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Too hot to ignore: should you buy these 2 top internet stocks?

ASX superstar REA Group Limited (ASX: REA), owns realestate.com.au, the most popular real estate website in Australia. But have investors overlooked Onthehouse Limited (ASX: OTH) the owner Australia’s number three real estate website?

The more popular site ranks 19 in Australia, according to Alexa (a website ranking service), domain.com.au, ranks 43 and onthehouse.com.au ranks 292..I don’t think many people would visit Onthehouse without also visiting Realestate.com.au. The only real advantage Onthehouse has over realestate.com.au is in the way it presents sales data, giving buyers an idea of what nearby property has sold for. Having said that, Onthehouse (the company) has a market capitalisation of under $55 million, whereas REA Group has a market cap of over $6 billion.

Realestate.com.au is supported by News Corp (ASX: NWS) and number two website, Domain.com.au, is supported by Fairfax Media Limited (ASX: FXJ). In comparison Onthehouse doesn’t have any major news source sending it viewers, and it’s surprising that the company hasn’t struck a deal with independent media companies, such as Private Media. Onthehouse has a chance against Domain.com.au, but it will need a media tie-up to secure sufficient brand recognition, in my opinion. I will eat my hat if it seriously challenges realestate.com.au.

The best thing about Onthehouse – the company, not the website – is that it has two businesses, and only the consumer facing website is speculative. Importantly, the company also generates recurring revenues by providing real estate software solutions to real estate agents. This means that, while the upside is substantial (if a long shot), the downside is reasonably limited.

For example, the core “Real Estate Solutions” business generated revenues of about $11.5 million in the first half of 2014, and operating cashflow for the entire company was just above $3 million. This cash pays the costs of both the profitable segment, and the development of the consumer-facing portal. Essentially, Onthehouse is using its profitable business to pay for the development of its unprofitable one. Revenue from the consumer website was up about 85% over the corresponding period, so there is reason to believe it might eventually generate profits. I almost bought shares in the company last year, on the basis of the Real Estate Solutions business alone; it’s hard to ascribe much value to its consumer facing website, at present.

iCar Asia Limited (ASX: ICQ) is a promising company in a similar field: it owns a number of car sale websites in Asia, its most important being the Malaysian Carlist.my. Shares are up by about 20% since I covered the company in February, and I have since sold my shares (because I’m trying to reduce my exposure to speculative stocks, as I said here.)

Having said that, I think the company is likely to succeed, not least because it has a proven business model and the backing of Carsales.com Limited (ASX: CRZ). Carsales.com bought another 3% of the smaller company in early March, demonstrating that it is willing to provide the smaller company with capital to fund growth.

I must note here that investors shouldn’t trust Comsec’s data regarding iCar Asia’s market capitalisation. Because of the shares in escrow, the true market capitalisation is close to $250 million at the current share price of $1.32. At that price, it’s clear the market expects the company will make good profits in Malaysia, in due course.

iCar Asia may not yet have profits, but it does have one huge advantage over Onthehouse. iCar Asia has a chance to own the biggest car sales network in Malaysia. If it does, the network effect will provide pricing power, just as Carsales.com has pricing power here in Australia. In contrast, Onthehouse is unlikely to ever have the kind of pricing power realestate.com.au can boast.

Foolish takeaway

Carsales.com and REA Group are two of Australia’s most successful companies. Both websites are the major marketplace for a transaction that most Australians hope to make at some point, buying a house or car. Because buyers flock to their sites, so too do sellers. It’s worth noting that real estate websites are more lucrative than car sale websites because real estate costs more than cars. It just may be that the Australian real estate market can support three profitable websites, although I remain undecided for now.

Many next generation internet companies, such as Airbnb, are not publicly traded. iCar Asia and Onthehouse belong on your watchlist because they may well be future winners. If iCar Asia shares drop to lower prices, I may even buy back in.

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Motley Fool contributor Claude Walker (@claudedwalker) does not own shares in any of the companies mentioned in this article.