RedHerring.com still pounding away at LDCL:
redherring.com
Loudcloud still overblown
By Tom Davey
Red Herring
3/5/2001
For a company in registration for an initial public offering, Loudcloud (Nasdaq: LDCL) has been
making a lot of noise lately. The flurry of announcements last week comes in stark contrast
to the veil of mystery that has surrounded the company for much of its existence.
With Loudcloud's IPO scheduled to price this Wednesday for trading on Thursday, March 8, I
find it somewhat curious that the company would choose the week before the event to
announce a customer the stature of America Online. Was the AOL deal coincidentally finalized
just now? After all, four of Loudcloud's founders had high-ranking positions at AOL, and
Loudcloud has signed numerous big customers -- Blockbuster, Brocade Communications, Nike,
News Corporation -- during its year and a half of operation. They couldn't agree on anything
sooner than this?
The halo effect of the AOL announcement is nothing more than eye candy and can't hide the
facts behind the IPO. Under the offering's latest revision, Loudcloud plans to sell 20 million
shares at $9 to raise $180 million. That would give the company a $609 million market value,
which is barely over half the proposed $1.15 billion market cap when the offering was filed in
September. Lead bankers Goldman Sachs and Morgan Stanley wisely decided to sell a bigger
chunk of Loudcloud -- 29.7 percent of the company versus the 9.6 percent stake originally
proposed -- by raising the number of shares and lowering the price. Loudcloud, which is
burning $10 million a month, gets more cash to play with and some investors will be convinced
they're getting a better deal by paying less than $10 a share. (It's similar to the residential
real estate market here in the San Francisco Bay Area. You buy a shanty on a
postage-stamp-sized lot. But hey, you're only paying $695,000 instead of more than
$700,000 for a mansion in a less desirable part of the country.)
It's also hard to hide the fact that public investors are being asked to shoulder more of the
burden and potentially more of the reward. For the nine months through October, Loudcloud
had an operating loss of $107.6 million on revenue of $6.6 million. At a time when business is
beginning to boom, recurring monthly revenue from maintenance contracts makes the
financial results appear worse than they really are. As of January 31, Loudcloud has
commitments of $120 million through customer service agreements that have an average term
of 1.8 years.
WATCH OUT
Any smart investor should be skeptical about Loudcloud. Despite numerous competitors with
overlapping strategies, Loudcloud's revenue potential may be enormous. But so are its costs.
In fact, 'costs of revenue' for the nine months through October were five times revenue
itself. For an Internet services company, costs of revenue include salaries, payments on
rental equipment, leases of data center space, and depreciation of equipment and software.
In the future, these costs will certainly come down in relation to revenue. But the company is
still a long way from ever seeing positive gross margins, much less generating an operating or
net profit.
Loudcloud management includes the boilerplate, 12-month clause in its prospectus, but they
also caution that the company may need to look for private equity or bank financing.
Considering its astronomical growth, that's not surprising, but it is troubling. Over the past
year, Loudcloud's head count jumped from 71 to 586.
Analysts say a close comparable to Loudcloud is SiteSmith, which Metromedia Fiber Network
(Nasdaq: MFNX) agreed in October to buy for $1.36 billion. SiteSmith provides similar
outsourced Web services such as monitoring, security, site backups, and load balancing. In
its financial statement for an earlier IPO filing, SiteSmith reported $7.4 million in revenue for
the first six months of 2000, which is not much more than Loudcloud reported for its recent
six-month period. A key difference, however, is that SiteSmith's cost of revenues was a
relatively modest 1.5 times its revenues. So the potential for profitability in the near future
looks much better. But investors still thought Metromedia paid too much and punished the
stock. And many Internet infrastructure stocks have lost at least half their value since
October.
I think Loudcloud will follow a trajectory similar to Transmeta (Nasdaq: TMTA), another
company that was heavily hyped because it was started in secrecy. In November, when this
IPO sweetheart went public at $21 a share, almost everyone was drooling over this
mysterious chip company. Even folks here at Red Herring were gushing. Shortly after the
offering, at a $51 peak, I told a fellow Herring reporter that Transmeta's shares would plunge
to $10 within six months -- the length of time insiders are typically required to hold their
shares after an IPO. Transmeta is now trading below $20.
Although my prediction still has another three months to pan out, I think the chances are
good that Transmeta will cross the $10 threshold around mid-April with its next earnings --
er, I mean loss -- report. Around that same time, news will begin to flood the wires about
pending lockup expirations.
Although the pattern should be similar, I don't think Loudcloud's stock will go to the same
extremes as shares of Transmeta in these sobering market days. The pedigree of Loudcloud's
founders and the offering's top-tier investment bankers should give the company's stock a
short-term lift. But investors have lost nearly all sympathy for money-losing Internet
companies of any stripe. Look for a quick post-IPO jump to around $12 and a gradual dipping
to about $6 over the next six months. |
