worldlyinvestor.com Sector of the Day
Beware Buying Buy.com
By Kelly Black, IPO Columnist
Buy.com seems like a sure thing. Better look again.
Every now and again a promising initial public offering arrives with great fanfare and all the qualities of a winner. But sometimes I find myself going against the grain of popular sentiment. Such is the case with cyber-celebrity buy.com (Nasdaq:BUYX - news).
At first blush, this IPO looks like a sure thing. At second glance, the aftermarket performance is likely to give investors a headache.
To be honest, I tried to buy into the hoopla surrounding this upcoming offering, but it just wasn't meant to be. Everybody likes good news first, so let me delve into what I like about this company before I tell you why I'm not crazy about it.
First, buy.com plans to sell a relatively bloated 14 million shares to the public at $10 to $12 each. By the time this goes to press, don't be surprised if the offering has already been bumped up to the $13 range. The company has the golden seal of approval from institutional investors with legendary sugar daddy Softbank owning a 34% stake. As if that weren't enough, Merrill Lynch and Bear Stearns anchor the underwriting team.
E-conomics 101
Through its lucrative partnership with Ingram Micro (NYSE:IM - news), the company sells a staggering 900,000 products on its Web site, ranging from plain vanilla books and CDs to golf equipment. So, what's the catch? Well, in 1997, the company took Silicon Valley by storm when it unveiled plans to sell goods at or below cost. In layman's terms, this means that the company loses money on nearly every sale. Welcome to Internet Economics 101.
Before you hit the 'back`` button on your browser, here's the method behind the madness. Buy.com is grabbing market share by the fistful with its ``at-cost' business model and plans to make up the revenue shortfall by selling advertising on its Web site. Branding itself as the low-price leader, the company hopes that aggregating eyeballs today will pay dividends tomorrow.
Think of its business model itself as its ad campaign. Companies spend millions of dollars on ads targeted toward fickle consumers. Buy.com looks to capitalize on consumers' tight-wad spending habits much like Wal-Mart (NYSE:WMT - news) has. Once you establish yourself as the ``low-price leader,' shoppers will likely return and buy higher margin products along the way.
Where's the Beef?
I like the swashbuckling attitude and risk-taking business model, but there are a few painfully obvious flaws. Will advertisers really want to spend money targeted toward cheapskate Web surfers? Not likely. Typically they look for affluent consumers prone to impulse buying.
And companies who plan to rely heavily on advertising revenue models need only look to theglobe.com (Nasdaq:TGLO - news). Once the toast of Wall Street, it's become the poster child for how not to rely on advertising as a sustainable revenue stream.
Buy.com boasts an impressive $396 million in revenue, on losses of $81 million for the nine months ended September 30, 1999. While that's up nearly 500% from the year-ago period, losses have mounted even faster. The company's cash-burn rate is rising so quickly that an IPO war chest combined with earlier private funding won't last beyond two years.
E-tailing Landscape
Rivals include Onsale, which recently merged with egghead.com (Nasdaq:EGGS - news) in 1999. The venture, Onsale atCost, sells goods at cost but charges a small fixed processing fee on each transaction. During the nine months ended Sept. 30, 1999, Onsale collected $242 million in revenue on losses of $34 million.
Value America (Nasdaq:VUSA - news) is another ancillary competitor, which has crumbled through mismanagement that began with its infamous CEO and culminated with an abysmal lack of communication with analysts covering the company. From its lofty 52-week perch of 74 1/4, the company now trades at a paltry 5 1/2 per share and finds itself trying to rise from the ashes - with the stigma of being one of 1999's worst performing IPOs.
Speaking of infamous CEOs, buy.com's founder Scott Blum has a few skeletons in his closet. Blum was in trouble with a previous company he founded, Pinnacle, for a run-in with the Securities and Exchange Commission. In 1997, he signed a consent agreement with the SEC, in which he neither admitted nor denied wrongdoing related to accounting discrepancies dating back to 1993. He exited buy.com gracefully prior to its filing for its IPO, though he still retains a 56% stake.
Final Thought
This IPO was born with a silver spoon in its mouth: terrific genes, strong connections, and a champion underwriter. But a few cracks in the armor show signs that make me wary. Whether its business model is a sound and sustainable one remains to be seen, although investors aren't likely to be forgiving in the face of negative gross margins.
The size of this offering is a real head-scratcher. Pure Internet e-tailers don't command the same valuations they did just one year ago. The company needs more cash and by the looks of it it's're going for the whole enchilada. While investors can count on a solid first-day pop from the Softbank and Merrill names alone, they may want to run for cover ahead of buy.com's aftermarket performance, which in my opinion could get ugly.
By the Way
Last week I wrote about b2bstores.com (Nasdaq:BTBC - news), taking them out behind the woodshed (or out from behind the curtain). Well, the B2B pretender did us all a favor and postponed its IPO indefinitely shortly thereafter, likely never to be heard from again.
Kelly Black is an IPO analyst and syndicated columnist. She provides investable ideas and commentary on each week's upcoming IPOs.
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