The Day Ahead: Will investors buy eMachines' IPO?

eMachines IPO will mirror that of Buy.com

eMachines, a pioneer of low-cost PCs, actually reported a fourth-quarter profit last year, and has strong brand recognition. However, investors should be wary of this long-in-the-tooth initial public offering (IPO).

The company is offering 20 million shares expected to price on Thursday night for trading on Friday. The price range is $8 to $10 (£4 to £6) a share. The company initially filed with regulators to go public in August. In January, eMachines acquired FreePC, a Bill Gross idealab! company that subsidised the price of a PC with Internet access and advertising. eMachines scrapped the FreePC business model, but will use the firm's expertise to gain advertising and direct marketing revenue.

Credit Suisse First Boston is the lead underwriter, and analysts said the blue-chip investment bank may have a tough sell. "The deal may work in the short term, but there's competition everywhere," said David Menlow, chief of IPOfinancial.com. "If the IPO doesn't have an upward price revision, or if there's a price cut, it may signal a problem with demand."

The PC maker, which offers desktop computers priced from $399 to $1,199 (£247 to £743), said it will leverage FreePC's model by dropping the free PC but continuing with the streaming ads on customers' screens. "This combination extends a Web-based portal business model to the hardware itself," the company said in filings.

That plan sounds impressive. Couple eMachine's ambition with the idealab! and America Online (AOL) partnerships, and you may even be convinced to buy into the IPO. The risks cited in eMachines' prospectus, however, may give you a reason to pause.

Menlow said eMachines' IPO could mirror that of Buy.com, a big business-to-consumer (B2C) company that did well on the first day, but lost momentum quickly. As for the financials, eMachines reported pro forma 1999 sales (including FreePC) of $815.5m (£505m) and a loss of $84.5m (£52m). Sans FreePC, eMachines reported sales of $814.3m (£504m) and a loss of $5.7m (£3.5m). Handing out free PCs and Internet access doesn't do wonders for the bottom line.

eMachines said costs related to FreePC will fall dramatically since it ended the PC and Net access giveaways, but losses are likely to continue in future quarters. The company, however, did report a slight profit of $2.2m (£1.4m) in the fourth quarter.

The real issue with eMachines, however, could be the revenue breakdown. The company will try to position itself as an Internet appliance business, but nearly all of its revenue comes from low-margin PC sales. Internet revenue, which primarily derives from sending customers to AOL, was only $3.2m (£1.9m) for 1999, including FreePC. That statistic means eMachines is a currently just a box maker that doesn't have much of a direct marketing strategy. The company relies on retailers such as Best Buy, Circuit City and distributor Ingram Micro to move its PCs. In addition, competition is fierce, with the likes of Dell Computer, Gateway, Compaq Computer, Hewlett-Packard and Apple Computer all battling for customers. Many of those aforementioned PC makers also offer Internet access deals and low-cost machines, so eMachines' access plan isn't revolutionary.

eMachines also competes with Microsoft's WebTV and other Net appliance makers. The company plans to launch some Internet appliance products in upcoming quarters.

Aside from the competition, eMachines is lacking the key IPO buzzwords. Business-to-business (B2B) is the clear king maker in the IPO market. eMachines is a B2C company. All one has to do is look at the stocks of e-tailers to see what Wall Street thinks of B2C.

The final reason to be skeptical about the eMachines IPO is pure supply and demand. After the IPO, eMachines will have 144.7 million shares outstanding. There's too much supply here. For reference, Buy.com has 129 million shares outstanding, and a smaller float. Buy.com is trading near its IPO price, and after a possible first-day pop, eMachines shares will follow a similar pattern.

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