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Software.net overvalued?
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June 18, 1998: 2:36 p.m. ET
With a 35 percent 1Q loss and no cash in the bank, IPO makes no sense
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SAN FRANCISCO (The Red Herring) - We don't get it.
Why would anyone in their right mind value Software.net (SWNT) anywhere near its current $350 million post-IPO market cap?
While the stock, buoyed by a suddenly strong market, now trades at a hefty 45 percent first-day premium, the numbers don't add up.
According to officials at lead underwriter Deutsche Bank Securities -- the new name for the Frank Quattrone-led investment house Deutsche Morgan Grenfell --Software.net priced at 9 Tuesday night, and then opened Wednesday morning at 12.88.
At current trading levels above 13, the total market capitalization of the 25.6 million share deal is $350 million; with 5 million of those shares now traded publicly. But should investors plunk down their hard-earned money on a business that is generating 35 percent losses on first-quarter revenues, has no cash in the bank, is dependent on the U.S. government for 43 percent of sales, and will turn most of its public offering proceeds over to pay off freshly inked e-commerce partnership deals with America Online (AOL), Netscape (NSCP) and Excite (XCIT)?
Don't get us started
"On the face of it, it looks like it should be shorted -- not bought," says Francis Gaskins, editor of Gaskin's IPO Desktop. "It's the most arbitrary pricing I've ever seen."
Gaskins points out that there simply are no comparable deals in the market which would justify Software.net's valuation. It's closest competitor is former retailer turned pure e-commerce company Egghead.com (EGGS), which, unlike Software.net, has a substantial amount of cash in the bank, has generated more than $30 million in revenues in its most recent quarter -- yet has a market cap of only $197 million dollars, or $150 million less than Software.net's.
By comparison, Software.net, which was spun off from electronic commerce service provider CyberSource last year, generated first-quarter revenues of only $6.2 million, with losses for the quarter reaching $2.2 million. According to its prospectus, the company expects its losses to increase "for the foreseeable future."
"If you look at (Egghead.com and Software.net) as comparables, there's no way Software.net deserves their valuation," agrees Ryan Jacob, director of research for the IPO Value Monitor. "To me, Egghead.com is really compelling. They are on track to do $150-200 million in revenues this year; Software.net is nowhere near that." (Jacob, who also serves as portfolio manager for The Internet Fund, maintains a position in Egghead.com through the fund.)
It's not that they haven't seen an overhyped, earnings-challenged Internet related IPO do well before, say Jacob and Gaskins. It's that Software.net needs this IPO to bail out its own business model. "They basically have already spent their IPO money," says Gaskins, pointing to recent deals with AOL and Netscape that will cost it $22 million alone in 1998, and that doesn't even include what it will have to pay out for its Excite partnership.
"If the business model doesn't work out, then it's bye-bye, Software.net," says a skeptical Gaskins.
No screamer
The marketing and e-commerce partnerships which will cost Software.net so dearly could actually save the company if -- and only if -- its click-through business model works. It's ironic that the relationships and agreements are so new that they're being evaluated in the public markets without having first been tested by Software.net as a private company.
At least Software.net had the sense to hire away Amazon.com's former vice president of marketing, Mark Breier, as its chief executive officer, as well as sign up Amazon's lead underwriter, Deutsche Morgan Grenfell, as its own.
While the parallels with Amazon are impressive at face value, sales and profits do not magically rub off through sheer proximity. Now that it's hit the Nasdaq, Software.net is on its own, and flying into this market's muddy IPO waters will be another challenge to its after-market performance.
While Software.net is the first pure e-commerce play since CyberShop (CYSP) went public on March 23, that golden status will only hold the same water if Internet stocks heat up as they did this spring. That's not entirely out of the question, given the recent announcement of AT&T's (T) interest in acquiring America Online.
"Is it a screamer?" asked John Fitzgibbon, editor of The IPO Reporter, taking the temperature of Software.net's first day of trading. "No, I don't think so." Although Fitzgibbon expected Software.net to trade at a 1- to 3-point premium over its initial pricing, it will not likely be the long-term homerun like Inktomi (INKT) or Verisign (VRSN). Yet it could finally provide a more accurate benchmark to some other Internet notables currently in registration, such as community web-hosting service GeoCities, or Cyberian Outpost and Digital River, both of which are e-commerce competitors to Software.net.
It pays to need cash
Is there any sense to be made of this deal as it begins life in the public eye?
According to Jacob, not really: "Egghead has signed up just as many really impressive partnerships, and yet, because it has revenues and cash, it actually might be penalized for not needing to raise money like Software.net. I don't get it."
We don't get it either, but for the moment at least, the market seems sold.
Software.net Corp.
1997 sales: $16.8 million
1997 income: -$5.4 million
Filing date: April 27, 1998
Pricing date: June 17, 1998
Proposed offer price: $7.00 to $9.0
Shares offered: 5.0 million
Offering amount: $40.0 million
Proposed symbol: SWNT
Proposed exchange: Nasdaq
Underwriters: Deutsche Morgan Grenfell; Donaldson Lufkin Jenrette; Merrill Lynch; C.E. Unterberg Towbin 
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