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Net spinoffs a risky business for old-line retailers

More offline retailers are gambling that Net spinoffs are the best hedge against the e-commerce threat, although almost everyone involved acknowledges it is still a high-risk bet.

More offline retailers are gambling that Net spinoffs are the best hedge against the e-commerce threat, although almost everyone involved acknowledges it is still a high-risk bet.

This week, Target Corp., owners of department store chains such as Target, Mervyn's and Dayton's, inched toward separating its online operations by forming a unit within the company to take charge of its Internet business.

Last month, Wal-Mart, with the help of venture capital firm Accel Partners, formed a standalone company to manage Walmart.com. At roughly the same time, electronics retailer Good Guys established a separate company to build and manage its future e-commerce site. In addition, Kmart has announced plans to take its Web store, BlueLight.com, public within two years.

The wave of brick-and-mortar spinoffs signals continuing enthusiasm for hitting an Internet jackpot on the public markets. Even as e-commerce stocks ebb, traditional retailers are looking to cash in on investors' love affair with online retail companies.

But analysts say that they need to ensure they don't spin out of control.

"There are plenty of ways to mess it up," said Jupiter Communications analyst Meredith Medland.

Analysts cited numerous pitfalls, including resentment among employees left behind in the offline world, a failure to integrate online and offline customer service issues, and a potential loss of control over the entity that was spun off.

"There is huge animosity between employees of parent companies and those in the spinoff," said Medland. "Employees on the offline side are seeing the Internet guys take in big salaries and bonuses, often for possessing similar or less skill levels. It doesn't sit well."

Worse, a Web firm out of sync with the parent company risks alienating customers if, for example, the two stores carry different products or have differing return policies.

If customers go shopping online for products they know are available in the firm's physical stores but can't find the products at the company's virtual store, they can grow frustrated, according to Forrester Research senior analyst Seema Williams.

"Customers don't care if an online company is a spinoff or not; they only know that the company's name is on the receipt," Williams said. "They want the same service online that the company provides offline."

In a worst case scenario, online shoppers who try to return goods at offline stores may be turned away. "If the first thing your store representative says is 'No, we can't accept that because that's an online item,' you've lost," Sears.com project director Andy Wetmore said.

The spinoff strategy is not a new one. In May last year, offline bookseller Barnes & Noble spun off Barnesandnoble.com. Microsoft also took online travel site Expedia public in November. In the summer, Toys "R" Us announced it had agreed to form a company with venture capital firm Benchmark Capital to run Toysrus.com, but the deal was scrapped after the companies quarreled over control.

Appetites for spinoffssee related story: Stellar e-commerce IPOs fall remain strong despite a falling-off in stock prices. The May public offering of Barnesandnoble.com saw the company's stock rise more than 27 percent from the initial price of $18. Today the stock is trading around $11.50.

Expedia shares soared in its November IPO, rising more than 280 percent from its $14 opening day price to finish at $53.44. Microsoft, which owns an 86.4 percent stake in Expedia, saw the company's market cap reach almost $2 billion. Since then, however, the company's value has fallen more than 40 percent.

Nevertheless, the temptation for traditional retailers to launch a Net company has remained too hard to resist. In addition to taking most of the risks and raising money, the standalone company can also help its parent avoid complicated tax issues and compensate high-tech talent.

And splitting off can help Net companies steer clear of corporate red tape often found in old-world traditional companies. The need for Internet speed is essential, said Terry Jones, chief executive of online travel site Travelocity.

"You can end up IPO market: one for the record bookslike a bug on a windshield if you're not fast enough," Jones said. "Speed is everything in e-commerce."

Recently, Expedia employees hefted their belongings to a new office building 10 miles away from Microsoft's Bellevue, Wash., compound, and according to vice president of marketing Erik Blachford, the move is symbolic.

Blachford said Microsoft's first spinoff is moving out of the behemoth software maker's shadow and steering itself.

In doing so, the new company can raise funds and lure high-tech veterans with stock options.

"Microsoft said, 'We are going to set you off and let you get money from outside.' " Blachford said. "We said 'Perfect.' That gave us flexibility, and for (Microsoft), well, I'm not sure they wanted to get into the travel business."

Privately owned Net divisions--without stock to attract investors, sought-after employees or merger partners--often are at a disadvantage, analysts say.

Wal-Mart spokesman Les Copeland said that the retailer wanted to use the spinoff to attract investments from experienced Internet players, such as Silicon Valley-based Accel. "We have the retail skills, and they have the Internet skills," Copeland said.

Recruiting top-tier Internet employees can be almost impossible unless companies can dangle plenty of stock options. The Internet arm of stalwart retailer Sears--which has not been spun off yet--is struggling to attract Web whiz kids, Sears.com's Wetmore told an audience in San Francisco this week.

"Without stock, we have to find other competitive means to compensate them, including offering them shares in Sears (the parent company)," Wetmore said at the eTail 2000 Conference. "But it's not easy...We have a ways to go."