Cash--Rich? So?

Cash on the balance sheet isn't worth much without a viable plan

What kind of value would you put on online pharmacy Drugstore.com Inc. (DSCM )? Since the company had $130 million in cash at the end of the year, you would think it would be worth at least that much, right? Wrong. Drugstore.com's market cap is a measly $80 million. Why the discrepancy? "Investors believe that Drugstore's management will blow through the remaining cash and end up closing operations," says Aram J. Fuchs, CEO at Fertilemind.net, a New York equity research firm. One key reason for his skepticism is that the Bellevue (Wash.) company, which lost $193 million on sales of $110 million last year, needs a minimum of $450 million in sales just to break even. "That's a lot of revenue for a company that's peddling vitamins and drugs," says Fuchs. Drugstore.com CEO Peter M. Neupert fires back that there is "no chance I'll run out of money."

It sure looks like there are barrels of free cash among Internet companies these days. At least 50 dot-coms have market values that are less than the cash they have in the bank, according to financial data for more than 400 companies gathered by Standard & Poor's Corp. and compiled by BusinessWeek. The marquee names include e-tailer Egghead.com (EGGS ), grocer Webvan Group (WBVN ), and used car seller Autobytel.com (ABTL ). In the cases of free Internet access provider NetZero Inc. (NZRO ) and media site NBC Internet Inc. (NBCI ), the difference is more than $100 million. In theory, an acquirer could buy all the shares of one of these companies, shut it down, and have millions of bucks left over.

But it's not that simple. For starters, the cash levels were measured when the accounting books closed for the last quarter, which typically means they're from Dec. 31. Many of the companies are burning cash so quickly that all the excess could disappear by the time an acquisition is completed. "Just because a company has more cash at hand than its market cap doesn't make it a good company," says Michael G. Linnert, general partner at Silicon Valley venture-capital firm Technology Crossover Ventures. In fact, it suggests the opposite: that the market has given these companies up for dead. Most investors believe that these outfits will never become profitable, let alone obtain additional funding, says Steven N. Kaplan, professor of entrepreneurship at the University of Chicago's Graduate School of Business.

Consider the case of Webvan, the Net grocer that was valued as high as $11.4 billion two years ago because some people bet that it would become the delivery service for the Internet. Then investors got nervous as the company started eating through the piles of cash without any sign of profits. Now, the company's market cap is a mere $132 million, even though it had $212 million in cash on its books at the end of December. Since it chewed through $55 million a month in the fourth quarter of 2000, investors can only wonder if the company has enough money to last through the summer. "Webvan's cash burn rate is horrific, and most people are skeptical of their business plan," says Jim Burkart, portfolio manager at the Strong Advisor Technology Fund, which does not own Webvan. Robert H. Swan, Webvan's chief operating officer, admits the company does need to raise $40 million to $60 million in capital over the next year to fund future operations until it has positive cash flow.

Companies that have found their stock market valuations dropping below the cash in their coffers are scrambling. The bravest are simply betting against the market. Financial news site TheStreet.com Inc., Internet software company NetManage Inc., and several others are buying back their shares to show their faith in the long-term viability of their companies--and to boost the value of their stocks. New York's TheStreet.com (TSCM ) is confident that its $72 million in cash will be enough to take it to operating profitability by the end of this year. So it plans to buy back up to $10 million of its stock over the next few months. Says columnist James J. Cramer, TheStreet.com's largest stockholder who bought 100,000 shares personally: "It shows that we believe in our business and that we're not so desperate that we need every penny."

The strategy can be effective. Besides displaying confidence in its business, a company that buys back stock helps shareholders financially. By reducing the number of shares outstanding, earnings will be spread over fewer shares--and higher earnings per share should boost the stock price. Since TheStreet.com announced its buyback plan in December, its stock has increased from a low of $1.69 to $3. NetManage also benefited from its Dec. 18 announcement that it would buy back as many as 2.6 million shares. Its stock surged from 93 cents to more than $2 in early January, before settling at $1.25.

Divine overhaul. Some of the cash-rich, market-cap-poor companies are taking the opposite approach. Realizing their original business plans were failures, they've done 180-degree turns and overhauled their strategies. Divine interVentures Inc. (DVIN ), for example, went public as an incubator and started up more than 50 companies. In February, with its stock market value lower than the $190 million in cash on its balance sheet, Divine announced plans to remake itself into a software company--CEO Andrew J. Filipowski's area of expertise. It even changed its name to Divine Inc. The moves have helped a little: The stock of the Chicago outfit has climbed from its low of $1 a share to $1.69, although that's still well off the $9 a share at which the company went public last July.

Ventro Corp. (VNTR ) is dumping its old business plan, too. In December, the Mountain View (Calif.) company closed two of its online business-to-business marketplaces--the Chemdex market that allowed companies to buy and sell chemicals on the Net and the Promedix market for medical supplies. Ventro then said it would change its focus to helping other companies build marketplace sites. So far, Ventro hasn't convinced investors that its new plan is any more viable than its last one. Its market capitalization is still only $50 million, even though it has a treasure trove of $235 million on its balance sheet.

Then there are those companies that are sticking to their guns. They simply think the stock market is unfairly punishing them and, if they perform well, their stocks will recover. Consider Neupert at Drugstore.com. "We've made a lot of changes in the last six months--laid off a substantial part of the workforce, dramatically reduced marketing plans, and reconstructed the business model to break even," he says. That's why he's confident his business will survive, even though its stock has dropped from $67.60 in 1999 to $1.31. "I don't need to raise more capital to break even in 2004," he says.

Autobytel is staying the course, too. The company, with $82 million in cash and a $41 million market valuation, expects investors will become bullish once it hits operating profitability in the third quarter. "We are well enough established that we aren't taking down marketing costs, nor are we anticipating any large-scale layoffs," says CEO Mark Lorimer. "After all, we're going to post profits in a few (months)." Strong Fund's Burkart remains unconvinced: "Considering how closely monitored the auto market is, if their business model is a profitable one, it would hardly remain a secret."

Despite the risks, cash can be a powerful lure for potential acquirers. If a purchase can be completed quickly, the leftover cash can help fund the operations of the surviving company. The women's site iVillage Inc. (IVIL ) acquired Women.com Networks (WOMN ) for stock in February, partly to get its hands on its one-time rival's $30 million in cash. The two sites combined some operations to reduce expenses and now should have plenty of money to make it to the third quarter when the business is expected to begin generating cash. "The deal that we cut with Women.com makes sure that we have enough dollars for a rainy day," says iVillage CEO Douglas W. McCormick.

There may yet be a handful of deals like McCormick's in the wings. But it's a treacherous market these days and potential acquirers will have to weigh the risks carefully--before moving licketysplit. The free cash is disappearing fast.

By Pallavi Gogoi

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