SAN FRANCISCO (www.redherring.com) - If you spend it, they will come. Many online retailers believed this mantra, and spent millions on advertising to attract customers to their site. But this spring's Internet stock crash has left many business-to-consumer companies in serious jeopardy.|
European online clothing retailer Boo.com shut down in May, and online furniture retailer Living.com, also privately held, announced Tuesday it has laid off 275 employees and is filing for bankruptcy. On August 10th, Value America, which sold discounted computers, software, office equipment, electronics, and entertainment online, filed for Chapter 11 bankruptcy protection.
The demise of Value America is significant because it's the first prominent, publicly traded online retailer to go the bankruptcy route. After posting a 139 percent gain on its opening day in April 1999, the stock has fallen every month since; Value America closed Aug. 10 at 71 cents, before the Nasdaq suspended trading on Monday. Value America has not traded since then.
Value America was one of 227 companies highlighted in a June Barron's magazine story about cash burn rates, a follow-up to the publication's now notorious March 20th cover story. Barron's ranked Value America as number six on its list. But rather than focus on just the sad tale of Value America, the more valuable question to investors is this: Who's next?
Pulling wings off Bluefly
The company right below Value America on the June Barron's list was Bluefly, a New York-based online designer fashion outlet. Its appearance on the list came as a surprise to Bluefly, which, according to CEO and founder Ken Seiff, had spoken to Barron's prior to the article hitting the street. Bluefly told Barron's that it had a commitment from affiliates of Soros Private Equity Partners for up to $15 million in financing, available at any time during the rest of 2000 -- but this fact was not included in the Barron's calculation.
As part of the financing, Soros received promissory notes that mature in January 2002 and carry an 8 percent interest rate. In addition, Soros received warrants to purchase 50,000 shares of Bluefly common stock, which could be exercised at any time during the next five years at a yet-to-be-specified price, according to filings with the Securities and Exchange Commission. As of June 30, Soros had provided Bluefly with $9 million of its $15 million commitment.
Bluefly has approximately $3.9 million in cash, but with its expenses totaling $5.1 million in just the second quarter of 2000, the company will need all the cash it has on hand now to make it through the end of the year (if it maintains its current cash burn patterns).
Mr. Seiff says Bluefly has recently retained the services of Credit Suisse First Boston to analyze all the possible funding options. On orders from corporate counsel, he declined to comment on the amount of money Bluefly might raise in the future or the amount needed to reach profitability.
Although Bluefly's plan of attack may prove successful, investors should be aware that a similar financing plan was followed by Value America prior to its bankruptcy filing.
In May, Value America secured commitments for $90 million in financing: $30 million from existing investors such as Paul Allen's Vulcan Ventures and FedEx and the remainder from Acqua Wellington North American Equities Fund, which planned to provide Value America with $60 million through periodic purchases of Value America stock at a small market discount over the next 14 months. That, it appears, only prolonged the inevitable.
Another company that appears to be in trouble is Beyond.com. The company, which used to sell PC software, is now basically an application service provider (ASP) that provides Web hosting service for individual software companies' online stores.
In other words, instead of serving as the middleman between Symantec's antivirus software kit and the consumer, Beyond.com now wants to serve as the behind-the-scenes company that manages Symantec's online store, which sells the same software directly to consumers.
Beyond.com's original business model was abandoned in January after things were clearly not proceeding as planned, but now the company faces the triple threat of dry capital markets, high infrastructure expenses left over from its original business model, and $63 million in outstanding convertible notes, according to Daniel Ries, managing director at investment firm C.E. Unterberg, Towbin in New York.
This combination of market forces and a new business model has left Beyond.com with only enough cash on hand to last until next April, according to estimates by Mr. Ries. To make matters worse, Beyond.com disclosed in a recent quarterly filing that it is in danger of having its stock delisted by the Nasdaq unless the minimum bid for the stock is above $5 for ten consecutive days prior to September 12. Beyond.com currently trades at just 78 cents a share.
Of course, there is one more option for a faltering dot-com that needs funding: selling out. In the case of CDnow, its cash burn issue was solved when German media group Bertelsmann purchased the online music retailer for $117 million, or about $3 per share, last month.
While the deal erased the company's cash concerns due to the deep pockets of Bertelsmann, there were, no doubt, secondary concerns at CDnow over the price of the deal. At just $3 per share, the price was well below the $16 price of CDnow's February 1998 IPO, and just 4 percent higher than CDnow's closing price the day before the deal was announced.
It just goes to show that investors should be wary of floundering retailers, even if they may be takeover targets. Although CDnow might have looked like a buying opportunity a few months ago given the low stock valuations, there was no need for Bertelsmann to pay a lavish premium for the company. Many other struggling online retailers may find themselves having to sell for a deep discount as well.
Common sense back in vogue
According to Catherine Skelly, vice president for equity research at Gruntal in New York, online retailers are having trouble raising capital despite the fact that, when these companies were going public, their business plans explicitly called for additional financing rounds in 2000 and 2001.
In the end, Ms. Skelly believes many online retailers are discovering that the retail model is much harder to execute than originally planned, given the capital-intensive aspects of retail that arise from inventory management, and the general logistics of getting the product into the hands of the customer after an order is placed on a Web site. Ultimately, these online retailers are so young that they have not been able to achieve the scale necessary to leverage their operations like their older offline counterparts.
Investors need to look at each of the players in the online retail space and judge them on the basic investment fundamentals -- not, as in years past, by simply investing in a company with an undeveloped idea or the perceived potential for success. Investors need to find the companies that have the customers, the revenues, and the potential for sustained profits. Enough cash to last more than a year or so wouldn't be a bad idea either.
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