Last week, InnerWorkings (NASDAQ:INWK), creator of a technology system for print runs, printed some cash on Wall Street with its IPO. Morgan Stanley (NYSE:MS) was the lead underwriter, and the offering raised about $95.3 million, of which $58.9 million went into the company's coffers. On its first day of trading, the stock surged 16%. But while InnerWorkings has a unique technology offering, the company will find it difficult to scale profitability.
The good news is that the top line has been on a tear. From 2003 to 2005, revenues surged from $16.2 million to $76.8 million. As of the first half of 2006, they came in at $57.6 million, up from $31.1 million last year.
However, cost of goods sold (COGS) is nearly 80% of revenues - which makes it difficult to post a strong bottom line. For example, net income was a mere $2.6 million this year.
To understand why, let's take a look at the inner workings of InnerWorkings' business model. The company has developed a sophisticated database platform that allows customers such as John Deere, Circuit City (NYSE:CC), and Vonage (NYSE:VG) to place bids on print projects like direct mail, brochures, books, packaging, and catalogues. The bids are then routed to a network of more than 2,700 print suppliers. The company makes its money by pocketing the difference between the purchase price from its customer bids and the overall cost from the print suppliers.
InnerWorkings' key competitive advantage is its technology, including "4caster" (real-time cost estimates based on historical data), personalized data-entry screens based on product type, and alerts if milestones are not being met. With each new print job, the company is collecting more information for its database, making its system more valuable.
Electronic platforms can be quite powerful, as seen with another recent IPO, Loopnet (NASDAQ:LOOP), whose website is a marketplace to buy and sell commercial real estate. Like eBay (NASDAQ:EBAY), there is a "network effect" in which the marketplace gets more valuable as more buyers and sellers come into the system. So far this year, Loopnet has posted gross profit margins of about 88% and net profit margins of 29%.
Unfortunately, InnerWorkings' inherent problem is its need to generate significant amounts of revenues to produce decent profitability. The company must also deal with entrenched competitors like Banta, Quad/Graphics, Quebecor, and R.R. Donnelley (NYSE:RRD), which will fight hard to keep market share. If you're looking for an electronic marketplace IPO to take a flier on, Loopnet looks like a better option.
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Fool contributor Tom Taulli does not own shares of any company mentioned in this article.
