By George E. Nichols | 11-12-99 | 12:00 AM | Email Article
Regardless of whether the online-grocer market proves to be lucrative, the IPO of one company in the industry, Webvan WBVN, has turned heads thanks to its all-star backing.
George Nichols is a fund analyst with Morningstar.

Founded by Louis Borders (of Borders Books fame), Webvan is led by some of the top names in venture capital (Benchmark, Sequoia, Softbank), and it has bagged the former chief of Andersen Consulting as its new CEO.

On November 5, Webvan's stock closed at $24 7/8 per share, up from its offering price of $15, giving the company a market value around $8 billion. That's a solid debut, to be sure, but it was somewhat anticlimactic after prominent Internet stock analysts predicted that Webvan stock could easily soar above $40 per share. That the stock jumped "only" 66% is a sign of how much the market's attention has shifted toward business-to-business Internet stocks.

That's not to say this is a cheap stock, though. So far, the company has rung up $4.3 million in net sales through September 30, and its underwriter, Goldman Sachs, forecasts losses of $302 million on revenue of $518.2 million in 2001. As for the general online-grocer market, research firm Jupiter Communications estimates revenue will be $3.5 billion in 2002, up from just $63 million in 1997.

Furthermore, based on its opening-day closing price, Webvan's stock is currently in lunar orbit at 672 times estimated 1999 revenues and more than 15 times projected 2001 revenues. For a rough comparison, barnesandnoble.com BNBN, drugstore.com DSCM, and Etoys ETYS--other e-commerce stocks that debuted this year--have price/sales ratios ranging from 17 to 58.

Webvan promises free same-day delivery within a 30-minute time window of the customer's choosing. It sounds appealing for the customer, but can Webvan actually pull this off while pocketing a nice profit, or will it be overpromising and underdelivering? Webvan will have to sort out the logistical nightmare of distributing perishable goods quickly to a customer while the customer is home. I, for one, don't want to receive a late delivery and open a package of Ben & Jerry's Chocolate Chip Cookie Dough soup.

Grocers typically have to deal with unappetizing, razor-thin profit margins, making Webvan's high price/sales multiple look even worse. However, Webvan plans to wield several advantages over its traditional counterparts. In its prospectus, Webvan estimates it can eventually achieve an operating margin of 12%, much better than the 4% for traditional grocers.

In addition to cheaper cost of goods sold achieved by its large scale of operations, Webvan "stores" will be used for just that--storage. This will obviate many costs associated with maintaining a retail storefront. One cost that chips away at traditional grocers (5% of revenues) is real-estate expense, but Webvan plans to knock down that cost to less than 1% of revenue by locating warehouses within industrial zones rather than prime commercial areas.

Also, all bets are on Webvan being more than a mere grocer. It is poised to emerge as a roll-up of various e-commerce merchants, offering drugs (backers of Webvan have a large stake in online drugstore PlanetRx), dry cleaning, videos, film, and an endless list of other deliverable goods. It's out to leverage this scale to conquer what is known as the "last mile" challenge--bringing instant gratification to customers awaiting shipment from orders initiated online.

Wading into largely untested waters, Webvan is anticipating that the shortcomings of its predecessor will not cloud its own future. The original online grocer, Peapod PPOD, initially acted as a middleman between existing grocers and their customers. It took nearly two years for Peapod to figure out that being an errand boy for traditional grocers is a sorry Internet business model. To add to its woes, Peapod's stock recently nosedived after the company reported a quarterly loss of $0.53, much worse than analyst estimates. And to top it off, Peapod is desperately seeking a new round of financing. A recent SEC filing notes that it is running low on cash, perhaps not enough to cover one more year of operations.

Investors hate Peapod stock as much as children loathe broccoli--the stock languishes well below its 1997 IPO price. Though late to the game, Webvan is stealing the thunder from this granddaddy and should easily leapfrog all other competitors in terms of scale. So much for the often-vaunted "first mover advantage."

Although Peapod is currently its largest direct competitor, Amazon.com AMZN (and maybe even FedEx) may be its long-term targets. Other competitors turning up the heat right now are Streamline SLNE, NetGrocer, kozmo.com, and HomeGrocer.com.

HomeGrocer.com is clearly gearing up to butt heads with Webvan. It is partly funded by Amazon.com, including a recent round of $100 million in financing from its various backers for expansion. To take on the competition, Webvan is throwing up some barriers to entry in the form of 26 massive warehouses. Webvan will shell out around $1 billion to fund this "clicks-to-bricks" buildout.

With strong management, ample financing, and vicarious experience gained through Peapod's struggles, Webvan is unlikely to be ensnared by the same traps that have seized its predecessor. Yet despite a relatively tame IPO bounce, Webvan could easily take a slide, as did earlier IPO offerings that formerly sported similar high valuations.

Investors are piling on Webvan in the hopes of catching the next Amazon at ground level. The stock price will be erratic as investors recklessly drive it like a runaway shopping cart. And, like Amazon, it may take years of extensive capital spending before we can see if Webvan has hit the road to riches or the road to nowhere.
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George E. Nichols does not own shares in any of the securities mentioned above. Find out about Morningstar's editorial policies.
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