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e-Commerce Meltdown

By Richard McCaffery (TMF Gibson)
July 18, 2000

On December 29, Value America (Nasdaq: VUSA) based in Charlottesville, Virginia said it wouldn't meet fourth quarter revenue estimates. It announced plans to lay off almost 50% of its workforce and restructure the company.

Six months later, it's firmly entrenched in the penny-stock water closet, closing recently at a buck and change. This is a far cry from where the e-tailer started out early last year. Investor enthusiasm over the e-commerce craze pushed the company's shares above $55 after an April 8 initial public offering. Proponents said Value America would do for electronics and other consumer products what Amazon.com (Nasdaq: AMZN) did for books. Well, not quite.

The Value America trickle became a flood as other high-flying e-commerce players saw their market values tumble. Here's a very short list of company's tossed around in the business-to-consumer e-commerce rapids: Peapod (Nasdaq: PPOD), drkoop.com (Nasdaq: KOOP), Pets.com (Nasdaq: IPET), Bluefly (Nasdaq: BFLY), and iTurf (Nasdaq: TURF).

What happened? One argument says the capital markets dried up and cash-starved companies were left to wither on the vine. Since very few were profitable, most relied heavily on venture capital and public equity financing.

But, the capital markets were just a symptom of the problem. At root, many of these companies went public long before they should have, with untested business models and highly uncertain futures. It suddenly became clear that successful businesses are built on more than bright ideas.

As one Fool analyst recently wrote: "Amazon may succeed or fail, but neither event will happen because investors are being optimistic or cautious. It will happen because the company has the opportunity and ability to create profits from the 14-million customer base it has aggregated."

Companies are valued on the amount of excess cash they can generate from operations. That cash is discounted at an appropriate rate, and voila, you have the stock price. The key phrase here is "excess cash." No profits, no long-term value for investors. The bottom line is this: Companies should be profitable, or show a clear path towards getting there before most investors should even think about getting involved.

Value America, for example, didn't hit the skids because it lost a popularity contest. Its plan to sell consumer and business products at narrow or negative margins to boost volume and brand awareness backfired. While a handful of low-margin retailers like Wal-Mart (NYSE: WMT) and Costco (Nasdaq: COST) turned low-margin strategies into great investments through excellent asset management, they are very tough acts to follow. That kind of operational efficiency isn't created overnight.

Amazon.com, over its short lifetime, has generated fairly impressive cash flow for a fast-growing, start-up company. At the same time, it's been nimble enough to expand its product base, driving new customers to the site. This doesn't happen willy nilly. The Seattle-based company has some of the top talent in the retail industry pulling the strings, such as a couple of logistics pros from Wal-Mart.

The meltdown is a great lesson for investors, since it's so easy to be swept away by the lure of new business models and emerging markets. How do you separate the new-world companies like Amazon.com (which at least has a shot at long-term success) from the coal heap?

There's no sure-fire method, but Fool writer Bill Mann suggested a few measures in this Fool on the Hill column. Try comparing gross profits to sales and marketing expenses, just to get a feel for where profits stand relative to what it takes to generate them. Also compare what it costs to acquire each company relative to the sales each customer generates.

The main point for investors isn't really whether these are the precise screens to use to predict profitability. Investors are clearly on dicey ground analyzing these companies. But, exercises like these get investors thinking about a company's business model, growth rates, and spending habits. That's what it takes to become a good investor, the ability to run companies through the works and think critically about their operations. The more time you take to turn a company around in your head before you buy it, the better.

Microstrategy's Bungle »


Related Links:
  • Are There Any Safe 'Net Stocks Left?
  • Valuation Metrics For Unprofitable Companies

    Other Midyear Stories:
  • The Biotech Rollercoaster
  • AOL Betting on Time Warner
  • e-Commerce Meltdown
  • MicroStrategy's Big Time Bungle
  • Antitrust Action - Microsoft & Beyond
  • SEC Moving Towards Open Dislosure
  • Interest Rate Increases Cool Economy
  • Feds Take a Bite out of Fraud


     

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     Midyear 2000
  • Introduction
  • Biotech Rollercoaster
  • AOL & Time Warner
  • e-Commerce Meltdown
  • MicroStrategy's Bungle
  • Antitrust Action
  • Open Dislosure
  • Interest Rates
  • Feds Fighting Fraud

  • Midyear Winners
  • Midyear Losers
  • Moves to Remember
  • Moves To Forget
  • Buzzwords Debunked
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