The Day Ahead: Buy.com soon to become Sell.com

Buy.com will soon carry the banner of e-tailing into the IPO market, but think twice: The company has a terrible habit of selling goods for less than what it paid for them
Written by Larry Dignan, Contributor

And that's no way to make money.

Buy.com, however, has become one of the largest e-commerce sites on the Web in terms of revenue and users. The company, which plans to go public in early February, runs a network of online stores that peddle everything from computer hardware and software to books, music and video to golf and travel.

The company has 1.9 million customers, 4.7 unique visitors a month and stellar sales growth. For the three months ending December 31, Buy.com had sales of $200.6m (£124.37m). For 1999, Buy.com reported pro forma sales of $597.8m.

Sounds great until you get to profit margins: Buy.com's gross margins improved from being very pitiful to just really pitiful. For the last three months of the year, margins improved to a negative 0.9 percent from a negative 1.4 percent for the same period in 1998. For 1999, the company lost $145.8m.

"They have a strong brand," says Randall Roth, an analyst with Renaissance Capital. "But the margins are either going to be their genius or their downfall."

The theory behind Buy.com goes like this: Undercut the world on price, grow brand and potentially make up the margin difference with advertising. It hasn't worked so far because Buy.com only received about 2 percent of its sales from advertising, according to regulatory filings. To improve margins, the company said it has moved to raise prices on certain goods, but offers no guarantees for overall advances in this area.

Nevertheless, Buy.com's advertising campaign and sales growth could attract a few investors. The company is hoping to raise a little more than $141 million by offering 14 million shares priced between $10 and $12 each. Merrill Lynch is the lead underwriter.

Buy.com said $20m to $30m of the funds will be used for technology and fulfillment upgrades, $70m to $90m will go to sales and marketing, $12.5m will repay debt and the remainder will be for working capital.

Here are some risks to ponder with Buy.com:

  • Margins: For the year ending December 31, Buy.com reported revenue of $596.8 m, but the cost of goods sold was $603.7m. That can't last forever.
  • Dilution: Following the company's 180 day lock-up period, a whopping 93,233,047 shares will be eligible for sale. That's a lot of shares poised to hit the market all at once. Look for Buy.com to become Sell.com. Buy.com will also have 129,140,175 shares outstanding after the offering.
  • Chief executive officer turnover: In the fall of 1999, Scott A. Blum, founder and CEO, resigned and deposited all of his shares in a voting trust. Blum has nothing to do with Buy.com's day-to-day operations but owns 54 percent of the company as of December 31.
  • Gregory J. Hawkins, 45, is currently CEO. Hawkins has been CEO since March 1999 and became chairman in September. Hawkins used to work for Ingram Micro, one of Buy.com's largest distributors.
  • Control issues: Softbank, the Internet incubator that owns a big chunk in ZDNet, controls more than 29 percent of Buy.com. And based on stipulations in Blum's exit, it effectively controls nearly 80 percent of the voting shares. Blum's voting trust has to mirror votes of other directors.
  • Softbank will "effectively control the votes of approximately 77.8 percent of our common stock on significant corporate actions and 29.7 percent on routine corporate governance matters immediately after this offering," the company said.

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