Based on this TSC column, yahoo could get whooped (not that I'd bet on it):
thestreet.com
Ziff-Davis Faces Possible Defaults on Heels of Recent IPO
By Christopher Byron
Special to TheStreet.com
1/8/99 3:38 PM ET
Eventually, it comes time to say enough's enough -- as in, enough of this baloney about the
Internet already. Enough with the "new paradigm" talk and the malarkey about the profits that
don't matter. In the end, business profits are the only thing that matters. They're the numeral
"one," after which comes all the "zeroes" of business success -- the market-share growth
numbers, the new product introductions, the stock options, the whole ball of wax. Without a
profitable business, all the other triumphs add up to nothing.
Those thoughts come to mind in light of two (allegedly) cutting-edge media companies that
are much in the news these days. One is Yahoo! (YHOO:Nasdaq), the Internet search-engine
outfit, which at the moment appears to be one of the few Internet-based operations that is
actually making a profit. The other is Ziff-Davis (ZD:NYSE), the magazine-publishing and
trade-show outfit, which is bleeding losses out of every pore and is desperately trying to raise
cash by way of a pseudo-spinoff of its Internet operations via a so-called "tracking stock" initial
public offering.
In fact, these two companies have more -- much more -- to do with each other than most
investors seem to realize. Like a latter-day version of Mike Milken's old junk-bond carousel
from back in the 1980s, these two companies are, in effect, joined financially at the
breastbones. The difference this time is that instead of junk bonds, we're talking junk equity,
and instead of Drexel Burnham Lambert directing the performance, we find the white-shoe
firm of Morgan Stanley Dean Witter standing at the podium, holding the baton.
The situation is simply stated: Ziff-Davis is in trouble, and its stock is yo-yoing, whereas Yahoo!
is thought to be healthy and its stock is soaring. But behind those two sets of contrasting facts
is a hidden process that explains -- and links -- them both: Ziff-Davis is dying so that Yahoo!
might live.
The story begins with Ziff's April 1998 IPO. As part of a cashout by Ziff's owner -- Softbank
Corporation of Japan -- the IPO's underwriters at Morgan Stanley loaded Ziff down with more
than $1.5 billion in debt, then handed the proceeds over to Softbank, thereby reducing
Softbank's credit exposure to the company to zero. At the time, we took one look at the asset
shuffle and predicted the company would soon be flat on its keester.
So let us now turn to Softbank, which has stakes in all sorts of Internet companies, and ask
what exactly it did with the money. As it happens, Softbank turns out to be the largest single
shareholder of Yahoo!, with 30% of its stock to its name. Thus, in July, Softbank peeled off
$250 million of its wad from the Ziff IPO cashout and bought roughly 2.7 million additional
Yahoo! shares directly from the company, at the split-adjusted price of 91 11/16 per share. At
about the same time, Softbank peeled off another $400 million and bought close to 16 million
shares of E*Trade Group (EGRP:Nasdaq), the Internet brokerage firm.
And what precisely did E*Trade do with the $400 million? Well, according to its most recent
financial filing, for the fiscal year that ended Sept. 30, no sooner did E*Trade get the money
than it signed an "extensive advertising, sponsorship and promotional program" on the Yahoo!
Web site.
If we next follow the money (as they used to say in Watergate) from E*Trade to Yahoo! and
take a canter through that company's latest financial filings, want to guess what we find?
Buried deep in the back of the filing, where (presumably) no one would notice, we find a
Yahoo! confession that during the July-September 1998 period, advertising revenue from
"Softbank ... and its related companies" leaped from 4% of Net revenue to 8%. In other words,
folks, more than one-third of Yahoo!'s total sequential revenue growth during the period came
directly from Softbank-financed advertising -- which is to say, via money that had been leeched
from Ziff's balance sheet by the Morgan Stanley IPO, then funneled by Softbank into the
revenue coffers of Yahoo!.
So what, you say? Well, here's so what: For the July-September period, the 24 financial
geniuses on Wall Street who follow Yahoo! had been collectively forecasting, on average,
earnings of 10 cents per share. But Yahoo! wound up "beating" the forecast by a stunning
50%, reporting 15 cents per share in earnings. The difference -- $5.2 million -- is not much
more than the $4.3 million in ad revenue taken in during the period via Softbank. Since the
gross profit on ad revenue at Yahoo! runs to about 90% and all the other business costs are
pretty much fixed whether the ads come in or not, we may say with some confidence that, were
it not for the Softbank revenue, Yahoo!'s actual third-quarter earnings would have been only 11
cents per share and not 15. The company would have beaten the Street's estimate by a mere
penny per share.
That hyped-up trouncing of the Street's consensus forecast, announced on Oct. 7, launched
Yahoo!'s stock on its most explosive price surge ever, from 104 per share to more than 320
per share just three months later. In fact, of course, nearly 100% of the run-up was fueled by
the most egregious sort of related-party transaction: Ad revenue supplied by a 30%
shareholder of the company.
And what of Ziff, the debt-bloated carcass that provided the cash? Eight months after going
public, the company is a total basket case. In spite of the spring 1998 IPO, the company has
no working capital, and its revenue is slipping -- down 2.6% since the start of the year to $731
million compared with the comparable 1997 period. Even on an operating basis, the company
loses money (another $14.8 million in the most recent July-September period) -- and that's
even before you throw in the interest on the debt. Add that to the picture, and the company's
losses will almost assuredly top $100 million for the whole of 1998.
The big problem is, of course, the debt. More than $1.5 billion of it now sits on the balance
sheet, devouring nearly $150 million in interest payments every 12 months. That's more in
interest payments than the company will even earn in 1998 to make those payments. This is
so-called EBITDA (earnings before interest, taxes, depreciation and amortization) -- Wall
Street's ultimate low-bar financial hurdle for crippled businesses. It was also the Street's
principal selling point for promoting the deal: There'd be enough EBITDA to meet the debt.
Well, there wasn't, which is why the company's latest quarterly financial filing discloses that the
company expected, as of Dec. 31, 1998, to be in violation of its loan covenants and is thus
frantically trying to renegotiate the terms.
I mean, holy smokes, folks, it was only last April when the company went public! Now it's
looking at the prospect of loan defaults? That fact alone is an amazing commentary on
underwriters like the Morgan Stanley bunch -- one of the most puffed-chested, snootily
self-important firms in the business. After all, here they were willing to take this thing to market
at 15 1/2 per share, walking off with the lion's share of maybe $20 million in fees for their
efforts -- which efforts basically boiled down to sticking their own clients with a
debt-mummified horror story that had virtually no chance of making a go of it.
We wrote on the eve of the offering last spring that, "at the present rate of loss, the combined
operation looks likely to reach balance-sheet insolvency by the end of next year." But, hey, what
did we know? The company beat our estimate by a year!
So let us now turn to the earlier-mentioned "tracking stock" IPO (I personally prefer the term
"bailout IPO"), by which the company hopes somehow to escape from its quagmire. As the
Dec. 22 registration statement says, the idea is to use the proceeds from the offering to pay
down as much of Ziff's debt as possible. But how much does the company think it will actually
manage to raise? After all, this business -- to be called ZDNet -- looks exactly like the one it is
being carved out of, only worse: $37.5 million in revenue for the nine months ended Sept. 30,
$8.3 million in operating losses, $7.7 million in net losses and even $3.1 million in EBITDA
losses.
What moron is going to pay anything for that? Don't forget, these are numbers from the actual
IPO registration statement, in which the underwriters (in this deal, it's Goldman Sachs in the
lead) try to make the thing look as prettified as possible. Prettified? This deal has welts and
lesions all over it! In fact, it's not even a real IPO at all, but a "tracking stock" offering. These are
some of the biggest Wall Street con jobs going.
Tracking stocks are created by issuing a class of stock that represents an equity interest in the
whole corporation as shown on the company's balance sheet, but is somehow intended to
"track" the performance of a particular corporate operation -- in this case, Ziff's Internet Web
site. The company hopes to trick investors into thinking this by issuing separate financial
statements for the two operations, but in reality they're one and the same thing. With a tracking
stock, you're supposed to think you have a stake in that segment or division alone, but you
actually own a share in the whole corporation.
As a result, the performance of tracking stocks stinks -- mainly because they never get out from
under the cloud of the companies that issued them in the first place ... troubled companies that
need to raise cash but can't get anyone to buy their stock, so they put a false nose and
mustache on the deal by calling the offering stock a whole new company when it isn't. In
February 1997, Circuit City Stores (CC:NYSE), the troubled electronics retailer, spun off (sort
of) its used-car business through a tracking stock, Carmax (KMX:NYSE) at 20 per share.
Those shares are now selling for about 5 1/2.
So, to ask again what jerk would buy a tracking stock issued by a troubled company, I can
certainly tell you what jerks the underwriters are hoping will buy it. The seemingly infinite
multitudes of jerks who stand ready to buy anything involving the Internet, that's who. The same
jerks who chased theglobe.com (TGLO:Nasdaq) from 9 to 97 1/2 in 15 minutes back in
November and are now sitting with a 33 stock that is assuredly worth nothing at all.
The same jerks who chased a fish-oil company Zapata (ZAP:NYSE) from 7 to 14 in a single
day back before Christmas because the company put out a press release saying it would be
opening a Web site.
The same jerks who chased a bulletin-board stock named PinkMonkey.com (PMKY:OTC BB)
from 1 to 17 back around Thanksgiving and are now holding shares worth, more or less, 4
3/16.
The same jerks who ... oh, nuts to it, you know who they are. The same jerks Wall Street firms
like Morgan and Goldman have been preying on since this Internet-stock baloney got going.
Christopher Byron's column appears in the New York Observer, and he also writes a Wall
Street and investing column for Playboy. He is the former assistant managing editor for
Forbes, the Wall Street correspondent for Time and the Bottom Line columnist for New York.
Byron holds no positions in any of the stocks discussed in his column. |
