CDNW will be hot tomorrow. I like the e-tailers at this time of year and CDNW has been creeping up. Now an article in Business week online likes them too. Read it and I think you'll like CDNW at these prices too:
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Is It Time for CDNow?
When Internet stocks sink, they dive straight to the bottom. In CDNow's case it might be a great buying opportunity
What is the individual investor to do when Wall Street universally hates a stock? In many instances, it's a red flag signaling that the Ivy League boys in their Manhattan towers have crunched all the numbers and come up with a really bad stock that everyone should stay away from.
Just as often, though, that red flag can signal something entirely different: that the herd is kicking a company when it's down. And nothing is more profitable -- in the long run -- than buying a decent stock when it's face down in the mud.
Such is the case with CDNow (CDNW), the online music retailer. Once a charming success story about a pair of Philadelphia twins, Jason and Matthew Olim, who founded an online record store that became a giant in the field, the company is now regarded by many as a has-been and a will-never-be-again.
FAR FROM DEAD. What went wrong? It got Amazoned. That's the word for what happens when the mighty marketing machine of Amazon (AMZN) decides to enter your turf and steamrolls your business plan into the pavement. That's an accurate description of what happened to CDNow about a year ago, when Amazon decided to start selling CDs. Quickly, Amazon replaced CDNow as the top music e-tailer. Even a merger between CDNow and the No. 3 in the business, N2K, couldn't save the company from losing favor with Wall Street. Of the five analysts who follow it, four rate it a hold or worse.
As a result of such pessimism, the stock has fallen from a high $39 a year ago to $15.25 as of the market close on Nov. 24. Several of the investment banks that used to do research on CDNow have since dropped their coverage. As Thomas Weisel Partners e-commerce analyst Chris Vroom put it, half-jokingly: "We only cover the winners."
Even though spadefuls of earth have been shoveled onto CDNow, however, it's useful to remember that this company is far from dead. In fact, with $27 million in cash, it's nowhere near needing CPR. For one thing, it continues to grow at a pace that, while not putting Amazon to shame, would be the envy of just about any other retailer.
The most enticing thing about CDNow is its stock price. While the company still loses money, it is expected to rack up about $200 million in sales this year. With a market capitalization of $462 million, that gives it a price-to-sales ratio of 2.3. Compare that with Amazon's 19.7. It's even way below the Standard & Poor's 500-stock index price-to-sales ratio of 6.1.
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CDNow looks even more ridiculously cheap when compared with other music sites like MP3.com
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The problem that most analysts have with CDNow is that it is no longer No. 1 in its niche. But should such a crime be punishable by that low a valuation? Not when CDNow can boast 2.6 million customers, which is only slightly below the number of customers Amazon has. When you buy Amazon's stock, you are paying $11,250 for each of those customers. When you buy CDNow, the figure drops to $178 a pop. Moreover, CDNow's customer list is growing at an admirable 14% per quarter. It added 314,000 new customers in the third quarter of this year.
CDNow looks even more ridiculously cheap when compared with other music sites. MP3.com (MPPP), which sells digital downloads of music, has been valued by the market at $2.9 billion. That for a company which has produced a total of $6.6 million in sales through the first three quarters of 1999 and can boast 468,000 daily unique visitors -- individuals who visit the site. CDNow has more than 700,000 daily unique visitors. That means that you are paying $7,051 per daily visitor at MP3.com and only $635 per daily visitor at CDNow.
Weisel's Vroom defends MP3's valuation. "Their business model is infinitely scalable," he says, noting that you don't need to build a warehouse to store digital downloads. Unfortunately, though, the barriers to competition are infinitesimal in the digital music retailing business. In fact, CDNow has already entered the business, though it hasn't broken down its sales in that area yet.
The biggest question hanging over CDNow is how it will integrate with its most recent merger partner, Columbia House. When it merged with N2K, it took several quarters before the two companies were working off the same set of instructions. A merger with an offline company like Columbia House, which sells disks through its monthly music club, will probably be even more difficult.
SONY AND TIME WARNER. But Columbia House brings a lot to CDNow -- most notably $1 billion in sales and $100 million in profits. It also has more than a million customers, whom CDNow can try to reach. Probably the most interesting intangible, though, is that the merger will give Columbia House's previous owners, Time Warner (TWX) and Sony, equal 26% stakes in the newly merged company. Such prominent traditional media partners will give CDNow endless opportunities for promotion, as well as seasoned management and board members.
Of course none of these positives will matter if CDNow doesn't make money. But profits should show up in the first quarter of next year, right after the merger is completed. Even without the merger, CDNow surprised analysts by increasing gross profit margins by 2% in the third quarter, mainly by slashing costs. That's a sign that the company is on the road to profitability.
One of the most interesting pieces in CDNow's puzzle is that after the merger with Columbia House, the company will have a float of only 10 million shares. That's the number of shares that are available on the open market for investors. It's so low because 72% of the company is now owned by Sony and Time Warner, and both companies are obliged to hold onto their shares for a minimum of three years.
A small float means that a move in the stock will be amplified because of a limited supply of shares. In other words, when CDNow's price moves, it will move big-time. One investor who says that he is about to place his bet on CDNow thinks that movement will be up. "We owned CDNow last year and made a lot of money in it and then sold it," says Alexander Cheung, manager of the Monument Internet Fund (MFITX). "It has become so cheap now that we're thinking of getting back in before the holiday rush." |
