The Goldman E-commerce list.
>Heard on the Street
Goldman Raises Eyebrows
With E-Commerce List
By SUSAN PULLIAM
Staff Reporter of THE WALL STREET JOURNAL
Here's a new twist on Darwin's theory: It isn't just the fittest that survive. It's those that are Goldman Sachs Group investment-banking clients as well.
At least that seems to be the message from a recent report by Goldman analyst Anthony Noto. He grouped 32 e-commerce companies into winners and losers in the battle for survival. Turns out, however, each of the clear-cut winners, except one, also are banking clients of Goldman. This has some of the "losers" quietly fuming.
The report looked at the companies' "cash burn" rates, subtracting operating losses for each quarter this year from their cash positions at the end of the first quarter. This left some companies solidly in the red, including Goldman client PlanetRx. The upshot: Mr. Noto projects that 10 of the companies in his report will need to tap the markets for capital this year or early next, which could prove to be tough, given the difficulty e-commerce companies have had trying to raise money lately.
No quibbles there. But Mr. Noto also divided the companies into three tiers, with the first having the best odds of survival; seven of the eight companies he listed were Goldman clients. They include eToys, which last week raised about $100 million in additional capital, but on terms less favorable than its May 1999 initial public stock offering. (EToys stock, which hit a high of $86 in October, traded at $5.28125 at 4 p.m. Monday on the Nasdaq Stock Market.)
The six other Goldman clients he rates as fittest to survive: Ashford.com, Barnes & Noble.com, eBay, 1-800-Flowers.com, Priceline.com and Webvan. Amazon.com was the only company without a Goldman investment-banking relationship to make the first cut.
But what about companies that didn't make the grade? They include HomeGrocer and Drugstore.com, which had cash at the end of the first quarter of $257.1 million and $174.7 million, respectively -- more than a few tier-one companies. The second-tier firms have "slight deficiencies but it is too soon to tell" about their ability to survive as stand-alone companies, Mr. Noto says in the report.
Those that didn't make the first cut declined to talk publicly, for fear of damaging their ability to build a banking tie with Goldman. But a chief financial officer of a tier-two concern grouses: "I know something about probability and that's not a random choice -- you have to discount its credibility tremendously."
In an interview, Mr. Noto asserts that his first-tier picks had nothing to do with Goldman's banking ties. "My research is independent from our corporate relationships," he says. "We have established a framework that supports our investment decisions."
Some investors back him up. "I give him credit," says Jack Eisenstat, a portfolio manager for Citigroup Investments. "Wall Street is full of momentum players, and to stand up and take a strong opinion -- right or wrong -- is not easy in this environment."
Still, Mr. Noto's report raises anew questions about how high Wall Street has erected the "Chinese Wall" between its research and investment-banking activities which are -- in theory, at least -- independent. It's an age-old issue on Wall Street, of course. But recently, as Wall Street firms fiercely compete for the banking business of "dot-coms," the walls, particularly in the high-tech area, have crumbled further.
"Research analysts have become integral members of the investment-banking units," and now beat the bushes for new deals, says Samuel Hayes, professor emeritus of investment banking at Harvard Business School. "Their compensation is tied importantly to the fee revenue that they generate for the investment-banking unit and they are expected to be supportive of any companies that are brought in as investment-banking clients."
At the same time, the red-hot market for IPOs last year caused institutional investors to place more emphasis on receiving big allocations in IPOs rather than solid analysis, causing the quality of research to decline, contends Steven Galbraith, a Sanford C. Bernstein analyst.
"We suspect deal allocations may have supplanted research in importance as part of the institutional commission structure," he says.
It's easy for Sanford Bernstein to bemoan the quality of research at other firms since it's largely research-driven and has avoided the frenzy to underwrite dot-com IPOs. But in this case, it may be true that investors are getting what they pay for in the research arena. Says a senior executive of another tier-two company: "It's interesting to note that the only Goldman client in tier two was PlanetRx."
Mr. Noto estimated in the report that PlanetRx will end the year $12.8 million in the hole on a cash basis, a bigger deficit than all but two of the third-tier companies, which Mr. Noto defines as those "less likely to be successful as stand-alone companies." (One of those two companies, Value America, is expected to end the year with a cash position of negative $38 million, not including a financing agreement announced on May 10 for an additional $90 million in equity.)
Meanwhile, none of the 15 companies in the third tier was a Goldman client. Yet they were selected as having the least promising prospects for going it alone in the dot-com world, even though 11 of the 15 third-tier companies, not including Value America, were projected to end the year in the black on a cash-flow basis.
What gives? Mr. Noto says the selection of companies for each tier was based not on cash flow but on a list of criteria called "key success factors," which also, it turns out, is the same set of criteria Goldman uses when deciding whether to act as a company's underwriter in an IPO.
Further he adds, it's not surprising that the criteria for selecting investment-banking clients are the same as those he used to determine the winners in the e-commerce battle. "Underwriting criteria are research-based," he says.
Indeed, Mr. Noto says, it's not the first time he has divided the e-commerce universe into three tiers, with the first tier having the best odds of survival. "Tier one has predominantly been Goldman clients," he says.
But Goldman's relationships are "not what drove my thought process," Mr. Noto says. "We have always provided investors a list of the critical success factors. We apply that list against all the companies in the sector and tiered them based on critical success factors. The tiers are not related to cash-burn rates."
Just what are the "critical success factors?" He says they include a large market, a clear path to profitability, effective online merchandising, good customer service, marketing and management.
Mr. Noto says he mixed the concepts of "key success factors" and cash-burn rates in the report because he didn't "want people to assume that companies with low cash won't continue to obtain funding," he says. Indeed, the report notes that first-tier Ashford.com, a Goldman client projected to be low on cash by the end of the year, should be able to eke out a "path to profitability."
Ashford, he says, should turn a profit by December 2001 without returning to the capital markets. The path, according to Mr. Noto: cost-cutting |
