AOL and Digital Courier
The Motley Fool - July 01, 1998 18:55
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July 1,
1998/FOOLWIRE/ -- Tuesday's deals with E*Trade Group, Waterhouse Securities,
and DLJDirect prove once again that America Online (NYSE: AOL) possesses
marketing muscle that demands a pretty penny. The three brokerage firms all
agreed to pay the online service $12.5 million a year for the next two years
to be featured on AOL's personal finance channel. That price is reportedly 3
to 4 times the previous average fee. Then again, with Cendant, Barnes &
Noble, and other firms already paying millions to reach AOL's 12 million
subscribers, and with AT&T (NYSE: T) reportedly interested in buying the
whole shebang if AOL CEO Steve Case would just say yes, America Online's
market leadership is hardly a secret.
So it's interesting to see the small fry that America Online has sometimes
partnered with. For instance, the company's landmark $100 million deal with
Tel-Save Holdings (Nasdaq: TALK) last year was part of what scuttled any
would-be marriage with AT&T. Yet that upstart long-distance provider has
proved a favorite of short-sellers who deem Tel-Save's CEO Daniel Borislow
unprofessional. Then there's Provident American Corp. (OTC: PAMC), a small
insurance provider that rose sharply after signing a multimillion dollar
deal this spring to market insurance to AOL subscribers. The stock then
plunged into penny stock land after being delisted from the Nasdaq national
market on June 12 due to failing to file its annual 10-K report. The company
blamed "the untimely and unexplained resignation" on December 22 of its
auditors Coopers & Lybrand.
The latest agreement to raise eyebrows came June 24 when AOL signed up
Digital Courier Technologies (Nasdaq: DCTI) to market VideosNow
(www.videosnow.com) through AOL and its Digital City service. Set to launch
in August, VideosNow is an online video store that will sell over 100,000
titles, including Hollywood releases, foreign films, and instructional
videos. Available in VHS, Beta, laserdisc, DVC, and Divx formats, titles
will be delivered by mail. Rumors of this pact had sent Digital's shares
soaring from around $4 in late May to $10 a share on June 23. Though the
stock didn't get much higher, it has held fairly steady, closing today at $8
3/4, down $5/8 yet still light years from its $2 trading price in February.
Under the terms of the three-year agreement, Digital Courier will pay
America Online at least $12 million and provide warrants to purchase up to
$2 million in Digital stock. AOL will also get 3% of revenues on sales over
$100 million and can increase its equity stake for additional carriage.
Digital booked an initial down payment of $1 million in the just-completed
June quarter, and the remaining $11 million will be paid in installments due
at nine month intervals.
However, some investors have doubted whether Digital has the financial
resources to handle this obligation. For the first nine months of FY97, the
March 10-Q shows that the company generated just $0.4 million in revenues,
most of which apparently came from the sale of a computer system to a firm
owned by a former director. It also lost $5.3 million from continuing
operations and reported just $6.9 million in cash as of March 31. Moreover,
the filing noted that "[m]anagement projects that there will not be
sufficient cash flows from operating activities during the next twelve
months to provide capital to implement its marketing strategy for WorldNow
Online."
More on WorldNow later, but this meant the company was short on working
capital even before committing to the new AOL agreement. Given that it has
the pick of the litter when it comes to partners, what was AOL thinking?
Company spokesperson Tom Ziemba said simply, "We wouldn't do a deal with a
company if we weren't confident that they were going to pay us."
In fact, Digital's recent filings don't offer an adequate picture of the
company. The roots of this public company go back to Exchequer I, Inc., a
firm incorporated in May 1985 that traded as a shell company on the OTC
Bulletin Board until January 1995 when it merged with a direct marketing
outfit called DataMark Systems. After this reverse acquisition, the new firm
was called DataMark Holding, Inc. The stock continued to trade on the
Bulletin Board until February 1997 when it moved to the Nasdaq national
market. Private placements of stock in May 1996 had pumped in $16.4 million,
with George Soros' Quantum fund and Dawson Samberg taking major stakes.
The drawing card was WorldNow (www.worldnow.com), a novel Internet network
built by linking websites from local TV affiliates to DataMark's national
WorldNow site in a channel format. The plan was for Digital to host websites
for the TV stations and provide some content and national ads while the
stations sold ads to local merchants and provided local content. In exchange
for a cut of the combined ad revenues, WorldNow would build a brand in part
by having the local television stations promote the WorldNow site on their
TV broadcasts. That is, WorldNow hoped to become a Yahoo! (Nasdaq: YHOO)
style Internet portal by first building a network of local sites like AOL's
Digital City.
WorldNow now has 45 TV affiliates and hopes to capture 60% to 70% of 211
local markets in the U.S. But the idea now is to build this platform into
something Digital can license to a Yahoo! or Excite (Nasdaq: XCIT), with
Digital serving as a kind of broker between the portal site and local
affiliates. This strategy, though, has only developed after Digital dumped
Sisna, an Internet service provider the firm bought in January '97 for
325,000 shares and sold back to its previous owner in March '98 for just
35,000 shares. It also follows the March '98 deal that sold off DataMark
Systems, the company's direct mail subsidiary and main revenue generator, to
Texas-based Focus Direct, Inc. for $7.7 million, $6.9 million of which is
already in the bank. As part of the deal, Digital paid former DataMark
Systems CEO Chad Evans $2 million for his 2.05 million shares of Digital
stock.
This maneuvering doesn't challenge the suspicion that Digital is a crappy
company whose stock has risen on hype related to the America Online deal.
The recent activity can only begin to be explained by the fact that the
public company now called Digital Courier is the product of a merger
announced March 18 between the public company previously known as DataMark
Holdings (old symbol, DTAM) and the private, San Francisco-based e-commerce
firm called Digital Courier International. The combined firm has changed its
name and stock symbol and is now run by R.J. Pittman, the former head of the
private Digital Courier. While R.J. is no relation to AOL's Bob, he was
co-founder of the successful online broker Lombard Securities, now Dean
Witters Discover's service. (Neither the new or old Digital Courier
Technologies has anything to do with Digital Courier International Corp., a
Canadian firm that's now in bankruptcy proceedings.)
In an interview today, Pittman said that the firm is concentrated on its
current content offerings, which include the weather information service
WeatherLabs (www.weatherlabs.com) from the private Digital, the online
retailer BooksNow (www.booksnow.com) and WorldNow network from the old
DataMark Holdings, and the new VideosNow. Pittman is a techie who thinks
Digital's technology platform and payment processing capabilities give the
company an edge. He said that the firm's development relationship with
Netscape (Nasdaq: NSCP), for example, allowed it to produce a WeatherLabs
offering for the relaunched Netcenter portal in just three days.
Pittman said that Digital's full back-office processing capabilities will
not only reduce costs in operating an online store such as VideosNow, but it
could give Digital a cost advantage versus credit card and other transaction
processing firms. One of Digital's long-range projects is to build a next
generation online brokerage system that could automate securities clearing.
Pittman said the firm has talked with Schwab, for example.
The first tasks, though, are to finalize the March merger agreement, raise
more cash, and sign more marketing partnerships with Internet portal sites
for VideosNow. The owners of the privately held Digital are supposed to get
up to 5.8 million shares of the new company. About 1.9 million shares have
already been doled out, but the earn-out portion is being restructured so
that any hit to reported earnings will come sooner rather than later. The
company is also looking to raise $6 to $8 million in private placements
before floating a secondary offering for 1.5 to 2 million shares,
potentially in early fall, assuming the stock is high enough for that to
generate $24 to $30 million. Though exact numbers are hard to pin down at
the moment, Pittman said there are perhaps 10 million shares currently
outstanding, but just one million being actively traded.
Roughly speaking, then, Digital has an enterprise value around $85 million,
currently unprofitable annual revenues of perhaps $2 million, and plans to
spend a lot of money marketing VideosNow. Although that combination doesn't
look immediately appealing, Pittman certainly strikes me as a far more legit
online contender than the old DataMark ever was. Why did he bother linking
up with the dubious DataMark in the first place? Pittman said that Art
Samberg of Dawson Samberg and Robert Soros of Quantum, both of whom
apparently like the company's new direction, asked him the same question. A
lot of the old Digital's technology was still at the R&D level, Pittman
explained. So going public by itself wasn't a real option. But he also said
that among other things, DataMark's tech facility in Salt Lake City
impressed him as state of the art, better even than operations run by the
leading portal companies.
A major benefit, though, has been a new link to Wall Street. Inheriting
well-known investors means Digital has new access to capital that it has
never had before. And e-commerce outfits need cash to build their brands and
to turn R&D into new product offerings. Whether the new Digital Courier can
turn this apparently forthcoming financial support into a profitable
business remains to be seen. But this is one case where a public company's
past may prove something less than a prologue. I'm still skeptical, but a
lot less so than before I talked to Pittman.
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