December 21, 1999 4:20 AM PST

Amazon-backed start-ups hope ties will boost IPOs

Two start-ups backed by Amazon.com, hoping to emulate the online bookseller's runaway success, may need more than close association with the Internet bellwether to overcome competitors.

Amazon, which owns 28 percent of HomeGrocer and 43 percent of Pets.com, dominates online shopping, far outpacing its competitors in number of customers and revenues. Investors have taken notice, pushing the Seattle company's stock up 77 percent this year and more than 3,000 percent since its May 1997 public offering. Just this week, Time Magazine named Amazon founder and chief executive Jeff Bezos as its "person of the year."

Both HomeGrocer and Pets.com, which filed for IPOs last week, have a long way to go before they earn such notoriety. Like their sponsor, both have racked up multimillion dollar losses. Amazon could lose millions more before it turns profitable, but the company projects that at least some of its growing number of businesses will be in the black by the end of the year.

By contrast, HomeGrocer and Pets.com could each find future earnings hard to come by. The former competes in the notoriously low-margin grocery business, while the latter has been selling its items for less than it costs the company to acquire products and ship them to customers, according to regulatory filings.

HomeGrocer and Pets.com's relationship to Amazon could give them a certain cachet, said Needham & Company equity analyst Dalton Chandler. But that doesn't mean the companies are necessarily ready for public trading.

In the past, companies used to go through several rounds of funding before going public, he said. Now, "it's sort of become a one-step-and-your-out process for a lot of these companies," Chandler said. "They are coming out at a stage that a few years ago would have been called seed capital."

Investors could have other reasons to look askance at the planned IPOs, as the filings come amid a generally down market for e-commerce stocks. CDnow, PlanetRx and eToys are all near their 52-week lows. Although Amazon and fellow e-commerce bellwether eBay have begun to climb back from a summer slump, they have not yet matched their April highs.

Additionally, like CDnow and PlanetRx, both HomeGrocer and Pets.com compete in highly competitive market segments.

The third online grocer to file for a public offering, HomeGrocer faces similar hurdles to Webvan and Peapod. While book, music and toy e-tailers can distribute their wares nationally from a few warehouses, selling fresh produce and meats requires the online grocery stores to be located much closer to their customers, often meaning that they need at least one warehouse per metropolitan area.

Building those distribution centers across the country can be an expensive process. Webvan, for instance, has placed a $1 billion order with Bechtel to build 26 new warehouses over the next 24 months. HomeGrocer, meanwhile, plans to use the $250 million it hopes to raise in a public offering to fund part of its own expansion. Both companies acknowledge that their IPO money will not cover their expansion costs.

Meanwhile, traditional grocery stores--which already have warehouses and established names--could enter the market. Veterans of cutthroat price competition, the traditional grocers have the potential to wage a price war that their red-ink-running online competitors couldn't sustain. Grocery giant Albertson's, for instance, has already begun serving online customers in Seattle.

Kirkland, Wash.-based HomeGrocer lost $39.1 million on $10.9 million in revenue for the 39-week period that ended Oct. 2 of this year.

"Many of our existing and potential competitors, particularly traditional grocers and retailers, have existed for a longer period of time, have greater financial resources and have more established relationships with leading manufacturers, suppliers and advertisers than we do," HomeGrocer said in its regulatory filing. "We expect our competition will intensify as more traditional and online grocery retailers offer competitive services, both in Seattle and other markets."

HomeGrocer does have a leg up on its online competitors. While Webvan currently serves only the San Francisco area, HomeGrocer already operates in three markets from four distribution centers.

The grocery market also represents a huge market opportunity, with total supermarket sales reaching $449 billion in 1998, according to the Food Marketing Institute. Forrester Research projects that online grocery shopping will grow from $513 million this year to $16.9 billion in 2004. In contrast, Forrester expects the total book market--online and offline--to be about $20 billion in 2004.

Neither HomeGrocer nor Pets.com would comment because both are in a Securities and Exchange Commission-mandated "quiet period" before their IPOs.

The companies have more in common than their Amazon alliances and outstanding losses. Hummer Winblad Venture Partners provided venture funding to both firms, and both have the backing of other prominent Web players. Bowman Capital has invested in Pets.com, for instance, while Kleiner Perkins Caufield & Buyers, Jim Barksdale's Barksdale Group and Martha Stewart have stakes in HomeGrocer.

Former Reel.com chief executive Julie Wainwright heads Pets.com. Mary Alice Taylor, a former executive of Citicorp and Federal Express, is CEO of HomeGrocer.

Despite its challenges, HomeGrocer could prove far more palatable to investors than Pets.com, which has not posted a profit in either of its two quarters of operation. The San Francisco company has lost $19.4 million since it began operations in February. During that time, the company paid $1.2 million more to acquire and ship products than it received for the items.

"We have yet to achieve meaningful revenue, and cannot be certain that we will obtain enough customer traffic or a high enough volume of purchases to generate sufficient revenues and achieve profitability," the company said in its regulatory filing. "We believe that we will continue to incur operating and net losses for at least the next four years, and possibly longer, and that the rate at which we will incur such losses will increase significantly from current levels."

Pets.com competes against an array of pet supply e-tailers, including Discovery Channel-allied Petstore.com, Petco-backed Petopia, and Petsmart.com, offline giant Petsmart's online venture. Pets.com hopes to distinguish itself and improve its margins by offering its own line of Pets.com-branded products and--following in Amazon's footsteps--by building out its own network of distribution centers.

But before the company completes its infrastructure expansion, investors could tire of paying for consumers' purchases, whether through promotional programs or through products offered below cost, said Keenan Vision equity analyst Vernon Keenan. If you wipe away the online veneer from Pets.com, the company is offering low-margin goods and an unproven distribution system, he said.

"How many cat toys are people going to order through the Web? Not many," Keenan said. "While I love Pets.com's commercials, the business model seems questionable to me."

But Pets.com has a number of advantages, including its simple URL and the fact that it is competing in a large and growing market. According to the company's regulatory filing, the pet supplies market grew at an annual rate of nine percent between 1993 and 1997, reaching $23 billion in 1997.

The company plans to distance itself from competitors by offering a one-stop pet shop where customers can get just about any pet product and receive an array of pet-related news, advice and information.

Other publicly traded companies with ties to Amazon haven't enjoyed much of a coattails effect. Although Drugstore.com's relationship to Amazon seemed to boost its IPO in July, the company has not been able to sustain investor enthusiasm. After more than doubling its $18 offering price on its first day of trading and surging to a high of 70 soon thereafter, the online pharmacy's stock has fallen in recent months. Drugstore.com shares closed at 39.375 yesterday, up 0.625 points.

Amazon owns about 27 percent of the online pharmacist.

Likewise, Ashford.com shares have actually fallen since Amazon announced its investment in the company earlier this month. The luxury-goods retailer, which went public in September, has seen its shares sink from 20.25 on December 1, when the companies announced the investment, to 15.375 today.

Amazon owns about 17 percent of Ashford.

 

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