IPO wake-up call: change or die
By Stephen Lucey
Redherring.com, September 07, 2000
Sustained long-term growth and profitability are basic goals of any company. During the IPO boom of 1999, however, such metrics were not always at the forefront of investor concerns.
Instead, investors shrugged away questions of long-term corporate profitability in the rabid pursuit of near-term personal profitability. Their real concern was locating innovative companies that would bring the next killer Internet-based application to the market. Indeed, little thought was given to the company's prospects in the aftermarket or the potential for the overall industry. It was simply a case of investors seeking instant "return" gratification.
CONTENTS
Introduction: 1999 IPO market revisited
- B2C cracks IPO foundation
- IPO wake-up call: change or die
Companies picked up on this new attitude and emphatically embraced the new mantra of "profits be damned." When the market collapsed this April, however, and this new breed of investors began demanding clearer paths to profitability, many of the 1999 debutantes weren't able to reverse gears fast enough. As a result, investors hit companies where it hurt the most -- in their stock price.
Management at companies like E-Stamp (Nasdaq: ESTM) and Rainmaker Systems (Nasdaq: RMKR) realized that the era of "irrational exuberance" had finally come to an end. Lacking access to the public markets and with dwindling cash reserves, the only rope of sustainability they could grasp was a focus on solid fundamentals.
CUT YOUR LOSSES
In the case of online postage company E-Stamp, Robert Ewald, the president and CEO, notes that the original target markets of small offices and home offices (SOHOs) were hard to find and expensive to reach through a traditional marketing campaign of direct mailings, print, and broadcast advertising. Not exactly the type of disclosure that investors wanted to hear from a company less than a year old.
Nevertheless, Mr. Ewald claims that E-Stamp had the discipline to realize its weaknesses and move forward with a strategy to reach the SOHOs. Instead of going it alone, the company tapped its strategic partners, many of which had been with it since its founding. One of the most effective channels the company uncovered was Intuit (Nasdaq: INTU), which selected the E-Stamp platform for integration into QuickBooks, its popular small-business accounting software system. With a customer base of 3 million users, QuickBooks quickly opened up a new, targeted audience for E-Stamp. The company capitalized on this in the first quarter of 2000, and in three months added 10,000 new customers.
Although this proved to be an important decision for E-Stamp management, a more significant change came when they reconsidered the company's mission. E-Stamp no longer wanted to be viewed simply as a supplier of postage, but to become synonymous with the "virtual stamp," thereby making it a recognized seal of approval for services conducted over the Web.
With its strong delivery platform and a known brand name in the postal markets, E-Stamp delivered upon new initiatives laid out at its annual shareholder meeting in May. Later that month, the company entered into a pilot program with Atraxis, a fully owned subsidiary of SAirGroup (the parent of Swissair) that provides IT services to the airline, airport, cargo/logistics, and travel industries, to test an online ticketing platform.
As part of this new initiative, the company also attempted to reposition itself under the broader label of "e-logistics" by focusing on branding itself as an infrastructure systems company that would power next-generation, e-commerce shipping solutions. With many companies already utilizing Federal Express (NYSE: FDX) and United Parcel Service (NYSE: UPS) workstations in their online shipping platforms, E-Stamp was now looking to integrate its postage services into the market through licensing arrangements.
While such changes were always long-term goals, the market drove E-Stamp to implement them much faster than anticipated. As a result, the company's vision is much different than it was just 10 months ago when it went public. And from Mr. Ewald's point of view, E-Stamp is a much stronger company, even if the stock continues to hover at about $1.50 a share (90 percent below its original $17 offering price).
NEW INVESTMENT BENCHMARKS
Since its IPO in October 1999, investors have placed three different investment standards on E-Stamp (and every other company), says Mr. Ewald. A year ago, the market simply wanted to see the potential for revenues, and no one seemed to care if a company was losing money as long as that potential was on the horizon.
At the end of 1999, the market refocused its investment philosophy. Customers and revenues were still crucial, he notes, but investors now wanted to see tangible evidence of earnings. Now, companies must not only have customers, revenue, and earnings, but a solid cash position as well. In this new environment, burn rate became an important metric to assess liquidity, and how much time a company needed in order to reach profitability.
E-Stamp took these new market requirements very seriously and, after repositioning its business model at the end of the second quarter this year, made the decision to downsize staffing by 25 percent. Having entered the year with a cash balance of $118.7 million, these cuts proved crucial as they extended the company's $65 million cash reserves by one year. As a result, E-Stamp now believes it has enough cash to support its business through 2001.
SHARING THE PAIN
The ability to transform and meet these new investment standards became the No. 1 priority for many Internet companies. It became implicit that if they did not make adjustments to their business models, they would not regain investor confidence. Companies needed to change or they would not survive.
In the case of Rainmaker Systems, a Scotts Valley, California-based outsourcer of Web-based sales and marketing services, change meant ending an aggressive "land grab" growth strategy that focused on locking up market share at the expense of profits.
Michael Silton, CEO of Rainmaker, admits that the company took the aggressive approach because the investment environment last year demanded such a strategy from recently funded companies.
But like E-Stamp, Rainmaker had to modify its strategy after the shakeout in April. "The climate was no longer, 'We [the investment community] will fund growth,'" says Mr. Silton. "The climate was no longer 'land-grabs are good.' The climate was now, 'You'd better figure out how to become profitable within your own cash reserves.'"
After soaring 131 percent on its first day of trading last November, Rainmaker failed to maintain favor among investors. Post-shakeout, the company's stock is trading at about $2.50, some 90 percent below its all-time high of $29.25 in December and 68.7 percent under its original offering price of $8.
Much like E-Stamp, Rainmaker management recognized the Street's new investment focus and positioned itself to become profitable by 2001, ahead of its original target of 2003. Since the company had a solid track record of profitability, the sudden change in focus was not a major concern, Silton claims.
Prior to the land-grab strategy that forced the company to begin a planned period of ten consecutive quarters of losses, Rainmaker had completed 16 quarters of profitability dating back to 1995. Given its current cash burn of $3 million per quarter and approximately $40 million in cash, Mr. Silton is confident the firm will be in the black by 2001.
The question left unanswered for companies like E-Stamp and Rainmaker is: Will investors accept these changes and revive their stocks from the dead? Until proof of positive earnings materializes, investor response remains decidedly skeptical. |
