The Internet Cash–Rich? So?

What kind of money value would you put on online pharmacy Drugstore.com?
Since the company had $130 million in cash at the end of the year, you would
think it would be worth at least that much, right? Wrong. Drugstore.com’s
market cap is a measly $80 million. Why the discrepancy? “Investors believe
that Drugstore’s management will blow through the remaining cash and end up
closing operations,” says Aram Fuchs, CEO at Fertilemind.net, a New York
equity research firm. One key reason for his skepticism is that the Washington
based company, which lost $193 million on sales of $110 million last year, needs
a minimum of $450 million in sales just to break even.

It sure looks like there are barrels of free cash among Internet companies
these days. At least 50 dot-coms have market values that are less than the cash
they have in the bank, according to financial data for more than 400 companies
gathered by Standard & Poor’s and compiled by BusinessWeek. The marquee
names include e-tailer Egghead.com, grocer Webvan Group, and used car seller
Autobytel.com. In the cases of free Internet access provider NetZero and media
site NBC Internet, the difference is more than $100 million. In theory, an
acquirer could buy all the shares of one of these companies, shut it down, and
have millions of bucks left over.

But it’s not that simple. For starters, the cash levels were measured when
the accounting books closed for the last quarter, which typically means they’re
from December end. Many of the companies are burning cash so quickly that all
the excess could disappear by the time an acquisition is completed. “Just
because a company has more cash at hand than its market cap doesn’t make it a
good company,” says Michael Linnert, general partner at Silicon Valley
venture-capital firm Technology Crossover Ventures. In fact, it suggests the
opposite: that the market has given these companies up for dead. Most investors
believe that these outfits will never become profitable, let alone obtain
additional funding, says Steven Kaplan, professor of entrepreneurship at the
University of Chicago’s Graduate School of Business.

Consider the case of Webvan, the Net grocer that was valued as high as $11.4
billion two years ago because some people bet that it would become the delivery
service for the Internet. Then investors got nervous as the company started
eating through the piles of cash without any sign of profits. Now, the company’s
market cap is a mere $132 million, even though it had $212 million in cash on
its books at the end of December. Since it chewed through $55 million a month in
the fourth quarter of 2000, investors can only wonder if the company has enough
money to last through the summer. Robert Swan, Webvan’s chief operating
officer, admits the company does need to raise $40 million to $60 million in
capital over the next year to fund future operations until it has positive cash
flow.

Companies that have found their stock market valuations dropping below the
cash in their coffers are scrambling. The bravest are simply betting against the
market. Financial news site TheStreet.com, Internet software company NetManage,
and several others are buying back their shares to show their faith in the
long-term viability of their companies–and to boost the value of their stocks.
New York’s TheStreet.com is confident that its $72 million in cash will be
enough to take it to operating profitability by the end of this year. So it
plans to buy back up to $10 million of its stock over the next few months.

The strategy can be effective. Besides displaying confidence in its business,
a company that buys back stock helps shareholders financially. By reducing the
number of shares outstanding, earnings will be spread over fewer shares–and
higher earnings per share should boost the stock price. Since TheStreet.com
announced its buyback plan in December, its stock has increased from a low of
$1.69 to $3. NetManage also benefited from its December announcement that it
would buy back as many as 2.6 million shares. Its stock surged from 93 cents to
more than $2 in early January, before settling at $1.25.

Divine overhaul

Some of the cash-rich, market-cap-poor companies are taking the opposite
approach. Realizing their original business plans were failures, they’ve done
180-degree turns and overhauled their strategies. Divine interVentures, for
example, went public as an incubator and started up more than 50 companies. In
February, with its stock market value lower than the $190 million in cash on its
balance sheet, Divine announced plans to remake itself into a software company–CEO
Andrew Filipowski’s area of expertise. It even changed its name to Divine. The
moves have helped a little: The stock of the Chicago outfit has climbed from its
low of $1 a share to $1.69, although that’s still well off the $9 a share at
which the company went public last July.

In December, the California company, Ventro, closed two of its online
business-to-business marketplaces–the Chemdex market that allowed companies to
buy and sell chemicals on the Net and the Promedix market for medical supplies.
Ventro then said it would change its focus to helping other companies build
marketplace sites. So far, they haven’t convinced investors that its new plan
is any more viable than its last one. Its market capitalization is still only
$50 million, even though it has a treasure trove of $235 million on its balance
sheet.

Free Cash? It’s
Going Fast

Some
Internet companies may look like bargains because the entire company is
valued at less than the cash it has on its balance sheet. But don’t
expect a rash of takeovers. Many companies are burning cash so fast that
the excess probably won’t last long. Here are a few examples:

COMPANY

MARKET
CAPITALIZATION

CASH

DIFFERENCE
Ventro

50.4

235.1

184.7

NetZero

101.5

217.4

115.9

NBC
Internet

124

230

106

Onvia.com

57

159.1

102.1

MyPoints.com

44.9

129.2

84.3

Webvan
Group

132.5

211.8

79.3

Drugstore.com

80.4

129.8

49.4

Quokka
Sports

7.9

50

42.1

Autobytel.com

40.7

81.9

41.2

IVillage

38.1

48.9

10.8

(All
figures are in $ millions.)

Data: Standard & Poor’s

Then there are those companies that are sticking to their guns. They simply
think the stock market is unfairly punishing them and, if they perform well,
their stocks will recover. Consider Neupert at Drugstore.com. “We’ve made
a lot of changes in the last six months–laid off a substantial part of the
workforce, dramatically reduced marketing plans, and reconstructed the business
model to break even,” he says. That’s why he’s confident his business
will survive, even though its stock has dropped from $67.60 in 1999 to $1.31.

Autobytel is staying the course, too. The company, with $82 million in cash
and a $41 million market valuation, expects investors will become bullish once
it hits operating profitability in the third quarter. “We are well enough
established that we aren’t taking down marketing costs, nor are we
anticipating any large-scale layoffs,” says CEO Mark Lorimer. “After
all, we’re going to post profits in a few (months).”

Despite the risks, cash can be a powerful lure for potential acquirers. If a
purchase can be completed quickly, the leftover cash can help fund the
operations of the surviving company. The women’s site iVillage acquired
Women.com Networks for stock in February, partly to get its hands on its
one-time rival’s $30 million in cash. The two sites combined some operations
to reduce expenses and now should have plenty of money to make it to the third
quarter when the business is expected to begin generating cash. “The deal
that we cut with Women.com makes sure that we have enough dollars for a rainy
day,” says iVillage CEO Douglas McCormick.

There may yet be a handful of deals like McCormick’s in the wings. But it’s
a treacherous market these days and potential acquirers will have to weigh the
risks carefully–before moving licketysplit. The free cash is disappearing
fast.

By Pallavi Gogoi in BusinessWeek. Copyright 2001 by The McGraw-Hill Companies, Inc

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