A Peek Inside RedEnvelope's IPO

Quick, put it on your calendar. Sept. 7 is National Grandparents' Day. Just what we need, right, another occasion for gift-giving? Sometimes I imagine millions of Americans lining up at consumer-credit counseling offices and having to recount every nickel wasted on gifts not given from the heart.

Most folks don't seem so dismayed by all the manufactured occasions for largesse as I am. The latest evidence is RedEnvelope, a little company with big backers (giant Sequoia Capital, for one) and ambitions. Its stated goal is "to make gift giving -- no matter what the occasion or circumstance -- easy and fun." Now, the San Francisco retailer aims also to sell stock in a $31 million initial public offering led by WR Hambrecht (table). As dyspeptic as I may be about giftmania -- not to mention being uniformly skeptical of IPOs -- this one may be worth investors' time looking into.

The place to begin is on the Net, where RedEnvelope got its start in 1997 as GiftWorks Online. Two years later, it adopted its current identity and signature red gift-wrapping. The Web site is easy to use, even if it pushes dubious stuff: a four-leaf clover pressed in glass ($28); a branding iron to "monogram" barbecued steaks ($65); a tin of "handcrafted" root beer ($49); a range of Kama Sutra kits, with such items as edible honey dust and Love Liquid, from the Weekender ($25) to the Pleasure Box ($65). For Grandparents' Day, RedEnvelope suggests the Tingler, a $20 acupressure tool promising "chills of ecstasy...oohs, aahs, and shivers of pure delight." Try explaining that to the grandkids.

Just the same, people are spending more and more money at RedEnvelope, which now has a database of 1.4 million customers, a third of them added in the past year. From $8 million in fiscal 2000, revenue grew steadily, to $70 million in fiscal 2003, which ended on Mar. 30. RedEnvelope remains unprofitable, but the red ink is fading. Net losses peaked in fiscal 2001, at $26.5 million, and fell to $7.7 million in fiscal 2003. In the current year's first quarter, losses sank 47%, to $1.2 million. Better yet, cash flow from operations, at $1.4 million, swung positive from a $1.8 million burn last year.

So the trends are up. Yet this holiday season, RedEnvelope faces an extra risk. In August, the company stopped outsourcing its fulfillment -- that is, picking items from inventory, packing them, and shipping out customer orders -- at its one distribution center in Ohio. For an Internet store, this is a critical function and one in which Red Envelope notes it has no experience. A spokeswoman, citing the IPO, declined to answer any questions about fulfillment.

So why pay attention to RedEnvelope? For one thing, with any growth in volume, the company figures to turn profitable. More intriguingly, it's one of the few companies going public via Hambrecht's new OpenIPO process (details at wrhambrecht.com). In this, anyone with $2,000 can open an account and bid (with a 100-share minimum order). High bidders win, but via OpenIPO you need not place an order and hope for the best. You can set a ceiling on your price.

The company, which is debt-free, estimates the stock will go at $12 to $16 a share. At the midpoint, $14, it would command a market value of $119 million, or 1.6 times the past four quarters' sales. That may seem cheap next to mega-rivals on the Net and off, given that Amazon.com (AMZN ) trades at 4.3 times sales and Tiffany (TIF ) 3.1 times. But a smaller specialty retailer, such as 1-800-Flowers.com (FLWS ) which is growing more slowly and trades at 1.1 times sales, is a better comparison. At that multiple, RedEnvelope would bring $9.38 a share.

Will the IPO be priced so low? Unlikely, for two reasons: First, the market's recent buoyancy is stirring investor greed. Second, RedEnvelope's current owners paid an average of $13.47 for their stakes. If you can get the stock below $10, consider it a gift.

By Robert Barker

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