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Slipped disc jolts the City

Analysts talked up Freeserve, says Dan Gledhill, and investors may wonder why they listened
When Dixons decided that July was the time to float Freeserve, its internet arm, the notion that share prices can go down as well as up temporarily went up in the air.

A queue of investors worthy of a balmy morning at Wimbledon fortnight lined up to take a stake, leaving the issue some 30 times oversubscribed. Their ebullience was justified by a raft of positive notes from City analysts whose employers, as advisers to the float, just happened to have a vested interest in its success. Sure enough, the shares promptly leapt from 150p to 244p and "stags" who took the first opportunity to sell were instantly in the money.

True, there were a few cautionary notes struck by some smaller brokers and the occasional newspaper, but these Cassandras were easily drowned out by the bullish fanfare.

Unfortunately, the punters who followed the advice of the investment banks and bought Freeserve as a long-term investment now find themselves in the red. Many clients of Charles Schwab, for example, have spent the last month bailing out of Freeserve, according to figures from the retail stockbroker.

They are the lucky ones. On Friday, further heavy selling sent the shares to a new low of 135p, below the offer price. Now, the deep-pocketed investors who have held on face a nervous wait until Tuesday, when Freeserve's key active-user figures will illustrate if its shares are cheap, or the bubble really has burst.

These data are vital because they represent the first opportunity to see just how much Freeserve's market has changed since August, when this loss-making company was briefly valued at pounds 2.46bn. At the time, Dixons' decision to sell 20 per cent of its online subsidiary looked far-sighted. After all, its vocation as a provider of free access to the internet (ISP) was unique. Since then, at least 70 free ISPs have emerged and by the year end that will have swollen to over 200. Most ominous is the arrival of BT and AOL, the giant US group that last month launched its own free service in the UK, Netscape Online.

"Netscape Online will offer a similar service to Freeserve's," says Henry Brun, an analyst at HSBC. "AOL has decided to claw its way back into the UK market. It wants to play in Europe and it is a direct threat to Freeserve."

Miles Saltiel, director of technology research at WestLB Panmure, says: "I think what's happening to Freeserve is that it's under tremendous pressure from new entrants. When it came on to the market as the first major internet float, it benefited from scarcity value. That's why it was able to get away at a very attractive level."

In addition, Freeserve is caught in the sudden global aversion to internet stocks that has now hit the UK. On Tuesday, QXL, the online auction house which is shortly to float in London, revealed that it will go under the hammer for less than a third of the pounds 750m asking price that had been expected. Then on Thursday, one of Microsoft's top executives sent the sector into a tailspin with the ingenuous suggestion that internet stocks were over- valued.

In the meantime, with competition intensifying, the concern is that any revenue to be had from the internet will have to be shared between a multitude of players.

Mr Brun says: "I suppose, in a nutshell, revenue streams are under pressure. Many other companies are now taking part in e-commerce."

There are those who believe that Thursday's Freeserve figures will confirm that it has lost subscribers since June. It is not a universally shared view (house broker CSFB is forecasting an increase from 1.32 million to 1.4 million, for example) but other analysts agree that increased competition has stunted Freeserve's growth. That, and a long, hot summer which has prompted a rediscovery of outdoor pursuits.

Confusion about Freeserve's true worth is reflected in a range of analysts' valuations. While CSFB's David Clayton believes the price will rise to 265p in the next year, arch-bear Saltiel foresees a slump to 60p.

Little wonder, therefore, that the Freeserve subscribers who have retained their shares are bewildered. Jeremy Batstone, head of research at NatWest Stockbrokers, blames the investment banks that advised on the flotation for all the confusion.

"Certain investment banks hyped Freeserve," he says. "They were very keen to get the business and get in Dixons' good books, so they did their best to talk up the value. The important lesson is that private investors need to be extremely careful about following the recommendations of institutional shareholders who have a hidden agenda."

As the only true internet player in town, a successful start for Freeserve was guaranteed. Now that its market has been invaded, investors have to separate the web-based wheat from the cyber chaff.

The task is to identify the next Amazon - the American online book seller that has already chalked up 11 million customers. Conflicting, not to mention partisan, City advice does not help.