for a significant premium.

Visionary, or Deal-hungry?

In part because of the risk, Terra has been a generous suitor. As part of the deal, parent Telefonica agreed to underwrite a $2 billion rights offering for the new company, to be called Terra Lycos. And anticipating potential deflation in Terra shares, the deal included a collar that guaranteed the deal price as long as Terra’s stock stayed within a 20 percent range for a 10-day period before the close of the merger, which is expected to be in October. If the price falls below the collar, Lycos holders would receive a maximum of 2.15 Terra shares per share; if the stock soars, Lycos shareholders would receive no less than 1.43 Terra shares.

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