WHAT TO MAKE OF COMPAQ'S DEAL FOR SHOPPING.COM FOOL ON THE HILL
An Investment Opinion
by Louis Corrigan
What to Make of Compaq's Deal For Shopping.com
The surprising market moves we've seen in Internet stocks over the first two weeks of 1999 can leave
one speechless. Over three days, online broadcaster Broadcast.com (Nasdaq:BCST - news) runs up
from $85 to $285, largely on the expectation of a stock split. Meanwhile, leading online portal Yahoo!
(Nasdaq:YHOO - news) , valued at about $27 billion on December 31, finds itself worth $51 billion by
yesterday afternoon only to end the day worth $46 billion. Today, after another rocking earnings report, it
opens down $7.6 billion only to close the day worth $42 billion.
Yet, the most surprising event so far this year may be the Monday morning announcement from
Compaq (NYSE:CPQ - news) , the world's top consumer PC manufacturer, saying it plans to acquire
troubled online retailer Shopping.com (OTC BB:IBUY - news) for $19 per share, or a total of $220
million. In cash, no less. The deal raises questions not just about Compaq's plans to capitalize on the
Internet but about the value of third-tier Internet companies in general. In short, if a blue chip technology
company like Compaq is willing to shell out such big bucks for what many short-sellers consider a
thoroughly suspect enterprise like Shopping.com, then we may have entered the realm of corporate
speculation on the Internet. Or, the naysayers may have badly miscalculated what some of these
companies are really worth. In either case, the Shopping.com deal has left some short-sellers who
dabble in third-tier Internet names feeling a bit spooked.
Based in Corona Del Mar, California, Shopping.com is an online retailer of over two million brand-name
products, such as computers, books, office supplies, and CDs. Its online store consists of 16
categories of merchandise and services available through 1,000 different merchants. Shopping.com acts
basically as an online intermediary between consumers and these suppliers. Its e-commerce software
allows suppliers to be contacted directly to ship customer orders as they're received by the firm's virtual
storefront. This commission model is ultra-light, meaning Shopping.com doesn't have even the inventory
or capital requirements of an Amazon.com (Nasdaq:AMZN - news) .
Despite opening for business on July 11, 1997, and scoring an 18-month online real estate deal last
January with leading broadband Internet service provider @Home (Nasdaq:ATHM - news) ,
Shopping.com doesn't have much to show for its efforts. While Amazon added a million new customers
during its six-week holiday season alone, Shopping.com claims only 100,000 customers total over the
past 15 months. For the first nine months of FY98, Shopping.com lost $18.9 million on sales of just $4
million. Moreover, it ended the third quarter with negative working capital and a negative book value.
Even better from a short-seller's perspective was the company's rocky history, part of which I outlined
last March around the time the SEC halted trading in the company's shares for 10 days while it
investigated possible market manipulation. Shopping.com was taken public by Waldron & Co., a
brokerage firm based in Irvine, California. In the middle of the IPO process, Waldron learned that Nasdaq
refused to list the company even on its SmallCap market because CEO Robert J. McNulty had violated
the securities laws in the past. (Though he neither admitted nor denied the charges, he signed a decree
in U.S. District Court on October 10, 1995 that enjoined him from violating the securities laws in the
future.) Waldron, then, had to sell the shares only to high-net-worth individuals. Faced with that
dilemma, Waldron allegedly engaged in unethical practices that drove some of its own employees to
call up the National Association of Securities Dealers to complain. (Nothing has yet come of those
charges.)
In any case, McNulty, who owns a third of the stock according to the last proxy, was out as CEO by
June. John Markely, a management consultant, was brought in as the new CEO at that time. Of course,
Chair Frank Denny, former Chair/CEO of Builders Square, had only joined the board in April. Yet, these
management changes weren't the last. Just last week, the company announced another shakeup.
Randall Read, former CFO at Stone Container, would become the new chairman while Denny slid into
the CEO's position and the company brought in a new CFO. Three CEOs in 8 months suggests
Shopping.com is more like a circus act than a cutting-edge online retailer. Indeed, the company's entire
history would suggest this is a business one should avoid at all cost.
Shopping.com went public at just $9 a share in November 1997. Even after soaring to nearly $33 a
share last spring amidst one wave of Internet fever, the company was only worth $132 million based on
the 4 million shares outstanding noted in the company's 10-Q filing. Of course, that underestimated the
dilution from the gobs of outstanding warrants, preferred stock, and options. The Compaq bid suggests
there are now some 11.6 million fully diluted shares outstanding -- and there's been no stocks split in
the interim.
More important, Compaq's bid looks eye-popping based on where Shopping.com has been and given its
dire financial straits. In September, it fell as low as $1 a share. As recently as November, even after the
broad indexes recovered, it traded for less than $2 a share. Compaq's offer, then, represents not just a
premium of nearly $6 per share from the stock's close last Friday. It values Shopping.com at 900%
more than investors were willing to pay for the company just two months ago!
Why did Compaq's management decide to move now rather than two months ago, when they surely
could have saved shareowners at least $100 million on the purchase. Has Compaq's strategy or the
competitive environment really changed so much in so short a time? Perhaps it has. America Online's
(NYSE:AOL - news) deal for Netscape (Nasdaq:NSCP - news) and the huge valuations being afforded
Yahoo! and Amazon suggest that investors are willing to pay quite a bit for viable Internet portals and
e-commerce sites. Compaq management seems to think they can play this game, too.
When Compaq acquired Digital Equipment last year, it picked up the highly respected Alta Vista
Internet search engine in the process. According to Media Metrix, Alta Vista ranks number 10, ahead of
even Amazon.com, among the most highly visited websites, with some 11 million visitors per month.
Yet, Compaq has appeared uncertain about how to capitalize on this asset. Rumors have repeatedly
floated that Compaq might simply spin-out this search service. The Shopping.com deal appears to be a
means for Compaq to sell this spin-out as a true e-commerce contender.
Rod Schrock, general manager of Compaq's consumer products unit, told Reuters that a link to Alta
Vista could drive 10 to 25 times more traffic to Shopping.com by the end of this year than it receives
today. "We definitely plan to turn Shopping.com into a premiere shopping site on the Internet," Schrock
told Reuters. "In our estimation, Shopping.com has one of the most state-of-the-art shopping
capabilities" of any site on the Web.
So Compaq appears to be saying, what's $220 million if we can use this company's technology to help
create a viable e-commerce portal that we can take public amidst the current Internet frenzy. No doubt,
it could prove a smart business deal even if it looks to some like a game of corporate speculation on the
current Internet frenzy. Nonetheless, at least one short-seller who says he's never been short
Shopping.com still thinks Shopping.com was merely a "stock promotion." He argues that Compaq
"probably hasn't done much due diligence" on the company. That's something to keep in mind if
Compaq does spin-out its Internet business. Given Shopping.com's history, it would simply be
surprising if it's really worth what Compaq is paying for it.
Related article:
-- The Dangers of Bulletin Board Stocks (3/27/98)
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