The Freeserve flotation could be eclipsed later this year if ScottishPower gives the go ahead for the sell-off of its telecom subsidiary including the subscription-based Internet Service Provider (ISP) Demon Internet.

The company is likely to put a valuation of £2bn plus on ScottishTelecom with £1.5bn of the figure accounted for by Demon, bought from founder Cliff Stanford in May last year for just £66m.

In another development, the latest free ISP to launch, Totalise.net, has begun trading on its first day and offered free shares to anyone registering.

But new industry research suggests a difficult time ahead for ISPs, whether or not they charge a monthly fee, with particularly sharp declines in subscription-based services like Demon.

Demon is Scottish jewel

"Demon is the jewel-in-the-crown brand of Scottish Telecom," says Martin Higginson, the ScottishTelecom director responsible for its Internet strategy.

"It's definitely on our agenda to prepare for flotation. the decision lies with ScottishPower. Hopefully, in late summer we will get the green light to proceed and if we do then we will be ready to do it very very quickly thereafter," he says.

The valuation of Demon would be based on its 290,000 existing customers - from businesses on leased lines to home users dialling up - being worth around £5,000 each. That would be similar to the rating of America Online, the most successful subcription service on the Internet.

The company says it will produce around £700m in revenues this year compared to Freeserve's £2.7m.

Demon refocuses

Demon has attracted bad publicity since its takeover. It has been involved in a messy Net libel case and has angered some members by blocking their newsgroup access. It is also perceived to have reacted too slowly to the free ISP challenge.

But Mr Higginson insists the company now has a clear strategy in place. Demon is supplying the backend technology for free ISPs such as freebeeb.net, due to be launched later this summer by the BBC's commercial arm.

Its own service will be divided into Demon Home and Demon Office to cater for the needs of its different users and to provide migration paths depending on their needs. Gamers, for example, are being offered free installation for an ISDN line if they upgrade to that service.

Demon says its subscribers have grown since the takeover by 20% and, with many small businesses using dial-up accounts, its actual number of users has grown to 600,000. It recorded a profit of £12m in its latest financial year.

Life in subscription model yet?

It has no plans to go free, saying its level of technical support and cutting-edge technology are enough to persuade business in particular of the value of the subscription model. It is promising a money-back guarantee if it does not provide the service it promises.

ScottishTelecom plans to spend £10m promoting and refocusing the Demon brand this year, including a Demon high-energy drink to be given away at clubs and festivals offering a three-month trial of the service.

"We've very highly literate, technologicaly able users, they are the most valuable customers in the UK ISP market today," says Mr Higginson.

ISPs face the squeeze

But a new research report says that subscription-based services are in deep trouble.

Durlacher Research's Quarterly Internet Report says annual growth in the subscription-based market has been cut from more than 80% to less than 1% because of the free ISP revolution. It forecasts a decline over the next 12 months.

It estimates the total number of dial-up users has grown 66% in a year to 5.8m and, adding academic and business users, the total number of UK Net users is now 10.5m.

There are now around 100 free ISPs and Durlacher forecasts the number could rise to as many as 200 by the end of the year. Traditional ISPs are being increasingly forced to re-price, differentiate their service, add value to their offering or face extinction.

Many free ISPs could also face a bleak future according to Durlacher's Nick Gibson: "Most subscription-free ISPs, including Freeserve, offer little to differentiate themselves and provide little or no barriers to exit for subscribers. As long as users can switch accounts so easily, free ISPs leave themselves vulnerable to churn."

Totalise adds up free shares

Meanwhile, new free services are being launched nearly every week - each with its own unique selling point.

A case in point is Totalise.net, which should attract users with a capacity for sheer greed, although it does appear to offer a decent level of service as well.

The subscription-free ISP was launched on Wednesday and began trading at 20p a share on the OFEX facility on the same day. It promises to give 50 shares to anyone registering with the company, and a further 200 if they use the service for 100 minutes a month for three months.

One drawback is the lengthy registation process spread over several Web pages and involving giving your consent for the company to pass on information about you to third parties who may call, fax or e-mail you with offers.

Yorkshire-based Totalise offers free technical support by phone and allows faxes to be received as e-mail among its features. It is a similar idea to themutual.net, which offers free shares in the company but has no plans to float at present.

ISPs becoming portals

Some analysts believe that eventually all ISPs will have to offer substantial content in order to survive. The Broadview investment bank predicts that all free ISPs will have to position themselves as portals for national content in each European country in order to build sustainable businesses.

It points to the French free ISP LibertySurf buying a majority stake in Nomade, France's largest remaining independent portal.

"For Freeserve to validate the valuation it is receiving from the stock market now, it must reposition itself very quickly as a portal," it says.