A One-Stock Way to Play The Net Here's an exclusive first look at the company analysts think is best poised to capitalize on the Net's next big wave: business-to-business e-commerce. Internet Capital has stakes in 36 hot B2B startups.
By Erick Schonfeld

(FORTUNE Magazine) – Late in the afternoon of Aug. 4, Walter Buckley was in a limo riding through the streets of Manhattan and feeling queasy. Three and a half years earlier, he and Ken Fox had founded Internet Capital Group, an e-commerce holding company; now it was set to go public. In less than 24 hours Wall Street would render its judgment on their years of work--and the Internet sector had been tanking all summer. Sitting across from Buckley was Merrill Lynch investment banker Ron Will, who was reviewing the stock's allocation. Will's cell phone bleeped. "Michael who?" he asked. Then he handed the phone to Buckley. "It's for you," he said. "You should take this."

The caller was Michael Dell--and Buckley was reminded that, really, he had nothing to worry about. Dell was interrupting a Hawaiian vacation to make a last-minute plea for Buckley to let Dell Computer pump up its allotment in the IPO from 750,000 shares to two million. Dell hinted that his company might want to form partnerships with several of the 30-odd business-to-business (B2B) Net companies in Internet Capital's stable. Buckley played it cool. He said he'd see what he could do.

Dell got only half of what he wanted (a total of one million shares, not two). Buckley, on the other hand, got everything he could ever have hoped for. When ICG's shares traded the next day, they opened at $15 (respectably above the $12 offering price) and closed at $24. One month later, the stock (ticker symbol: ICGE) was trading around $80, giving the company a whopping $10 billion market capitalization (larger than that of CMGI, E*Trade, or Lycos). Not bad for a startup in Wayne, Pa., with a mere 42 employees. And not bad for ICG's initial investors, which besides Dell Computer include IBM, GE Capital, Comcast, Amerindo Investment Advisors, the Saudi royal family, the Penske family, and LBO baron David Bonderman.

What attracts these investors is the fact that Internet Capital is positioned better than any other company to enjoy the spoils of the next great Internet wave: B2B e-commerce. While the markets it has targeted are just taking off, they already dwarf business-to-consumer markets addressed by the likes of Amazon, Yahoo, and eBay. A guesstimate by Forrester Research in Cambridge, Mass., puts U.S. Internet B2B sales this year at about $100 billion, vs. $18 billion for consumer e-commerce. Forrester thinks that by 2003, B2B e-commerce sales will reach $1.3 trillion in the U.S. alone. Says Sergio Zyman, former head marketer of Coca-Cola and now a member of ICG's advisory board: "This business-to-consumer thing is kind of cute, but the real thing is going to be business-to-business."

There's nothing cute about ICG. Asked how much of that $1.3-trillion-a-year market he wants, co-founder Fox says, "Eighty percent." It's easy to muster up bravado when you're 29 years old and worth more than $400 million (both Fox and Buckley, 39, would have made FORTUNE's list of the 40 richest people under 40 had the cut-off for the list been three weeks later). But Fox and Buckley have a specific business goal in mind: They want Internet Capital to be, well, like GE. Just as Jack Welch requires GE's divisions to be No. 1 or No. 2 in their markets, they want each of ICG's B2B e-commerce companies to dominate theirs.

So far, Internet Capital has backed two kinds of companies. Half its investments are in businesses that create online marketplaces and communities, where buyers and sellers in particular industries can meet to conduct transactions. The other half are computer consultants and software makers that serve the infrastructure needs of those marketplace companies. (See table for a complete list of ICG's investments.)

Internet Capital combines the virtues of a venture capital firm with those of a holding company. Like a VC firm, it takes stakes of varying sizes in a wide range of companies. Over the past 3 1/2 years, ICG has paid more than $200 million for holdings in 36 companies. This year alone it expects to spend on B2B e-commerce about twice as much as noted venture capital firm Kleiner Perkins will spend on all its tech investments. But unlike many venture capitalists, ICG is not looking to quickly cash out of its bets. Instead, it plans to work with companies for years, counseling them on strategy, finance, infotech, recruiting, and marketing. To do so, it has hired its own topflight management team from the upper echelons of Microsoft, McKinsey & Co., and even GE. Says Fox: "We want to own these companies ten years after they go public."

In it for the long haul, Internet Capital in some ways resembles holding companies CMGI (whose bets on consumer-oriented Net companies like Geo-Cities and Lycos have paid off handsomely) and Safeguard Scientifics (an older company that has scored with a broad range of technology investments, including an early stake in Novell and, more recently, computer consulting firm Cambridge Technology Partners). Buckley and Fox once worked at Safeguard, which also happens to be Internet Capital's largest shareholder.

ICG's hybrid business model has made fans of some of the Street's most influential analysts. For instance, Henry Blodget of Merrill Lynch raves that "Internet Capital has the potential to emerge as the dominant 21st-century operating model for creating shareholder value." Sure, Merrill was lead underwriter for ICG's IPO. But even investors skeptical of Blodget's rave may find themselves attracted to the stock. It offers investors a rare opportunity to own a stake in 36 promising, mostly private, companies at the heart of a red-hot sector of the new economy. Buying a share of ICG is an easy way to make a diversified bet on the future of e-commerce.

In the short term, there are reasons for caution. The stock has quintupled in the past month alone, soaring partly on buy recommendations by analysts who recently started covering ICG. And Internet Capital is a difficult stock to value by conventional means. As CFO David Gathman puts it, the company's income statements are "exactly correct but utterly useless" to investors. Consider: The statements show that ICG earned $14 million in 1998 and $20 million in the first three months of 1999--on revenues of only $3 million for each period. The profits were mostly from windfalls from the sale of three of its companies to Excite @Home, Lycos, and i2 Technologies.

In an attempt to gauge the company's value, Wall Street sums up its parts and tacks on a huge premium for the quality of ICG's management, its early entry into this market, the value it's likely to add through new acquisitions, and the advantages its companies derive from being part of its network. The present book value of ICG's assets--its cash and securities, including its stakes in the private companies and two that have already gone public (VerticalNet and U.S. Interactive)--is $1 billion. Analysts then add to that another $1 billion for the book value of companies it will presumably acquire soon. That means Wall Street is wagering $8 billion--remember, ICG has a $10 billion market cap--that ICG's leadership will hit some real home runs.

Can anyone justify that much faith? Here's how Merrill Lynch's Blodget does. He starts with the fact that the combined market cap of all consumer-oriented Internet stocks (such as America Online, Amazon, and Yahoo) is around $250 billion. Making a big back-of-the-envelope calculation, he assumes that the combined market cap of B2B e-commerce companies will grow from $12 billion today to at least a quarter-trillion dollars over the next four years (a plausible assumption if you accept that the B2B e-commerce market is supposed to be 12 times larger than the consumer e-commerce market). So, asks Blodget, "how much of that combined market cap can the leading B2B company get? Does 10% seem reasonable?" His answer, obviously, is yes--he thinks ICG's stock, while currently ahead of itself, will reach $125 within two years.

When Buckley and Fox founded Internet Capital in 1996, the promise of B2B e-commerce was less clear. At Safeguard, Buckley and Fox had looked at all types of Net deals. But business models were changing so rapidly that they could not keep up. So they created Internet Capital to focus on B2B e-commerce. Buckley explains, "We liked B2B because we knew who the customers were and could see they would be easier to lock in than consumers. B2B is grimy and dirty, but you can make a lot of money at it."

Buckley and Fox so believed in their niche that they passed up opportunities to invest in such consumer-oriented successes as CDNow and AutoWeb. But their focus impressed the community they were wooing. Slowly but surely, Buckley and Fox developed a reputation as the VCs to see if you were an entrepreneur with a B2B idea.

One of their first investments was in Water Online, headquartered just a half-hour from ICG's Wayne offices. At the time, Water Online was little more than a Website where municipal wastewater engineers could find industry news and trade show listings. Then the company changed its name to VerticalNet and expanded into other industries, such as solid waste, pollution control, and power generation.

Still, in late 1997 the company remained a shoestring operation, so Buckley and Fox decided to go after some big-name talent. They brought in Mark Walsh, head of AOL's B2B unit. ("Being the business-to-business guy at AOL," grumbles Walsh, "was like being the electric-car guy at GM.") VerticalNet's bootstrap organization appealed to Walsh, a 12-year veteran of the online world.

With Walsh at the helm, VerticalNet now boasts 47 Websites for 47 different industries. The sites are being transformed into full-fledged e-exchanges. One of the first B2B companies to go public, VerticalNet's stock shot up from $20 to $70 earlier this year, before settling to a recent $33. Internet Capital's original $9 million stake is now worth about $400 million.

Internet Capital didn't snap up another marketplace company until 1998, when it invested in e-Chemicals. By some estimates, as much as one-third of the cost of a barrel of chemicals can be attributed to paperwork and other inefficiencies involved in procuring the stuff. E-Chemicals' Website is like an online catalog for the entire bulk chemicals industry, helping to streamline that procurement process. Realizing that almost every other industry's distribution system could also be streamlined, Buckley and Fox went on to buy stakes in e-exchanges dealing with everything from plastics (CommerX) to paper (PaperExchange).

By early 1999, holding some 20 companies, Fox and Buckley decided they needed more heavy-hitter executives to prepare Internet Capital for its IPO. So they went on a hiring spree. In the space of four months they lured a Softbank general partner who previously had worked on the Yahoo, eBay, and GeoCities IPOs at Goldman Sachs; a co-founder of Cambridge Technology Partners; the co-head of McKinsey's e-commerce practice; and the top Silicon Valley recruiter for headhunting firm Heidrick & Struggles. They even went after Sam Jadallah, Microsoft's chief of enterprise sales and marketing, which accounts for some two-thirds of its revenues.

Jadallah had no intention of leaving Microsoft when he first received overtures from ICG. Driving home late one night, he returned a call from Fox fully expecting to get an answering machine. Instead he got Fox. "My first thought," recalls Jadallah, "was that I don't want to work anywhere where someone answers the phone at 11 at night." But Fox started his spiel about the B2B market and wouldn't stop. Jadallah lived only 15 minutes away, but an hour later he was still sitting in his dark green Lexus, parked in his driveway with the engine turned off, mesmerized by Fox's pitch.

Three weeks later, Jadallah flew to Pennsylvania for a day at ICG. After the visit, as they headed back to the airport, Fox asked Jadallah what he thought. "This is Microsoft all over again," he said, remembering the software giant's early days.

Still, Jadallah had not decided. So Fox called him at home every night. After a few weeks of this, Jadallah's wife started to lose patience. "You spend more time talking to Ken Fox at night than to me," she chided. Jadallah was in touch with two others ICG was trying to recruit: Rick Devine of Heidrick & Struggles and Todd Hewlin of McKinsey. When both accepted in early summer, it tipped the scales for Jadallah.

Jadallah's role now is to mentor ICG's member CEOs. Devine and Hewlin are setting up recruiting and strategy practices that will cater to their needs. Meanwhile, Buckley and Fox built a world-class advisory board. Besides marketing maven Zyman, it includes Merrill Lynch's chief technology officer John McKinley, technology guru Esther Dyson, GE Capital's former CEO Gary Wendt, and Disney's former chief strategist Larry Murphy. Peter Solvik, chief information officer of Cisco Systems, sits on ICG's board of directors.

Wall Street's bet, finally, is that this group of execs and advisers can both help the individual companies in ICG's portfolio and create a keiretsu-like system in which member companies derive competitive advantage. Though each company addresses a different market, all face the similar challenge of bringing together buyers and sellers on the Web.

ICG's network is on display at the end of August at its fourth annual hobnob in the tony resort town of Beaver Creek, Colo. The setting appropriately evokes the sense that ICG executives, advisers, and 30-odd CEOs in attendance are prospectors in a latter-day gold rush. Instead of picks and shovels, they wield cell phones and palmtops. Deals are being cut left and right. The CEOs swap stories and try to learn from each other's experiences. Soaking it all in, Ron Bienvenu, CEO of a company called SageMaker, which organizes corporate information drawn from internal databases and the Web, says, "This is a perfect way to manage chaos."

That, in fact, may be the greatest task facing Internet Capital. As its companies go public and grow into adolescence, will they rebel against their parent and siblings? VerticalNet, for example, is trying to balance the tension between rolling out e-exchanges on its own and partnering with other ICG companies (such as a recent deal it penned to link its Pulp and Paper Online site to PaperExchange's). Another danger the companies face is that as they try to reconfigure entire industries' distribution channels, incumbents they want to displace will not go away without a fight.

These pesky questions seem remote for now, though, as Internet Capital's executives and CEOs enjoy their newfound wealth and each other's camaraderie amid the Colorado splendor. At the end of the two-day meeting, they throw themselves a party in a hall filled with one of the world's largest private collections of Wild West artifacts. Letting loose, the CEOs tie napkins around their foreheads samurai-style, down shots of tequila, sing "Honky-Tonk Woman," and dance on the 100-year-old tables. One participant drapes an old bearskin over himself and wanders around the room. It's somehow comforting to know that there are still people who can give in to Internet mania--even if they do happen to come from the grimy, dirty world of B2B.