ACTV, Inc. (NASDAQ: IATV)

Comments on Recent Events: (1) AT&T's MediaOne & Microsoft Transactions,(2) Roll-out of HyperTV in Exodus Facilities and (3) the Acquisition of the Wolzien Patent;New Financial Model Incorporating HyperTV Networks - Raising Target Price Range to $32 - $35 Per Share and Reiterating BUY Recommendation

AT&T/MediaOne: AT&T (NYSE: T) signed an agreement to purchase MediaOne Group, Inc., the nation’s fourth-largest cable television company. Together with MediaOne, AT&T will control the cable connections to 25 million homes. This announcement has some specific positive benefits to ACTV, such as:

• We believe that this will expedite the roll-out of ACTV’s Individualized Television in the Fox Sports West region, and will shorten the timeframe to profitability:

• MediaOne has a large presence in Los Angeles; ACTV’s obvious choice for the second regional roll-out of Individualized Television programming (after the SouthWest region) is the Fox Sports West region, which includes Los Angeles.
• MediaOne has been aggressively upgrading their cable plant to digital capacity, which is necessary for the roll-out of ACTV’s Individualized Television programming.

AT&T/Microsoft: This week AT&T and Microsoft (NASDAQ: MSFT) announced a deal that, in return for an investment of $5 billion, AT&T will use (on a non-exclusive basis) Microsoft’s Windows CE operating system in some of its digital cable set-top boxes. How does this impact ACTV’s programs:

• We believe that this transaction is an endorsement of ACTV’s vision that the converged Internet/Cable TV infrastructure is going to be about interactive, enhanced programming in the converged space. It also is an endorsement of HyperTV’s "TV-centric" approach to a convergent experience, which supports the brand identity of programming networks and their advertisers.

• We believe that this reinforces AT&T’s commitment to upgrading its cable plant to digital, and deploying digital cable set-top boxes as fast as possible (ACTV’s Individualized Television programming requires the digital set-up boxes for its functionality);
• ACTV’s software which underlies Individualized Television and HyperTV proprietary programming is MS-Windows CE compatible (in fact, TCI had committed, prior to its acquisition by AT&T, to putting Windows CE into set-top boxes, and ACTV has participated in the past in Microsoft’s Interactive TV Sneak Preview Program);

Roll-Out of HyperTV Network POPs — Making it Real

ACTV announced on May 3^rd that it was building its first point-of-presence (POP) for its HyperTV Network at an Internet Data Center facility hosted Exodus Communications, Inc. (NASDAQ: EXDS) in its New York facility. We view this announcement as extremely positive for ACTV. Exodus is a leading provider of Internet hosting and bandwidth solutions for mission-critical Internet operations, and will provide ACTV’s programming partners, consumers and advertisers with highest levels of reliability and security. Points of interest:

• This first POP will support approximately 100,000 simultaneous users of HyperTV. We believe that this level will be sufficient, initially, for what we call "regularly scheduled" HyperTV programming. We expect ACTV to build-out additional POPs this year, and over the next few years.
• We believe HyperTV Networks will soon be able to support the type of Special, or Marquee Event, Programming — such as a nationwide pay-per-view sporting event, music concert, or an event such as the Victoria’s Secret fashion show — that have been shown to attract several hundred thousand convergent users.
• Further, we believe ACTV is close to signing its first network programming agreements.

As network programming partnerships are established, ACTV will be ready with a functional HyperTV network to begin offering programming to advertisers and HyperTV users.

Acquisition of Wolzien Patent — ACTV’s Preeminent Intellectual Property Position in Convergence

ACTV announced recently that it had acquired a patent from Thomas Wolzien, a leading Wall Street media analyst, which is complementary to its own HyperTV patent. We have evaluated the Wolzien patent, the HyperTV patent and other intellectual property applicable in this "convergence space," and are convinced that ACTV has assembled a uniquely valuable, preeminent intellectual property position pertaining to the two ways to get information from the Internet and the television (described below). The applications of the HyperTV technology, supported by ACTV’s patent portfolio, enables the convergence of the Internet and television, and has broad implications in the evolution of entertainment programming (across all genres), advertising and e-commerce. We envision an aggressive licensing program, and HyperTV marketing effort, to a broad range of companies, including the entertainment networks, programming companies, Internet portals, new media companies and software producers.

Below, we address some of the questions pertaining to the Wolzien patent acquisition, and provide additional information on HyperTV and its applications. We are currently updating our HyperTV financial model based upon the current plans to roll-out the HyperTV technology, and will be providing a research update in the near future with a new earnings model.

What is "the Wolzien" patent, and why did ACTV buy it?

ACTV has acquired US Patent 5,761,606 from Tom Wolzien, the senior media analyst at Sanford Bernstein. Generally speaking, the Wolzien patent pertains to any system that would allow a user to "pull" Internet information from a video or audio program. This patent is uniquely complementary to the "HyperTV" patent (US Patent 5,778,181) which ACTV already owned, which pertained to any system that would allow a programmer to "push" Internet information in a video signal to a viewer. With both the "push" and "pull" patents under one corporate entity, ACTV has established a uniquely strong patent position pertaining to any system which essentially combines the power of the television (as it pertains to delivering mass audiences) with the power of the Internet (and its ability to deliver information, and facilitate e-commerce).

Who is Tom Wolzien, and why did he do a deal with ACTV?

Tom Wolzien is a leading Wall Street media analyst, working for Sanford Bernstein, who covers the largest media companies in the US, including Liberty Media, Time Warner, AOL and Disney. Prior to joining Sanford Bernstein in 1991, Mr. Wolzien spent 16 years at NBC. It was approximately 10 years ago, as Vice President of Business Development at NBC, that Mr. Wolzien was first introduced to ACTV, Inc. Mr. Wolzien had been aware of the ACTV business model, and its technology, since its inception. Mr. Wolzien applied for his patent in early 1996, and the patent was issued last July 1998. In a recent interview with theStreet.com, Mr. Wolzien was quoted describing his patent and the significance thereof:

"It’s a process patent that basically links programming with online, so that you can go straight from viewing a television, straight to an online site. It’s an icon that comes up on the screen, you push a button, then you go … it’s a technology that has application pretty much across the board." Tom Wolzien, to Alex Berenson, Senior Writer, theStreet.com, 3/15/99

Obviously, given his position and relationships in the industry, Mr. Wolzien could have gone to practically any media giant with his patent. In conversations with senior management and Mr. Wolzien, we believe the following to be the most salient reasons for his choosing ACTV to commercialize his patent:

• Wolzien has known ACTV management for many years. He was aware that ACTV had the technology, HyperTV, to bridge the gap between TV and the Internet, ensuring a more expeditious path to commercialization. HyperTV is commercially available today.

• Wolzien has significant TV network experience, and appreciated ACTV’s "TV-centric" approach to the convergence experience. ACTV’s HyperTV experience supports the brand identity of programming networks and their advertisers.

• Liberty Media’s significant ownership position in ACTV provides a comfort level that the technology will be commercialized, rather than "warehoused."

• We believe that Wolzien’s choice of ACTV reflects his confidence in William Samuels, ACTV’s Chairman & CEO, and the management team he assembled, and the team’s ability to deliver and commercialize technology (Individualized Television, HyperTV, eSchool Online), deliver corporate partnerships (FOX Sports Net, Liberty Media, TCI, General Instrument) and ultimately grow shareholder value.

What is HyperTV?

HyperTV is a patented software application that enables entertainment programmers and advertisers to seamlessly integrate Internet content and chat functionality into a video program — simultaneously and in real time. Using ACTV’s patented software, programmers can "push" Internet URLs (universal resource locators) and chat functionality to viewers/users, enabling an enriched interactive TV/Internet experience. This functionality enables programmers to enrich the entertainment experience by providing additional information, chatting, playing games — all in reference to the program they are watching. More importantly for media companies, HyperTV also enables interactive and highly targeted advertising, and integrated e-commerce applications.

Examples of a HyperTV Enriched Programming

As described in detail in earlier research, ACTV has corporate alliances with TCI, FOX Sports Net, and Liberty Media. We are anticipating the roll-out of ACTV’s Individualized Television technology in the sports entertainment market within months, as well as additional HyperTV enriched programming from TCI’s The Box Music Network. Examples of HyperTV enriched programming in sports and music entertainment markets are below:

HyperTV enables the convergence of cable TV and the Internet now. Anyone with a browser that enables video can receive HyperTV. The video will appear in the browser, together with the enhanced Internet content, whether streamed over the web, a CD-rom, DVD or if the video comes from a TV tuner card. Otherwise, the video can appear on the television while the enhanced web content appears on the computer.

What is proprietary about HyperTV?

ACTV invented HyperTV in 1995, and owns the rights to the technology. ACTV has been awarded patents pertaining to provision of video over the Internet, and integration with other information. In particular, ACTV has been awarded patents on systems that integrate and display video with information retrieved from the Internet, including URLs, or web addresses. The patents were acknowledged by personnel from Liberty Media in announcements pertaining to their recent investment, and we believe they will be a significant source of value to ACTV in the future as it commercializes its technology, either directly or through licensing agreements. We believe this week’s acquisition of the Wolzien patent significantly enhances ACTV’s patent position, and greatly enhances shareholder value.

Who will use HyperTV (who will be interested in licensing, buying, or acquiring HyperTV)?

We believe a wide range of companies could benefit from using HyperTV. Television/Video programmers, faced with ever increased competition for viewers, are looking for ways to enhance the viewing experience, provide differentiated programming and increase viewership (and advertising revenues). Advertising firms, can utilize HyperTV to generate consumer profiling, enabling much more effective, targeted marketing, and interactive advertising. HyperTV viewers will be able to view ads, interact with them, and even make purchases of products in real time. Internet Portals are seeking new content to differentiate their sites — to make them more "sticky" — which enables greater advertising revenues. And Online Retailers can utilize HyperTV to enhance the shopping experience, with integrated video and chat functionality enriching the e-commerce experience.

Financial Information (New Model) and Valuation Discussion

With the guidance of management, and based upon analysis of the business models of other Internet companies, we have updated our financial model to include the roll-out of HyperTV Networks in the entertainment industry. We have also made some changes in the assumptions about the regional roll-out plan for Individualized Television, such as increasing the roll-out schedule (number of Fox Sports Net regions entered), and modestly decreasing the penetration rate of addressable digital cable boxes.

HyperTV Networks: Before discussing the assumptions of the model, it is appropriate to review some of the reasons why we believe HyperTV Networks will be successful at signing up networks, getting programming onto their Internet "channel", and getting advertisers excited about the HyperTV Networks capabilities:

• Firstly, ACTV has taken a "TV-centric" approach to the design and marketing of HyperTV Networks. Their approach requires a collaborative arrangement with the networks, and is supportive of the network’s "brand" identity and their advertisers. We believe this approach will be critical to signing up a number of networks quickly.
• The networks are well aware of the erosion of their audience, especially to that part of the audience that is spending more and more time on the Internet. They are also aware of the growing number of convergent users, and the demand for interactivity (as reflected in the very high level of online interest in the ESPN/Fiesta Bowl Internet experience, and events like the Victoria’s Secret online fashion show). By offering an interactive HyperTV online experience, synchronized with the TV experience, networks can reclaim "eyeballs" in a very cost-effective manner.
• HyperTV will allow ACTV, networks and the advertisers to collect a significant amount of information about the users — what they buy, what they watch, what they spend, what they enjoy. This will allow them to do targeted, interactive advertising, and will lead to very powerful marketing activities such as customer profiling, interactive marketing, lead generation, online coupons, prizes, and ultimately, e-commerce. We believe that HyperTV will be particularly effective in stimulating "point-of-sale" or "impulse" purchases. For example, during a TCI Box Music concert, HyperTV can be pushing the convergent user the opportunity to purchase the CD, or a concert T-shirt or hat, or even an autographed guitar from that concert. Convergent users will be able to purchase merchandise right "in the moment," at the "point-of-sale."

With respect to HyperTV Networks, we have provided a "bottoms-up" look at the business. First, we looked at the number of potential convergent users (those who surf the Internet while watching TV), number of HyperTV Network programming deals with networks, number of potential 30-minute programs and Special Events in any given month. We have assumed that they sign up three networks this year, which we believe is achievable given their arrangements with Liberty Media and Fox Sports Net.

From these assumptions, we generate a total number of "regular programming" events (30-minute programs) and a number of "special event programming" events, or marquee events like a sporting event, a concert, or another type of event (like a lingerie fashion show) that is able to draw hundreds of thousands of online users. We believe we are being conservative with respect to the number of events that HyperTV will host. If one assumes that there are roughly 80 networks providing 10 hours of programming per day, that equates to approximately 600,000 30-minute programs annually. In our model, we assume that HyperTV is only capturing approximately 9,600 30-minute programs per year in Year 5 (2003), or roughly 1.5% of the total potential market. We also believe we have been sufficiently conservative with respect to the number of convergent users, and the HyperTV penetration into that convergent market for any given event.

Revenue generation: HyperTV Networks will generate revenues from a number of sources — both direct and "shared revenues." The direct revenues will be hosting, licensing and content consulting fees which HyperTV Networks will charge to host and produce the synchronized HyperTV event. We have assumed that HyperTV will charge a fee per user, based on a volume scale, for hosting and licensing, and will charge a "fee for service" for content consulting. These fees will be paid by the network "partners" to HyperTV Networks. Please refer to the model, and the footnotes thereto, for the details on the fees. We believe that we have been conservative with respect to our assumptions.

HyperTV will participate in the advertising and e-commerce opportunities through some "sharing of revenues" agreement with the network providing the entertainment content. With respect to advertising, we have focussed on banner advertising, although advertising in general could take many different forms on the Internet (banners, gateway ads, sponsorship, etc.). All of the basic assumptions are based on current Internet advertising rates for banner ads (we have included some representative advertising rates and commentary on the last page of the model). Again, we believe that using current advertising rates is being conservative, as the HyperTV interactivity and customer profiling capabilities should add significant value to the advertising and marketing effort, thereby providing for pricing power. As an example, we have used a very typical $40 CPM ($40 per one thousand impressions) banner ad rate, when @Home charged $150 CPM in a recent interactive advertising test case involving General Motors. We have also made an assumption based on a percentage of banner ad revenue for what we call "e-commerce and other revenue." We believe that this could be the most significant revenue generator for HyperTV networks and its network partners, as it includes customer profiling, market research activities, campaign advertising, coupons and other promotional activities such as prizes and award programs, and direct online purchases (e-commerce). We have used a relatively conservative percentage, and feel that this could be adjusted upward significantly based on initial user experience over the next 12 months or so.

Lastly, we make some assumptions on "sharing" arrangements with the networks. One might ask why networks would want to include HyperTV networks in their programming to any extent, and share advertising dollars. We believe there are many reasons. First, we believe that a HyperTV Networks synchronized convergent experience will be accretive to the networks current activities, so that they will essentially more than pay for themselves right from the start. Second, we don’t believe networks have the in-house experience, capabilities or desire to build, manage and maintain an Internet network such as HyperTV networks. Third, the HyperTV software and authoring tools are available now, and the network is rolling out and should be up and functional in a matter of weeks. By partnering with HyperTV, networks can begin almost immediately to test the convergent, synchronized programming capability. For this initial model, we have assumed that HyperTV Networks will be able to capture 10% of the shared revenues as defined in the model. We believe this is sufficiently conservative, given the potential of the HyperTV experience, and could possibly be quite higher over time. However, we should have a better idea in a very short time, as network agreements are put in place.

Valuation: As was done in the initial model, we have provided a variety of different valuation methodologies, including discounted cash flow, terminal P/E multiples, and terminal operating income multiples. We have also decreased our discount rates modestly, as we believe "financing risk" and "technology risk" has decreased over the past four months with the additional funds being invested by Liberty Media, and the Wolzien patent being acquired. We are raising our 12 month price target range to $32 to $35 per share, and are reiterating our BUY recommendation.

Risk Considerations

This section of the document is provided to remind potential investors to undertake a prudent level of due diligence prior to making an investment in the securities of ACTV, Inc. For a complete description of risks and uncertainties to ACTV’s business, see the "Risk Factors" section in ACTV’s SEC filings, which can be accessed directly from the SEC Edgar filings at www.SEC.gov on the Internet. Other potential risks include:

• Market risk: Investors should consider technical risks common to many small-cap or micro-cap stock investments, including liquidity levels, small float, risk of dilution, dependence upon key personnel, dependence upon single products or technologies, and the strength of competitors that may be larger, better capitalized and hold dominant market positions.
• Business risk: ACTV has limited experience in emerging business of interactive television programming and internet educational software and support. Many of its products and services are in the early stage of commercialization. There can be no assurance that ACTV’s business or the markets in which it competes will materialize or achieve the desired levels of revenues or profitability as expected.
• Competitive risk: The entertainment and software industries are extremely competitive, and many perceive the barriers to entry to be low. Added competition could lead to price competition and lower margins.

For Additional Information

Please visit our website at www.SmallCapsOnline.com for copies of our earlier research reports on ACTV, Inc.

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Sources for Additional Information

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