This is close to home:
Wall Street Whistleblower: CDnow's Planned
Stock Offering May Hit a Sour Note with
Investors
By Gregg Wirth
Staff Reporter
5/15/98 5:06 PM ET
CDnow (CDNW:Nasdaq) isn't going to win any awards for timing.
Just as the online retailer's stock and a slew of others are coming down
from Internet-related highs in April, CDnow may accelerate its slide by
belting out a secondary offering.
After enjoying strong performance early in the year, CDnow has
skidded along with some other Internet stocks. CDnow is down about
40% from a high of 39 last month to a close of 23 3/8 on Friday. The
news of more shares coming to market is also coinciding with another
troubling fact: The shares are getting awful close to their first trade
price of 22. CDnow's IPO was priced at 16 in February.
Shareholders of the Jenkintown, Pa.-based Internet retailer of compact
discs have lauded the company's plan to become to music what
Amazon.com (AMZN:Nasdaq) is to books. But cheers may diminish
once the secondary offering comes into focus. The secondary will dilute
the current public float about 60%.
In a May 11 filing with the Securities and Exchange Commission,
CDnow said it plans to raise about $70 million by selling 2.5 million
shares. The underwriters for the offering are BT Alex. Brown,
NationsBanc Montgomery and Hambrecht & Quist. A member of
BT's equity syndicate said the deal is likely to go out in early June,
following a roadshow -- in case any investors have forgotten the
company's story in the last 12 weeks.
"I don't know why they are doing this secondary now," says Paul Cook,
portfolio manager for Munder Capital's Net Net fund, which
specializes in Internet stocks. (The fund currently doesn't hold any
CDnow stock.) At a time when the stock is continuing to sputter, another
output of shares could only exacerbate problems, Cook notes.
Even followers of the stock's fundamentals and story aren't completely
sold on an offering at this time. "Rarely do you see a secondary offering
on a stock down nearly 50% from its recent high," wrote one poster
called "gsb99" in an Internet chat room devoted to the stock. "This is a
clear indication that management still feels the stock is at a high --
otherwise they'd wait for the 30s to sell more shares."
Shareholders curious for answers won't find many in the company's
prospectus on the deal. In the filing, CDnow admits it still has almost all
the cash proceeds on hand from the IPO, about $60.5 million, as of
March 31. The company also concedes it "has not designated any
specific use for a significant portion" of either the existing cash or the
proceeds from the proposed offering. The successful completion of the
secondary offering could give the company about $130 million in idle
cash reserves. (CDnow does plan to spend around $19 million for linking
alliance agreements, $17 million for advertising and promotion, and $4.5
million for a Web site upgrade, according to the prospectus.)
Shorts Take Notice
Joel Sussman, CDnow's chief financial officer, defends the company's
planned offering, saying the deal is weeks away and the stock price is
likely to fluctuate prior to pricing. "You don't try to raise funds right when
you need them," Sussman said, adding the secondary has been in the
planning stages for a while.
The company is followed by only two analysts: Steven Horen at
NationsBanc Montgomery, who declined comment, citing his firm's role in
the secondary offering; and Christopher Feiss, at BT Alex. Brown, who
did not return phone calls. Both have a buy recommendation on the
stock.
CDnow is tightly controlled, with almost 70% inside ownership. The
secondary offering will drop that to around 55%. At the conclusion of
the offering, founding brothers Jason and Matthew Olim will each
own a 16% stake; Alan Meltzer, a director, will own 11.2%; and
Grotech Partners, a venture capital firm, will hold 12.5%, according to
the filing. Following the offering, there will be around 18.5 million shares
outstanding, with about 8.3 million, roughly 44%, in public hands.
None of the inside holders are selling shares in the secondary, although
the restriction period on the IPO shares was lifted earlier this month.
Indeed, according to the prospectus, some insiders have signed
agreements that they will not sell their shares until some time after the
secondary. In addition, the company filed a separate registration
statement last month to cover up to another 1.6 million shares under an
equity compensation plan for certain employees.
The fact that no insider is selling shares is "considered a positive,"
Sussman explained. "It shows a great confidence in the company."
While that's true, a cynic could point out that while insiders have no
problem issuing new shares at $23, they are reluctant to sell their own
shares at that price.
CDnow sells music CDs via its Web site, and it regards itself as the
leader in online music sales, boasting a catalog of 250,000 products,
according to the filing. The company has sought name recognition
through alliances with a number of well-known Net names, including
Yahoo! (YHOO:Nasdaq), Excite (XCIT:Nasdaq) and Lycos
(LCOS:Nasdaq).
However, the online music retail sector is about to become much more
crowded. Amazon.com recently began adding CDs to its arsenal for
online consumers, and Borders Group (BGP:NYSE) is looking to elbow
into the sector, too. Both companies have deep experience in squeezing
out the little guy.
The other companies usually named as CDnow's two closest rivals,
K-tel (KTEL:Nasdaq) and N2K (NTKI:Nasdaq), also are ticking down
after the Internet-fueled run-up. Both retailers took the opportunity to
increase liquidity at the height of the Internet run-up: K-tel elected to do a
2-for-1 stock split; N2K chose to do a secondary offering. N2K now is
being sued by new shareholders who don't like the 30% nosedive the
stock has taken since the offering.
In addition, short-sellers likely are loving CDnow's secondary offering
and its potential to further hammer the stock. Short activity in CDnow
has almost doubled in the last month, from around 177,150 shares at the
end of March to almost 332,470 shares at the end of April -- roughly
equivalent to about one day's worth of average trading volume.
Even though the company's sales revenue is increasing, losses are
galloping ahead at an even faster rate. Last year, CDnow's net sales
almost tripled, reaching $17.4 million, compared with $6.3 million for
1996. However, losses increased sixfold, to $10.7 million last year, up
from $1.8 million in 1996.
For the first quarter, ended March 31, the company posted a net loss
equal to almost all its red ink of last year, $9.2 million, or roughly a loss of
78 cents per share. For the first quarter of 1997, by comparison, the
company lost $544,000, or 7 cents per share. Revenue continued to
increase, however, reaching $10 million compared with $2.6 million for
the first quarter of last year.
Still, if you are going to lose $9 in earnings for every $10 in sales,
perhaps investors better hope CDnow doesn't become too popular. In
the offering prospectus, the company cited its possible inability to
manage potential growth and its cost-of-sales problem as two main risk
factors in investing in the company. |
