September, 1998
Online System Services NASDAQ: WEBB
Online System Services is a small company that provides software to support the development of online communities among users of cable modems. The company lurks on the periphery of the Internet business, which may attract interest among tech-hungry investors. But these investors should exercise caution, else they wind up as roadkill on the information superhighway.
Online System Services ("OSS") is trying to stay afloat in the face of escalating losses by issuing additional stock, rapidly diluting what little book value remains. The company anticipates continuing losses from operations and huge write downs in equity as a result of pending mergers. Supposed synergies from those mergers appear elusive. Its products are not meeting with widespread market acceptance. OSS' future looks bleak, as it attempts to compete against some of the largest players in the industry by using local content web pages provided by volunteers.
OSS, based in Denver, is losing a great deal of money. The company has yet to earn a profit, while accumulating over $9 million in losses. Recently, losses have risen rapidly even as sales have fallen. OSS lost $4.3 million during the two latest quarters, far exceeding revenue in the same period of only $1.0 million. Even OSS' most recent quarterly report states that operating and net losses are expected to continue this year and into succeeding years.
Company Name Online System Services
NASDAQ Symbol WEBB
Stock price, 9/17/98 $5.625
52-Week Range Low: $4.875
High:$16.00
Market Capitalization $20 million
Common Shares Outstanding 3.5 million
Float 2.1 million
Price/Earnings N/A
Price/Book 4.0
Price/Sales 7.0
Short Position (7/98) 39,000
Trading Days Equiv 0.8
These losses are substantial for a small company of 54 employees that, as of June, derived 74% of its sales from only three customers. The three companies are Intermedia, a small cable operator in Tennessee; FiberTel, a cable company in Argentina; and American Telecasting, a wireless broadcast provider. None are considered a major presence in the domestic cable or Internet industry.
OSS is targeting small markets with a product for which little demand may exist. The company offers a service called i2u that allows cable operators to offer high-speed Internet access to subscribers of the cable system. This is similar to the service provided by @Home, a much larger company in which AT&T just acquired a substantial interest. OSS recently began giving away the non-proprietary hardware that allows the cable operators to provide Internet access to its subscribers. OSS hopes to make money on the related proprietary software that helps create local communities.
OSS' business plan calls for it to sell premium local content to subscribers of the cable Internet providers. OSS recognizes that Microsoft's Sidewalk and AOL's Digital City, among others, provide local content for free, and plans to target smaller markets of a couple hundred thousand people or less not currently served by Sidewalk or Digital City.
Unfortunately for OSS, these plans for premium local content appear to fly in the face of business reality. The task of creating and maintaining up-to-date, comprehensive content for hundreds of local communities is immense and well beyond the company's resources. OSS now relies on volunteers to use its software to create local content pages, and plans to provide one-person staffs to work at the cable operators to assist the volunteers. The customer base for the premium local content is restricted to the fraction of the community subscribing to the cable Internet service. Additionally, OSS expects these customers to pay an additional fee for information they most likely can find for free in their newspapers or elsewhere on the Internet. An OSS executive acknowledged that the company may want to rethink its current strategy of limiting its customer base to cable access subscribers and instead broaden its service to all Internet users.
OSS has a history of trying and failing at businesses. This time last year, the company was also in the business of developing and hosting web sites and providing healthcare information services. It has since exited both businesses and taken a sizeable charge against earnings as a result.
OSS is now in the process of merging with two companies, SkyConnect and Durand. The announced purchase price for SkyConnect and Durand is $24.7 million and $12.4 million, respectively. SkyConnect had accumulated losses of $31.5 million as of March 31, 1998; Durand had accumulated a deficit of $6.8 million as of December 31, 1997. Neither company has ever posted positive earnings results for any full year.
SkyConnect provides digital ad insertion into cable programming and is developing video on demand. OSS sees strong synergies between its relationship with cable companies and SkyConnect's video products that could be delivered through cable connections. Given OSS' small customer base, it's difficult to see much synergy resulting from the merger.
Durand brings expertise in creating virtual communities, like those OSS hopes to create in small towns throughout the United States, but does not appear to have enjoyed much success. Electric Minds, free and open to people throughout world, is considered the company's premier community even though fewer than 100 people signed on during one recent morning.
OSS appears to be in serious financial difficulty. Its outside public accountants have indicated "substantial doubt regarding the Company's ability to continue as a going concern." Losses are accelerating and revenues are falling. Its shareholders equity of $4.9 million, as of June 1998, will not last long if losses continue at the $4.3 million rate posted for the first six months of this year. As a result of the pending mergers, OSS will take a $25 million charge later this year against shareholders equity to write down acquired in-process research and development.
The most recent quarterly statement, filed August 14, indicated that OSS would need additional funding to continue operations beyond October. The SEC filing states that OSS will need to raise at least $15 million to implement its business plan. The 10-Q states that the company possesses a letter of intent to raise between $15 million-$18 million in gross proceeds through a private placement. But OSS' chief financial officer recently indicated that the placement may be scaled back to two million shares, due to the recent decline in the stock price. If so, OSS would only be able to raise some $10 million before underwriting discounts, less than the amount needed to implement its business plan.
OSS has already turned to complicated convertible preferred offerings to raise approximately $3 million in the past 12 months. These securities are floorless convertibles, meaning that the conversion rate can fall in step with a decline in OSS' share price. These securities minimize the investment risk for their holders, but not for owners of common stock. If the share price continues to fall, current stock owners will see increasing dilution in the value of their shares as the number of shares that are converted increases as the price of OSS' stock falls.
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