The Tech Meltdown's Other Victims
Jeff P. Bezos, the founder and chief executive of Amazon.com Inc., is more than the top retailer on the Net. He's also the leading evangelist for the movement. Besides building his company into a retail giant, he has invested heavily in similar companies. But now Amazon's portfolio of e-tail investments looks like a who's who of dot-bombs. The stocks of Drugstore.com Inc. and Ashford.com Inc., both major Amazon investments, have dropped about 90% from their peaks. Pets.com Inc., which went public in February at $11 per share, is trading at less than $3. Amazon is still in the black with its holdings, since it often took early positions at low prices. But the decline in the value of its stakes is staggering: Amazon's holdings have dropped by at least $1.4 billion in recent months.
While Amazon is an extreme example, it is by no means the only corporate investor to see a steep decline in the value of its venture holdings. Dell Computer Corp. and Microsoft Corp., for example, also have taken huge hits to the value of their investments. A detailed review of numerous financial documents by Business Week reveals that the prospects of many tech companies are tied more closely together than outsiders may realize. Even as investors flee to what they consider "quality" stocks, many market leaders are exposed through their investments to some of the worst casualties of the tech market carnage. "We were at the stage where there was too much money chasing deals," says Luigi Zingales, a finance professor at the University of Chicago's Graduate School of Business. "When there's too much money around, mistakes get made."
The extent of the damage to corporate venture portfolios may not be clear for months. Since much of the sell-off in tech stocks came after Mar. 31, earnings reports from last quarter do not show the degree to which technology giants are entwined with fallen high-fliers. Amazon declined to quantify the decline in the value of its investments, but a spokesman did say its holdings in companies now public are worth 38% more than its original investments. Still, the attrition in some corporate venture portfolios may hurt the ability of tech leaders to boost profits by realizing investment gains. Eventually, some companies may have to write down assets or take charges against earnings.
All this comes after years of windfall returns in technology-focused corporate venture funds. Intel Corp., which began investing in the early '90s, has turned roughly $2 billion into a portfolio valued at nearly $10 billion as of Mar. 31. Encouraged by such success, corporate venture investing exploded last year. While not all companies divulge the scope of their investments, the 28 that announced new venture funds committed $6.3 billion in 1999, compared with just $1.7 billion in 1998, according to Asset Alternatives Inc., in Wellesley, Mass., which tracks such investments. A total of 203 corporations made venture investments last year, nearly double 1998's 108, according to the firm. A company doesn't even have to be profitable to have a venture fund. Amazon, which lost $720 million last year, is paying for its investments largely from debt offerings.
Part of the appeal of such investments is that they can contribute to the bottom line. If the value of a company's equity stake rises above the original investment, the company can sell that stock and add the profits to net income. In the quarter ending Mar. 31, Intel reported that stock sales contributed $449 million to its quarterly earnings. "The selling is just prudent portfolio management," says Steve Nachtsheim, vice-president and director of operations at Intel's venture capital arm. Microsoft tacked $885 million onto first-quarter earnings. And on Mar. 29, executives of Dell Computer Corp. told analysts that the company's $700 million in venture investments was worth about $2.7 billion and confidently predicted that sales of appreciated assets would contribute steadily to earnings in coming quarters.
DELL TOLL. On the other hand, maybe not. With numerous investments in Internet retailers and B2B players, Dell has seen the value of its equity stakes plummet. One example is NaviSite Inc., a Web-hosting company whose stock has tumbled from $165 at its peak to $37.56. The value of Dell's 2.2 million shares has dropped by $279 million. The value of Dell's 1.2 million share stake in Selectica Inc., which sells computer systems for e-commerce, has declined by 70%, or $140 million, from its peak. And Calico Commerce Inc., which sells applications for e-commerce, has seen its stock slide 67% from its high. Lost value for Dell? About $93 million. In addition, Dell has stakes in Net incubator Internet Capital Group Inc., Linux hotshot Red Hat Software Inc., and others that have seen their shares decline recently. It does not disclose the size of those holdings.
Of course, financial returns are not the only metric for gauging the success of corporate venture programs. Many companies, including Dell, invest in startups to help their own core businesses. "Our key motivation is strategic. [Not all venture] investments will be home runs," says Alex C. Smith, managing director of Dell Ventures, who would not comment on how the decline in stock prices would affect future earnings. In many cases, Dell invests in companies that are meeting a demand of Dell's customer base. For example, Dell's smaller business customers are using Web-hosting services because they prefer to have specialists build and manage their Web sites. Hence, Dell's investment in Web-host NaviSite, which lets Dell study the Web-hosting business and direct customers to a service they may want.
Like Intel, Microsoft has benefited handsomely from its investments in tech companies, including Apple Computer and Net incubator CMGI Corp. While it has substantial gains on its overall portfolio, Microsoft has not been immune to the carnage in tech stocks. One big holding is United Pan-Europe Communications, whose stock has dropped by half in recent months. That has shaved the value of Microsoft's 10-million-share stake by $462 million. Shares in Wink Communications Inc., which is developing interactive advertising for television, plunged from $75 at its peak to $20.31. While Microsoft is still ahead on the investment, since it paid $12 a share, the decline in the stake's value is about $164 million. One outright loser in Microsoft's portfolio is Careerbuilder Inc., an online job service. The software giant paid $13 a share for its 1.4 million share stake. Now with the stock at $2.62, Microsoft is down about $14 million.
Like Dell, Amazon has been making venture investments for strategic reasons. By taking stakes in other e-tailers, it has been able to broaden the variety of products it can offer its customers without investing in inventory and distribution. That helps Amazon even if the investments themselves don't pay off, Bezos argues. In addition, Amazon gets money back from companies it invests in. Over the next three to five years, Amazon expects to collect $600 million from affiliated companies that rent out space on Amazon's site.
Still, a detailed look at Amazon's portfolio raises questions about the financial merits of its venture program. Begin with Pets.com. Amazon pumped a total of nearly $58 million into the company and, after the stock's recent tumble, its stake has declined to roughly $24 million. Amazon also has lost money on its investment in audio-books provider Audible and on its purchase of warrants in Internet credit-card provider Nextcard Inc., according to Business Week calculations.
STEEP DROPS. Even the profits on Amazon's money-making investments have declined in recent weeks. Amazon's 24% stake in Drugstore.com, worth $868 million last year, now is valued at $108 million, a decline of $760 million. Since it paid an average of $6.04 a share, Amazon is still about $33 million ahead on the deal. The value of its stake in Ashford.com, an online merchant of jewelry and other luxury goods, dropped from $260 million last year to $21 million. And Amazon's holding in HomeGrocer, a Net grocery store, is worth $128 million, down from $443 million in March.
In hindsight, analysts are critical of Amazon's venture strategy. "It does round out their product offerings, but they could have done that more cheaply," says analyst Dalton L. Chandler of Needham & Co. Simply selling screen space to niche retailers may have made more sense, he adds. "Cash investment wasn't the way to go." Lauren Levitan, an analyst with Robertson Stephens, recently wrote a report saying that Amazon's venture investments could add to the volatility of the company's stock because the company's value "is increasingly based on not only Amazon's core business but its incubation model."
Bezos is undeterred. He says he still sees the strategic value of Amazon's venture deals. He also contends that the decline in e-tailers' stock prices may result in even more attractive investment opportunities. "Warren Buffett always says he likes it when stock prices go down because he's a net buyer of stocks," says Bezos. "If there's anything you're a net buyer of, you should be happy when it goes down."
DEJA VU. It's worth noting that earlier corporate venture cycles have ended badly. This is the third major wave of such investing, according to Josh Lerner, professor of business administration at Harvard Business School. The prior two waves also came in the latter years of major bull markets. But bear markets in 1973-74 and 1987 short-circuited both corporate venture thrusts. "Many of the programs were discontinued after market downturns," says Lerner, noting that companies like Exxon and Amoco suffered in the shakeouts. He acknowledges that the same could happen again, though he stresses that it's too early to tell.
When markets peak, the most recent investors get hurt the most. Such is likely to be the case in tech venture funds. Veteran corporate investors like Intel and Microsoft will suffer dented portfolios and, at worst, lowered expectations for asset-sale contributions to earnings. But latecomers, such as Amazon, are not likely to get off so easy.