Speculating on the Internet is risky - that's the point

Hype is good when it comes to the Internet. People who punt on it are voting for the future

THE LAUNCH of Freeserve on the stock market has been Britain's first case of the Internet frenzy that has driven share prices across the Atlantic to giddier and giddier heights. Some investment experts warn that shares in Freeserve, an offshoot of Dixons, will prove to be a bad buy. At the very least it is a risky investment. The company is less than a year old, loses money, and could not have been floated on the stock market at all unless the London Stock Exchange had deliberately relaxed its rules earlier in the year to allow an Internet flotation.

Yet 50,000 private investors applied to buy the shares, which soared from their launch price of 150p a share to 215p a share within five minutes of trading, starting yesterday afternoon. This valued the loss-making company at pounds 2.2bn, which puts it in the same league as some of the best- known public companies in this country - bigger than WH Smith, and close to Safeway or Airtours. The fact that investors were persuaded to provide new funds of pounds 300m suggests an extraordinarily successful exercise in hype.

Hype is good, however, when it comes to the Internet. People who punt on a new Internet stock are voting for the future, and, crucially, voting for it with their wallets. It is easy to forget that the purpose of the stock market is not as a get-rich-quick mechanism for investors and executives, although that is an important part of the story. Rather, its function is to raise finance for investment in the economy, especially risky investment that could not be funded in any other way. If every new flotation were a sure-fire thing for investors, the stock market would not be doing its job properly.

The stock market boom that is financing the construction of Internet businesses is similar to the one that accompanied the creation of the railway network in the mid-1840s. An investment feeding frenzy made some individuals very rich; many more lost their shirts when the bubble burst. But Britain was left with a railway network afterwards. No matter how speculative it seemed initially, a real industry with real assets emerged.

And think what followed the railways: urbanisation. For the first time in history, cities could be fed with produce grown well outside their immediate area. And that allowed for the appearance of a mass workforce, industrialisation and the entire edifice of a modern economy. Without the boom in railway shares, we might still be living in the squalid rural poverty that had ever been the lot of most human beings.

Even if you are sceptical about whether the Internet is an equally revolutionary technology, there is a reasonable probability that it will transform the economy radically. It is worth taking a bet at unfavourable odds if the potential prize is big enough. That is just what the tens of thousands of Freeserve investors, and millions of Americans who invest in Internet stocks, are doing.

To condemn the whole thing as hype and speculation is to miss the point. Any Internet business that is not losing money at an early stage will fail to go far. Companies need to raise the finance to buy in the best talent, buy up their rivals and bulldoze their way to a reasonable market share and a presence on the Net. There are such economies of scale in online business and e-commerce that size does matter. New companies have to grow quickly to succeed, though success may be slow. It is costly but a few of them will reap enormous rewards if they can spark off this self- fulfilling process.

Only a few, of course. In the US out of every 10 Internet companies that get initial backing from venture capitalists half will fail, three will be bought up by a bigger company and only two will go on to a successful stock market debut. The amazing volatility of the stock market from day to day can pose a massive threat to fledgeling companies, which could be grounded if their launch date were to coincide with a bout of market weakness. It is to minimise the risk posed by this arbitrariness that investment banks tend to underprice the shares.

Besides, they want the buzz generated by headlines the next day about shares soaring to a massive premium in the first session of trading. That buzz says that investors want a piece of this outfit. Indeed, so many investors do want to buy a stake in the future that Internet shares are in short supply. Most of the new flotations offer only a small part of the business for sale in the market - less than a fifth in the case of Freeserve. This helps to account for a monthly average first-day premium of 62 to 241 per cent on US Internet flotations since January.

The real problem with Freeserve is not that the business may fail because of competition or uncertain growth prospects. It is that we have only one big, quoted Internet company in the UK. If eight out of every 10 online businesses are going to go bust, it would be nice to have at least 10 of them. Freeserve itself has listed its shares on Nasdaq, the US high technology stock market, as well. It was only in January that the London Stock Exchange relaxed its listing requirements to make an Internet flotation possible, an extraordinarily tardy recognition that its job was not to safeguard the country's industrial heritage, but instead to help build its industrial future.

Just as ominously, the Government's e-commerce bill is mired in inter- departmental wrangling and party political point-scoring. The Home Office wants to control the Internet even at the expense of its commercial development. The Conservatives will not signal their willingness to maintain the same legal framework if they are re-elected. Meanwhile Brussels is toying seriously with the idea of a "bit-tax", in contrast to the tax holiday the US government granted e-commerce.

This year the US federal government has also budgeted $850m for public sector investment in leading-edge computer and communications research, including the so-called Next Generation Internet Initiative. American taxpayers are financing the building of a new Internet before the rest of us have even started using the old one. In the UK we like to congratulate ourselves on being, at any rate, ahead of Continental Europe, but that is a myth, too. Internet penetration in the UK lags behind Scandinavia, the Netherlands and Germany.

At least Freeserve has opened the door to private investment in building the future of our economy. In classic British style, it is an offshoot of a high-street retailer rather than an exciting new venture formed by 20-year-olds in their parents' spare room. No nerdy young turk will make squillions of pounds in stock options. It may flop, as titans like America Online move to offer free Internet access too. But it's a start.