Is OnSale on Sale?
The Motley Fool - July 29, 1998 18:19
July 29,
1998/FOOLWIRE/ -- In the recent Internet frenzy, investors all but
ignored OnSale Inc. (Nasdaq: ONSL), a leading e-tailer that has blazed a
path in interactive auctions with its onsale.com and related websites.
True, the stock had already rocketed from its April 1997 IPO price of $6
to an October high of $35 1/4 (which it briefly surpassed this past
April). The roller-coaster ride since then has provided Net investors
with plenty of the requisite thrills and spills, as competitors such as
Egghead's (Nasdaq: EGGS) Surplus Auction and Creative Computers'
(Nasdaq: MALL) uBid entered the crowded field. But the stock has
basically been stuck in a trading range between the low $20s and the low
$30s, even as other e-tailers and portal sites have enjoyed triple-digit
gains. Yesterday's second quarter earnings report did little to
jumpstart the stock, which sank $2 1/2 to $24 1/8 today.
The news, however, was mostly good. Revenues leaped to $50.8 million, up
26% versus the $40.2 million reported in the first quarter and up 173%
from the year-ago period. Gross merchandise sales, which includes
transactions for which OnSale served as a commissioned agent, increased
to $58.6 million, up 16.5% from the first quarter. For the first six
months of FY98, the company has sold $89.5 million in merchandise, or
$108.8 million including commissioned transactions.
Despite the growth, however, OnSale continues to lose money. The loss
from operations was $4.8 million. After figuring in interest income from
its hefty $52 million in cash and short-term investments, the net loss
for the quarter was $4 million, or $0.21 a share. That was slightly
worse than the $0.20 mean estimate reported by Zacks. However, the
results included a one-time marketing expense of three cents per share
paid to Cendant (NYSE: CD) in connection with a joint venture. For the
year so far, the e-tailer has lost $8.2 million, or $0.44 per share.
Industry-wide weakness in PC sales during the quarter hurt OnSale, which
still derives nearly 80% of revenues from PC-related items. OnSale's
average sales price (ASP) also dropped to $185 from $206, in part
because of growing sales from its sports and recreation auctions, where
golfing equipment was hot but the overall ASP is lower. All of this cut
gross margins to a lower-than-expected 7.9% versus 8.5% in the first
quarter and 9.9% in the year-ago period.
CEO Jerry Kaplan said that the company chose to sacrifice margins to
grow its customer base by growing sales faster. OnSale now has 667,000
people registered to bid, up 25% in the quarter from the roughly
comparable 535,000 cumulative registered bidders reported at the end of
the March quarter, during which the number of bidders grew by 28%.
Repeat customers accounted for 77% of all orders, up from 74% in the
first quarter. Meanwhile, operating expenses as a percent of gross sales
fell to 16.1% from 16.7% in the first quarter despite rising marketing
expenses, which hit 8.2% of gross sales versus 7.9% of sales in the
first quarter and 5.4% for all of FY97.
A number of positive developments are embedded in these numbers,
including the fact that OnSale is enjoying operating leverage despite
spending heavily to grow its business and to control that growth. For
instance, part of those expenses went to installing new Oracle financial
software and beefing up the accounting staff following an embarrassing
gaffe in the first quarter that initially left $1.6 million in
unreconciled merchandise adjustments. New CFO John Labbett said that new
controls are largely in place and that some of the $0.8 million reserve
taken in the first quarter to account for the screw-up might be recouped
once an accounts payable audit is finalized.
OnSale is also looking to leverage its customer base and diversify its
product offerings by experimenting with several new opportunities. This
quarter it plans to launch an OnSale-branded travel and vacation site to
rent condos provided by Cendant's RCI, the world's largest
timeshare-exchange company. This partnership provides OnSale an
inventory of about 100,000 units per year as well as fixed margins with
little risk. OnSale also recently signed a deal with VerticalNet, a host
of business trade communities, to launch a business-to-business auction
site. Forrester Research recently suggested this sales niche could grow
to a staggering $52.6 billion by 2001. OnSale and VerticalNet will each
take a chunk of the listing fees and the commissions.
OnSale has also formed a partnership with Softbank to launch OnSale
Japan. Given Softbank's huge investments of late in Yahoo! (Nasdaq:
YHOO) and E*Trade (Nasdaq: EGRP), this deal suggests that OnSale likely
has a deep-pocketed backer should it need one. Yet, the recent results
suggest it may not need one.
While numerous e-tailers have spent heavily to lock down exclusive
marketing deals with America Online (NYSE: AOL) and other Web portal
sites, OnSale has largely bet that its first-mover status will allow it
to keep marketing costs low compared to other e-tailers. Indeed, looking
at second quarter results, one sees that the firm spent just over $36 to
acquire each new customer during the period. By comparison, the better
known Amazon.com (Nasdaq: AMZN) spent about $30 whereas CD sellers N2K
(Nasdaq: NTKI) and CDNow (Nasdaq: CDNW) spent roughly $82 and $67,
respectively.
Kaplan thinks that just as the search engines turned themselves into
portals partly to avoid paying rich fees to Netscape (Nasdaq: NSCP) to
gather traffic, e-commerce companies must become destinations in their
own right or be buried by marketing expenses. His view is that in highly
competitive areas, locking down exclusive marketing deals with the
portals simply isn't cost-effective.
On that score, OnSale seems ahead of the game. Of the two million unique
visitors that its sites see every month, only one-sixth are coming from
the portals. OnSale has become a distinct destination for shoppers, who
bookmark the site. That means that ad spending can remain relatively
controlled. It also means that the company can expect to see growing
high-margin ad revenues. OnSale recently added a VP of ad sales, and
Visa has signed on as a major customer.
OnSale's name-recognition among shoppers and its growing reputation
among manufacturers is also allowing it to readjust its business model
in other crucial ways. A year ago, the company moved to increase the
amount of products it purchased under the theory that this would ensure
ample supplies from hesitant vendors, enhance the customer experience by
giving OnSale greater control over shipping, and lead to higher gross
margins.
Since then, gross margins have actually slipped, hardly a surprise given
the firm's dependence on rapidly depreciating PCs. In the meantime,
suppliers have become more interested in dealing with OnSale, even on a
fixed commission basis. Also, OnSale is now working with higher quality
manufacturers who are more interested in customer service. Thus all the
reasons for adopting the purchase model have disappeared. At the same
time, OnSale has new opportunities to sell services or to garner fixed
commissions on product sales. The transition from the high-risk,
high-cost purchase model has only just begun, but one can see progress
in the fact that inventories fell 9% from the first quarter even as
gross sales rose 16.5%.
OnSale isn't expected to turn profitable until the end of FY99, when the
company should earn, according to current guesstimates, about $0.09 per
share. Some analysts see earnings rising to $0.90 per share by 2001. So
the stock still looks expensive on a near-term earnings basis. Still,
there's lots to like about the progress OnSale is making experimenting
with new offerings and improving its business model. While competition
is heating up in the online auction business, the market may be
underestimating OnSale's competitive strengths at this point.
-- by Louis Corrigan |
