America Online is emerging as one of the biggest stakeholders in the Internet economy, turning itself into the Web's most desirable partner for fledgling online companies. What is behind its investing prowess? In addition to its venture-capital funds, AOL offers its partners instant access to 22 million potential customers, the Web's biggest audience. This vast of pool of spenders gives it unparalleled clout in a marketplace jam-packed with thousands of hungry new dotcoms. And because AOL has an inside track to how the Web is evolving, it has been willing to make big investments in complex but potentially significant new technologies. Moreover, its pending purchase of America Online is emerging as one of the biggest stakeholders in the Internet economy, turning itself into the Web's most desirable partner for fledgling online companies. What is behind its investing prowess? In addition to its venture-capital funds, AOL offers its partners instant access to 22 million potential customers, the Web's biggest audience. This vast of pool of spenders gives it unparalleled clout in a marketplace jam-packed with thousands of hungry new dotcoms. And because AOL has an inside track to how the Web is evolving, it has been willing to make big investments in complex but potentially significant new technologies. Moreover, its pending purchase of Time Warner will give AOL even more attractions to lure partners. "They have the best names or a majority of the best" in their investment portfolio, says Danny Rimer, a venture capitalist with Barksdale Group, the Menlo Park, California, firm founded by Internet investor Jim Barksdale, an AOL board member. In recent years, AOL has reaped enormous rewards from bets on Sandpiper Networks, InfoSpace, Inktomi, the former Excite, chinadotcom, Net2Phone and Palm. The Dulles, Virginia, company has investments in more than 70 public and closely held companies now valued at about $2bn (£1.26bn). That doesn't include the $1.5bn it has agreed to invest in satellite operator Hughes Electronics, a unit of General Motors, and $800m in computer maker Gateway, both established companies. 'Carriage' arrangements Nor does the $2bn include the stock warrants that AOL receives in startups. Warrants are a common element of the many "carriage" deals AOL strikes with companies eager to receive promotion on AOL's online services. AOL declined to comment on the value of those warrants, but said it is "substantially less" than the $2bn in value it has received through its cash investments. The equity AOL garners through these promotional deals has prompted unfavorable comparisons in some quarters to cable-TV companies. Some cable operators demand equity in television programmers as a condition of carrying their channels on their cable networks. In 1992, Congress passed legislation limiting cable operators from using their ownership in programmers to deny television satellite companies access to channels. In a recent hearing on the proposed AOL-Time Warner merger, Sen. Orrin Hatch of Utah asked executives from both companies if they thought the 1992 law also should limit AOL from taking stakes in programming partners. Steve Case, AOL's chairman and chief executive, replied that two practices weren't comparable. Cable networks, he argued, have limited channel capacity, while there's no limit to the amount of content available on the Internet. AOL promotes to its members Web sites that pay AOL in cash or equity, but it doesn't block access to other sites, Case added. Concern over equity deals Andrew Schwartzman, president of the Media Access Project, a public-interest advocacy group in Washington, says AOL's growing equity deals could be a concern, especially if AOL charges companies that choose not to give it equity a higher rate for promotion deals. "Then we are interfering with the very characteristics that have fueled this market," Schwartzman said. Yet most AOL partners don't seem to be complaining about the practice, either. Emusic.com, for instance, was eager to see its music Web site promoted on AOL's music and chatting services. The company agreed to pay AOL a fee in the "seven figures" and to grant it warrants to acquire up to 2 percent of its stock, depending on the amount of business AOL generated for eMusic. Because of the warrants, AOL agreed to a lower cash fee, which was fine with eMusic. "We got a better deal," says eMusic Chief Executive Officer Gene Hoffman, who also gave Yahoo! warrants in the company. Naveen Jain, CEO of InfoSpace, is also happy to have AOL as a shareholder. In 1998, Jain struck an agreement with AOL to carry its online white-pages service. As part of deal, InfoSpace agreed to share advertising revenue with AOL and to give it warrants equal to about 5 percent of the company. Jain says the warrants give AOL more of an incentive to see InfoSpace succeed. Depending on how much business it generates for InfoSpace, AOL has the potential to acquire stock that would be worth more than $500m at today's prices. Investing as a priority In its more traditional cash investments, AOL is in the same mold as Microsoft, Intel and other high-tech players that have made investing a major priority. Unlike most venture capitalists, these corporate investors are less focused on the direct payoff from their investments. Instead, they tend to favor investments with strategic value for their companies. Intel, for instance, has invested a fortune in multimedia companies whose products may heighten demand for powerful microprocessors, Intel's core business. Ken Novack, vice chairman of AOL, says the company's investments help it stay on top of the latest developments in the industry. "We see our investments helping us monitor and stimulate interest in new technologies," Novack says. Hughes and Gateway are the two biggest examples of this. Hughes is working on developing high-speed Internet delivery via satellite; Gateway is planning Internet "appliances" that will be AOL-friendly. Sandpiper Networks is a similar investment. The company developed a technology to help online media companies speed up the delivery of Web pages and multimedia to Internet users. But to work, Sandpiper's technology needed to be deployed throughout Internet-service-providers' networks, which made AOL a logical partner. After discussing an agreement to install Sandpiper equipment throughout the AOL network, AOL decided to invest in the company, too. "I personally can't think of any company in the Internet space that has a more strategic asset than AOL because of its 22 million subscribers," says Leo S. Spiegel, who founded Sandpiper. Strategic benefits aside, the payoff for AOL has been sweet. Sandpiper was eventually acquired by another Internet company, Digital Island; AOL has since sold most of its resulting stake in Digital Island for a gain of about $123m. AOL's initial investment in Sandpiper: $3m, according to people familiar with the matter. Not all of its investments have paid off. The company's first stab at investing was the AOL Greenhouse, a project it designed as a Hollywood studio for developing new media. The Greenhouse effort largely failed, but there are a few prominent survivors, such as the Motley Fool financial Web site. Greenhouse also passed on what could have been spectacular investments. For instance, in its early days it had a shot at taking a 19.9 percent stake in Amazon.com for about $3.5m, according to people familiar with the matter. It passed. Today that stake would be worth billions. What do you think? Tell the Mailroom. And read what others have said.