The Day Ahead: Priceline shareholders suffer

Commentary: Priceline.com seemed to have an accounting stroke of genius on its hands with its WebHouse affiliate. Priceline shareholders were supposed to be sheltered from downside risk from the venture, but could reap the benefits on the upside. It didn't work and shareholders still got whacked.

You could call the WebHouse debacle a clash between accounting reality and Wall Street's perception of Priceline.

On Thursday, Priceline said its WebHouse and Perfect Yardsale affiliates were closing down. The news sent Priceline shares plummeting 38 percent, the second plunge in a week.

It wasn't supposed to be this way. As Priceline was quick to point out in its press releases, the company wasn't harmed by WebHouse because technically it wasn't a part of Priceline. The affiliates merely licensed the business model, Priceline said.

Never mind that radio commercials made WebHouse sound like it was part of Priceline. Never mind that Priceline and WebHouse founder Jay Walker sold Priceline shares to private investors to help fund WebHouse. And never mind that Priceline will take a revenue hit and a $189m non-cash loss and will lose a few users because of WebHouse's demise. In accounting terms, WebHouse and Perfect Yardsale were separate, privately held firms.

The idea behind the setup was this: WebHouse was set up as an independent entity so Priceline shareholders would be insulated. If and when WebHouse took off, it would be folded into Priceline and shareholders would benefit from an IPO or spinoff. Some analysts questioned whether Priceline's move was right, considering WebHouse walked like Priceline and talked like Priceline, but on an accounting basis the venture was separated.

Chief financial officer Heidi Miller tackled the issue at an investor conference this summer and sang the best of both worlds theme when it came to WebHouse. Miller said WebHouse was kept as a separate entity so it wouldn't hurt Priceline's march to profitability or shareholders.

Technically, Priceline succeeded. The closing of WebHouse will have a "modest" effect on Priceline's financial results, said Robertson Stephens analyst Lauren Cooks Levitan. "Priceline created a structure to shelter shareholders from the huge startup costs and risks," she said.

Many analysts agreed that Priceline's accounting treatment of WebHouse saved investors from really being shellacked. Priceline will take a non-cash loss on WebHouse warrants in the third quarter. If you're familiar with Priceline's financials, you're used to non-cash charges (the company has issued tons of warrants).

Based on the snazzy accounting, you'd think shareholders would be sending Priceline a thank you note. Simply put, if WebHouse was a wholly owned division of Priceline, the carnage would have been even worse.

But the WebHouse collapse gave Priceline a black eye at the worst possible time. Last week, Priceline issued a revenue warning, citing a slowdown in airline ticket sales. That warning led many analysts to question Priceline's business model.

WebHouse represented Priceline's ability to expand into new markets. The way Priceline shares reacted, the company could have been funding WebHouse, which burned through a whopping $369m.

"Priceline served its purpose by insulating shareholders, but I was surprised by how much Priceline was actually liable," said Faye Landes, an analyst at Bernstein. "WebHouse still raises the question about how Priceline will monetise its brand."

Levitan said the WebHouse closing just added the next level of scrutiny for Priceline. Investors were buying into the Priceline story for two reasons. They believed in the Priceline core business and reckoned the company could extend into new markets. Now both of those things are in question.

A Priceline spokesman said that the problems at WebHouse Club and Yardsale had more to do with the current capital market than the Priceline business model.

On most counts, WebHouse was a consumer hit. Through 30 June, WebHouse had more than 750,000 households using the service.

And through an August deal with Liberty Media and Paul Allen's Vulcan Ventures, WebHouse received $125m in a third round of funding.

WebHouse, however, did not have enough cash to "complete its business plan and achieve profitability", and it was unlikely that it would be able to raise the money needed in the next year.

That statement is a mouthful for a company that had three rounds of funding. Investors decided to bail. "Part of being an investor is knowing when to cut your losses," said Levitan.

Priceline couldn't secure discounts for groceries and gas like it could for airline tickets, a market where it takes excess inventory and briefly owns the tickets. WebHouse depended on companies to cooperate with discounts, but they didn't. Priceline subsidised too many WebHouse sales.

The dot-com collapse also didn't help matters. This time a year ago -- a time where losses didn't matter -- Priceline would have funded WebHouse's operations via an IPO.

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