Microsoft Investor article on H&Q Conference. [One minor ASND reference]
[Check out the Landis comments on networking chip companies]
Can OnSale Scale the
Heights?
Everybody's hyping "scalability" at H&Q's
tech-stock conference. But online
auctioneer OnSale Inc. may have the real
thing.
By Jon D. Markman
Early in this century, pioneering radio
companies invested over decades to
create the world's first
mass-communications medium. Now,
pioneering Internet companies are trying
to build a new mass medium in just a
couple of years, which means they need
more money, faster.
Enter the investment-conference circuit,
where these companies' executives are
spending a lot of time these days flogging
their vision and wares as they try to
persuade professional fund managers to
pour more money into their stocks, driving
up the prices. It's like a second job for
them. They depend on lifting their share
price so they can use stock as a
currency for acquisitions, as a
salary-substitute to retain veteran
employees, as a lure to snag top recruits
and as a way to keep score. They also
need to lift the market value of their
companies to appear more stable to big
banks -- and thus obtain cheaper credit.
Investor columnist Jim Jubak and I caught
up with the virtually nonstop investment
road show in San Francisco this week, at
the 26th annual tech-stock conference
sponsored by brokerage Hambrecht &
Quist. We sat in on a couple of dozen
presentations and talked with a few dozen
pros. I'll empty my notebook today and
Friday, and Jim will chip in with more in
his regular Friday and Tuesday columns.
Let's Get Big -- On the Cheap
At the start of any presentation, you could
bet a week's pay that the speaker at
some point would utter the week's single
most popular buzzword: Scalable.
It's no longer important just to grow a
great brand on the Internet. Companies
are also scrambling to create a business
model that will allow them to grow really
big, really quickly, and at the lowest cost.
Scalability is all about determining the
largest market for your products and then
ramping up to feed that market as fast as
possible without adding costly equipment
or personnel -- a neat trick.
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OnSale has no
meaningful
competition, very
few employees and
appears able to
scale up in size
primarily through
the purchase of
equipment rather
than the hiring of
people.
One company stood out when gauged on
this metric: OnSale Inc. (ONSL). The
online auction-sales company may well
face the biggest market on the Web, yet
it has no meaningful competition, very few
employees and appears able to scale up
in size to meet future demand primarily
through the purchase of equipment rather
than the hiring of people.
In a measure of the leverage it gets
from its lean 145-person workforce,
OnSale gets the highest amount of
revenue per employee of any
player in the space -- $806,000
each. That's approached among
other high-tech firms only by Dell
Computer (DELL) at $770,000 per
employee and Microsoft (MSFT) at
$615,000.
In contrast, in the past 12 months,
Amazon.com (AMZN) took in
gross revenues of $216,000 for
each of its 1,000 employees and
Yahoo! (YHOO) had revenues of
$176,000 from each of its 500
employees. (These employee
figures are current through the
most recent reporting period;
Investor's data is gathered
annually.)
Yet by at least one measure,
OnSale is also one of the few
values in the Internet investment
space, trading for 4.1 times sales.
Contrast that with AOL at 7.7
times sales; Amazon at 11 times
sales or Yahoo! at an astonishing
72 times sales. (See Jim Jubak's
column Friday for another take on
valuing Internet stocks.)
Chief executive Jerry Kaplan told investors
on Monday that his firm is "bringing the
bargains of Costco to the entertainment of
QVC." I don't get too entertained by QVC
on television, but I do find OnSale
addictive both as a user and as an
investor.
Here's the big idea: Computer and
consumer-electronics companies always
end their selling seasons overstocked
with millions of dollars worth of perfectly
good but unsold inventory. And
electronics retailers always end up their
seasons with millions of dollars worth of
returned products that are also perfectly
good but cannot be sold as new. In the
old days, this type of merchandise was
dumped at surplus auctions, swap meets
and discount-store bargain sales, or
ground up and loaded into landfills.
OnSale's founders hit on the idea in 1995
of buying up vast quantities of all that stuff
on the cheap, marking it up a little bit,
and auctioning it off to the public via the
Web. They started with computers, then
moved on to consumer electronics and
sports equipment. Next they're targeting
travel packages, frozen steaks, power
tools, big computer systems, low-end real
estate, industrial commodities -- you
name it.
What grabs your attention are the prices
for brand-name, new or refurbished
merchandise: They'll start the bidding for
six $3,500 Dell notebook computers at
$199 each; you can buy one or all. The
price might eventually ramp to $1,500 or
more apiece -- but it's rare that you don't
see real bargains. Customers get factory
warranties. And the bidding, which
generally lasts 24 hours, is fun once you
get the hang of it. It's also "sticky" -- one
of those great new Web business words --
as users return to the site again and
again to check on their bids.
VIDEO
OnSale CEO Jerry
Kaplan says his
company was profitable
for 5 quarters before
going public, and after a
period of variable
investment, should once
again be profitable in
Q2 of '99.
Get Tools
OnSale was profitable before it went
public, but has since gone into the red to
invest in its marketing and infrastructure.
Its business is not easily replicated
because it runs on very cool, very fast
proprietary software. And its repeat
business -- 74% of first-timers buy again
-- seems to show that the model works.
"Our customers are omnivores, they'll buy
anything," Kaplan said. "It's like Costco,
where you go in for a bag of carrots and
come out with prescription drugs, a TV
and a barbecue."
The firm's scalability stems partly from
the fact that the sharp rise of new
high-tech merchandise for sale at retail is
creating ever more quantities of overstock
for OnSale to buy cheap. The firm turns
around and sells this merchandise at
predictable (if rather tiny) margins without
the intervention of human order-takers.
Inventory is low and turnover is high,
because almost every item is sold at
some price that's profitable to OnSale.
And while shoppers might buy one or two
items at a time from Web retailers like
Amazon.com (AMZN) or CDNow (CDNW),
Kaplan said that in the last quarter, 3,700
of his customers spent more than $5,000,
45 spent more than $50,000 and one
customer spent over $1 million. "No one
buys $1 million in books online," he
cracked. While most Web content
companies are relying on advertising for
revenues, in other words, OnSale is
actually selling stuff; it's estimated it will
gross $223 million in fiscal 1998. Ads, as
they grow, will be gravy.
How big is the market? Kaplan lamented
that there were few reliable statistics, but
he figures there's at least $11 billion worth
of overstocked/refurbished PCs to sell per
year, and more than $30 billion in
consumer electronics. Add travel, real
estate, leftover industrial pipe and last
week's frozen Omaha steaks to the mix,
then take the concept to Europe and Asia
-- and you get the picture.
Barry Sosnick, an analyst at Genesis
Merchant Group Securities, has
concluded that OnSale's business model
has "greater profitability potential" than
any other online retailer, and will be
considered "the star" of the industry once
its business model is better understood
by the Street. He is forecasting 16 cents
a share in profits in 1999 and 51 cents in
2000.
How big is OnSale's
potential market?
Kaplan figures
there's at least $11
billion worth of
overstocked and
refurbished PCs to
sell per year, and
more than $30
billion in consumer
electronics.
"Our customers don't just buy goods,
they win them -- there's a high emotional
impact in the thrill of the hunt," Kaplan
said. Considering that the price of this
stock is actually kind of reasonable at
$22 to $25 -- and is being held back now
due to unsubstantiated rumors of
accounting and inventory problems that
Sosnick discounts -- the same might well
be said for value-seeking Web investors.
It's the Infrastructure, Stupid
Kevin Landis, co-manager of the red-hot
Technology Value Fund, has a different
take on the auction-sales company.
"OnSale is a good reason to buy
PMC-Sierra (PMCS)," he said.
Landis can't repress a smirk when talking
about Web content companies. Visiting
the conference to catch up on his
holdings and learn about new companies,
he said he much prefers the firms that
make the hardware that make the Web
work. The reason: "They have similar
upside but they are much less
experimental -- and that makes them less
risky," he said. "Some of the content
guys can succeed wildly and others fail,
but it doesn't matter to the guys who push
the bits around."
Landis' favorite bit-pushers are
semiconductor manufacturers whose
products -- sold in huge quantities and
reordered constantly "like razor blades" --
give smarts to the routers and switches of
corporate and public networks. Top
choices include PMC-Sierra, which
powers wide-area network equipment sold
by companies like Ascend (ASND) and
Nortel (NT); Level One Communications
(LEVL), which powers local-area
networks; and Vitesse (VTSS), which
powers the Internet "backbone." Other
favorites are TranSwitch (TXCC) and
Applied Microcircuits (AMCC).
H&Q Internet
Stocks
Check to see which
Internet stocks get a
bounce in price from
their H&Q
presentations.
Landis' advice to investors seeking to
make their way in the new world of
high-tech investing: "Identify the biggest
waves, then identify the strongest
swimmers -- and ignore everything else."
More from H&Q on Friday: New-age
ways to make losses look pretty . . .
brand-new buzzwords . . . a short chat
with venture capitalist Roger MacNamee .
. . the one truly ubiquitous piece of
software . . . the unveiling of my 10-stock
portfolio of top Internet plays for the rest of
1998 . . . and the sobering perspective of
a Milwaukee money manager who figures
he won't buy his first Internet stock until
sometime after 2000.
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