RAGING BULL'S CYBERSTOCK INVESTOR REPORT
War of the roses
Timing in the stock market is everything, especially when you're talking about
Internet IPOs these days. Just ask 1-800-FLOWERS (FLWS) Chief Executive Officer
and founder Jim McCann. On the surface, the August 3rd IPO of 1-800-FLOWERS,
one of the Internet's strongest retail brands and one of the world's largest
florists, looked like a sure-fire home run. The company seemed to have all of
the makings of a big-time Net IPO.
Let's tick off the list of pluses. One, well-known Internet venture backers in
Chase Ventures, Benchmark Capital, and SOFTBANK. Two, a proven management team
led by Jim McCann, one of the most requested speakers in the country. And
three, a brand name consolidator and market leader in a multibillion-dollar
fragmented business - the floral industry. But first looks can sometimes be
deceiving, especially when investors are faced with a shaky IPO market, coupled
with an overall slide in Net stocks like they've experienced for the past few
months. Any excuse becomes a good excuse to sit on the sidelines, put on your
raincoats, and wait out these cyber-thunderstorms. And that's exactly what
institutional and individual investors both did when push came to shove on the
day of the 1-800-FLOWERS IPO. They sat and watched. The IPO priced at $21 a
share, above its initial range of $16-$18, but closed its first day of trading
at only $18.19, down almost 14% from its initial offering price. The past two
weeks have not proven any kinder to McCann and company. As of Friday's closing
price of 16 5/16, 1-800-FLOWERS now sports a market cap of roughly $349 million.
What must be particularly bittersweet and extremely frustrating for Jim McCann
and the rest of the management team is that his firm literally helped pioneer
the e-commerce arena. Now the Flower King finds himself temporarily being swept
aside by investors for flashier e-commerce darlings like eBay (EBAY), Amazon.com
(AMZN) and barnesandnoble.com (BNBN). Let's quickly take a trip down memory
lane. 1-800-FLOWERS first began selling flowers online over CompuServe back in
1992, and cut its first e-commerce deal with America Online (AOL) back in 1994.
In essence, these guys were tinkering with e-commerce before Jeff Bezos had even
officially launched Amazon. I can't remember another bricks-and-mortar retailer
that was quicker to wholly embrace the Web than 1-800-FLOWERS.
Truth be told, McCann appeared to be in position to IPO his company and cash in
on the Internet stock bonanza whenever his heart desired for at least the past
three years, but instead he sat patiently on the sidelines. McCann has always
been more interested in building a viable long-term business than in becoming
the next hot dot-com cover story for BusinessWeek. The fact of the matter is
that 1-800-FLOWERS previously hadn't needed access to the public markets, since
McCann had already built 1-800-FLOWERS into a powerful national online and
offline brand that was already profitable - yes, profitable. Last year, the
company racked up sales of $220.6 million and posted a net income of $3.5
million. Not bad for a guy who started out as a social worker, and acquired a
single 800-cubic-foot retail florist in New York back in 1976 for $10,000.
Racing for the IPO gates
However, the sizeable online success of 1-800-FLOWERS has not gone unnoticed by
its offline competitors and a variety of online startups. Simply put, the
floral industry is an ideal category for e-commerce backed by a set of
attractive growth projections. Forrester Research calculated that the U.S.
online market for flowers was $212 million in 1998, and that this number will
reach $906 million in 2003. In addition, Forrester estimates the online market
for gifts will reach $544 million in 2003. Together, these two figures suggest
over a billion-dollar market opportunity for floral Web sites over the next four
years. It's no wonder, then, that floral companies are rushing to ramp up their
web operations and drastically increase their advertising spending. But this
all takes cash - lots of it - which of course means, "let's let the public
shoulder the burden for our astronomical marketing expenditures with an Internet
IPO." So in a period of only eight days in May, from the 13th to the 21st,
1-800-FLOWERS, as well as two of the company's largest competitors, FTD.com and
PC Flowers & Gifts, all filed for IPOs. The race was on. However, after the
lackluster opening day performance of the 1-800-FLOWERS IPO, FTD.com postponed
its offering for the time being. The underwriters for PC Flowers & Gifts have
not yet postponed its debut, but I wouldn't be surprised to hear the same from
them shortly. Without raising cash via IPOs, I don't see any way that FTD.com
and PC Flowers & Gifts can put a dent into 1-800-FLOWERS' market share. In
contrast, with $117 million in its coffers from its IPO, I expect to see
1-800-FLOWERS pull even further away from the pack this holiday season.
Doing the Amazon thing
One knock against 1-800-FLOWERS has been the company's expansion into new
product categories such as gourmet foods, home and garden products, and casual
lifestyle furnishings. The company entered this space by acquiring The Plow &
Earth, Inc., primarily a catalog retailer, back in April of last year. I don't
believe these new product categories will in any way dilute the 1-800-FLOWERS
brand. While I admit that the name 1-800-FLOWERS doesn't exactly scream "garden
tools and furniture" to customers, I still believe that many of these new
categories will be well received by the existing 1-800-FLOWERS customer base.
So far, the acquisition of Plow & Earth appears to be paying off. A SEC filing
for 1-800-FLOWERS attributes a 2% gain in gross margins for the company in the
nine months ended March 31 of this year to Plow & Earth. So why is
1-800-FLOWERS still getting hammered by the Street? In my opinion, investors
don't like the bricks-and-mortar component of its business that is still
responsible for deriving a substantial amount of the company's total sales.
After all, for the past nine months ended March 31 of this year, the online side
of the company's business generated just 15% of the total revenue pie. Now,
before you start saying that 1-800-FLOWERS is simply a bricks-and-mortar company
trying to masquerade in dot-com clothing, one needs to remember that the online
side of its business alone generates more revenue than many publicly traded
e-tailers. The company's online revenues of $30 million for this recent
nine-month period represents an 85% increase over the same period in the last
fiscal year. There is nothing to suggest that the company will not be able, in
four or five years, to shift roughly half of its entire revenue over to its Web
site. Thus, if 1-800-FLOWERS can keep its increased online marketing costs from
destroying its bottom line, the company should reap substantial costs savings
from gravitating customers over to the low transaction costs of the Web, and
away from its labor-intensive telephone call center structure. In the end, this
should leave 1-800-FLOWERS as an even more profitable entity than in the past.
However, in the meantime, pure play Internet stock enthusiasts don't appear
interested in hearing about an integrated player like 1-800-FLOWERS that
operates not only a web site, but also a mail order, telephone ordering, and
bricks and mortar operation - but they should. "Clicks and mortar" - the
integration of offline and online assets - appears to be the future paths for
many e-tailers. Just look at Amazon.com's mad dash to build bricks and mortar
distribution and fulfillment centers around the country, or PETsMART's decision
to announce an online partnership with well-known Internet incubator idealab!.
Bricks and mortar shops and e-tailers will only tie the knot with greater
frequency in the coming months through partnerships or acquisitions, and
ironically, 1-800-FLOWERS has had this strategy of vertical integration and
multiple sales channels in place all along. Investors may not ever see the kind
of hyper-revenue growth of an Amazon.com or Beyond.com (BYND), but they are
receiving a taste of what I believe will be one of the surviving business models
in the long run.
Can anyone catch the flower king?
So far, I have not been very impressed by the competition facing 1-800-FLOWERS.
The largest potential threat would appear to come in the form of Gerald Stevens
(GIFT), a relatively new national florist firm formed by a group of former
Blockbuster executives. The company has gone on a buying spree that includes
purchasing Calyx & Corolla, a direct-from-grower operation, and Shackelford's &
Maxwell's, the second-largest independent chain in the country. Gerald Stevens
now owns over 200 retail locations. In addition, the company owns two flower
order generation firms and FloraFax, a flowers-by-wire service. All of these
recent acquisitions have helped the company report recent third quarter revenue
of $36.3 million, compared to only $4.8 million for the year-ago period. While
I am impressed with Gerald Stevens' rapid revenue growth, I believe the company
is embarking on the wrong long-term strategy.
While 1-800-FLOWERS has made the Web its primary growth vehicle, Gerald Stevens
appears headed in the opposite direction by acquiring bricks and mortar
operations. Clearly, the Web is only a secondary priority for this
ex-Blockbuster management team. In my eyes, having an offline sales channel to
an extent is valuable, but placing all your eggs in the offline basket, while
ignoring the inherent cost savings of the Web as a sales channel, appears
ludicrous. Look at it this way: with 1998 revenue of $220.6 million and a total
employees count of 1,691, 1-800-FLOWERS generated $130,455 in revenue per
employee last year. Compare this to the $13.4 million in revenue and 194
employees that Gerald Stevens had for 1998, which generated revenue of only
$69,000 per employee. Now, you decide who runs the more lean and mean operation
that will end up with the right business model in the long run. I have little
doubt that 1-800-FLOWERS will be that company.
Other competitors that 1-800-FLOWERS must keep an eye on include FTD.com, a
subsidiary of Florists' Transworld Delivery, owners of the popular Mercury Man
logo; and PC Flowers & Gifts, a floral e-tailer that is now 48% owned by direct
marketing and catalog giant Fingerhut. Once again, it's clear to me that
1-800-FLOWERS is the superior operator when one considers that it boasts a
higher gross margin, as well as stronger overall revenue growth than any of the
competition. The truth is in the numbers. 1-800-FLOWERS posted 1998 sales
growth of 18.3%, compared to revenue growth of 17.1% and 16.8% for PC Flowers &
Gifts and FTD.com, respectively. What's impressive about this total is that
even with "the law of big numbers" in play, that 1-800-FLOWERS was still able to
achieve faster overall growth. Between them, FTD.com and PC Flowers & Gifts
scraped together a total of roughly $33 million in sales, while 1-800-FLOWERS
posted revenue of roughly 6.5 times this total. For the nine months ended March
31 of this year, 1-800-FLOWERS posted a gross margin of 39%, which topped gross
margins of 21.4% from FTD.com and 36% from PC Flowers. Needless to say, with
economies of scale continuing to kick in for 1-800-FLOWERS and McCann now
controlling his very own war chest and Internet currency, I wouldn't want to be
in PC Flowers' or FTD.com's position right now.
While online investors appear frustrated by McCann's gutsy decision to take
1-800-FLOWERS from profitability back into a sea of red ink with a
multimillion-dollar marketing campaign, it will be these types of aggressive
moves that can eventually build it into a $1 billion business. After all, kill
the competition today; why wait until tomorrow, when it may be stronger? It
must have been similar thinking that spurred SOFTBANK, Benchmark Capital, and
LVMH (LVMHY) into investing $101.6 million back in May. In return, these three
backers would receive a 25% stake in aggregate of 1-800-FLOWERS after the IPO,
according to the company's SEC filings. This suggests a total private valuation
of at least $400 million pre-IPO for 1-800-FLOWERS. Obviously, the public
markets have not shared the same opinion as this group of venture capitalists.
Instead, 1-800-FLOWERS currently sports a market cap of under $350 million.
Looks like it's not just Flower King, Jim McCann, whom must be stumped about his
company's performance in the market. Don't worry, Jim. Your colorful stock
bouquet is only temporarily wilting under this current fascination for only
pure-play Internet stocks. Longer term, investors will realize that you're still
the Pied Piper of the retail flower world.
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