FOOL PLATE SPECIAL
An Investment Opinion

Value America Not Living Up to Its Name

By Brian Graney (TMF Panic)
December 29, 1999

Online retailer Value America (Nasdaq: VUSA) destroyed some of its market value today after announcing a restructuring and warning that Q4 revenues will fall 6% to 9% short of analysts' current expectations. The news dropped the company's share price, which now trades at a fraction of its post-IPO glory of earlier this year.

"We are building on Value America's proven strengths and are discarding what doesn't perform,'' said Value America CEO Glenda Dorchak. Judging by the details of the restructuring, Dorchak's comment suggests that a sizable chunk of the company is not performing. Some 47% of the company's workforce is being discarded under the plan and facilities are also being consolidated. That might sound like a big cost-cutting shake-up, but the company only operated a total of 45,000 square feet in seven office buildings and employed 227 full-time employess as of Jan. 1. It's hard to imagine that there is really that much fat to trim.

Still, the company believes the restructuring will "streamline Value America's operations, improve product fulfillment performance and dramatically improve customer service, which will drive additional revenue, reduced expenses and higher gross margins." Exactly how a company improves customer service and fulfillment by laying off half of its workers is beyond the business comprehension of this writer, but then again Value America hasn't been one to do things by the book.

The basis of the company's business model was to embrace the successful, late 20th century American retailing model of low margins coupled with savvy asset management and take the whole thing to the Web. Unfortunately, Value America's founders bear-hugged the model a bit too hard and squeezed out any potential of future profits. By the firm's own admission, the official short-term game plan entailed selling all types of consumer and business products -- but mostly electronics -- at narrow or even negative margins in order to boost volume and brand awareness. Given today's revenue shortfall warning, it appears the margin hara-kiri experiment has backfired in a big way.

A vaunted "inventory-less" asset management structure was supposed to bail Value America out in the end, but that hasn't exactly happened either. Surprisingly, the company still feels that going sans inventory is a "competitive advantage" somehow.

Sure, Costco (NYSE: COST), Wal-Mart (NYSE: WMT), and Home Depot (NYSE: HD) became huge retailing value creators partly by zeroing in on asset management and turning inventories faster than Robbie Alomar can turn a double-play. But then again, those companies also understood that revenue growth without corresponding asset growth is an accounting non sequitur. Carrying $2.7 billion in inventories on the books, as Costco currently does, is not that worrisome when the company knows that it can keep operating expenses low and turn its inventory faster than practically any other retailer out there.

Further, Costco also recognizes that margins cannot be cut entirely to the bone. Costco's gross margin is a low 12%, but that's still twice Value America's 6% gross margin in its most recent quarter. Wal-Mart and Home Depot's gross margins are an even higher at 23% and 29%, respectively.

Craig Winn and Rex Scatena, Value America's co-founders and the braintrust behind the unconventional inventory-less, low-margin model, have both been shown the door. With its stock underwater and 73% below April's IPO price of $23 per share, financing the company by selling more shares is out of the question. Value America will need to think of a new way to jumpstart its business soon or risk making an even more unconventional business move for an Internet company -- such as filing for bankruptcy.

Related links:
Fool on the Hill, "Shopping Costco, Part 1," 09/08/98
Fool on the Hill, "Shopping Costco, Part 2," 09/11/98