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Was Loudcloud's IPO worth the pain?

A week after Marc Andreessen's company limped to the IPO finish line, analysts are dissecting the issue for signs of the market's health--and of the company's own chances.

A week after Marc Andreessen's Loudcloud limped to Wall Street's IPO finish line, analysts are dissecting the issue for signs of the overall market's health--and of the company's own chances for survival.

In many respects, it is remarkable that the company was able to make it to the public markets at all. It was largely a testament to Andreessen's personal brand name--as well as to the company's willingness to cut its offering price in half--that the stock did go out against the odds, analysts say.

But now the question for Loudcloud, and for any other company that hopes to follow it into hostile market waters, is whether the pain was worth the returns. Andreessen's company got about as much cash as it had originally expected, but it was forced to give up more than twice as much equity as it had planned.

Loudcloud, an infrastructure company with high capital costs, was caught in the position of needing a critical cash infusion at exactly the wrong time. Its lesson shows companies should be leery of trying an initial public offering today without clear profits to show, analysts say.

Loudcloud's troubles have served as bad omens for other upcoming IPOs, including that of Lucent spinoff Agere Systems, which has been forced to cut its offering price once and is now facing pressure to do so again before going to market next week. Many companies lacking the high profile of an Andreessen or a Lucent connection are choosing simply to cancel their offerings at the last minute.

"The only reason (Loudcloud) was able to come out at all was because of the star power of Andreessen," said George Nichols, an IPO analyst with Morningstar. "But there's not enough star power in the world to make an (unprofitable start-up) into a successful IPO right now. If you can't wait, you're going to get fire-sale prices for your offering."

Loudcloud tumbled south for a second day Friday, falling to $4.43 after remaining steadily near its IPO price of $6 until early Thursday.

Was it worth it?
Loudcloud's bank account has been boosted by nearly $140 million as a result of the IPO. That's at least enough to take it through another year or longer at its current cash burn rate. But analysts say the company is still on shaky ground.

Loudcloud's model revolves Tune in to CNET News.com TV's IPO
Forecast in large part around letting different customers share infrastructure and maintenance costs that otherwise would have to be paid in full on an individual basis. But even with this relatively more efficient use of equipment, manpower and automated technology, the company is incurring significant new capital costs as its customer base grows.

It is in large part this dynamic that has required the huge infusions of cash, both previously from private investors and this time from the public markets, analysts say. But there is some hope that as the business matures, Loudcloud itself will be able to slough off some of its capital costs by using outsourced infrastructure, analysts say. This could greatly speed the road to profitability, a point that still appears distant today.

"What they're doing is controlling their (infrastructure) environment in the short term," said Merrill Lynch analyst Robert Stimson. "What we hope is that the company doesn't have to be that capital intensive" in the future, he added.

What cooled institutional investors on the stock was the simple financials. The company is still a relatively early stage start-up, spending nearly $10 for every dollar it earns. Merrill Lynch analyst Robert Stimson predicts that the company isn't likely to reach the break-even point before 2003 or 2004.

The company itself remains in a quiet period, so representatives declined to comment on Loudcloud's financials and on the plans it has for its new funding.

But it is clear from previous documents filed with the Securities and Exchange Commission that the business is on an accelerating expenditure trend even as it signs up new, high-quality customers.

Ringing up expenses
In the six months ended July 31, 2000, the company's total expenditure outside of stock-related balance sheet charges was about $25.7 million, with actual revenue of about $1.9 million. By the end of the next quarter, the year-to-date expenditures had more than doubled to about $62 million, meaning the company had spent more than twice as much in the third quarter alone than in the previous two quarters put together. In return, the company made about $4.6 million that quarter, or a little more than twice its revenue for the first half of the year.

There are good signs and bad signs in those figures. Loudcloud is clearly gaining customers, and revenue is growing quickly. Since the release of those third-quarter figures, the company has added several large customers, including AOL Time Warner, Ford Motor, News Corp., Nike and Fannie Mae. The company said that as of January 2001, it had contracts worth $120 million that spanned an average period of 1.8 years.

The outsourced Web services appear to be gaining traction among large customers, a key component in attracting other large-paying customers, analysts say.

But as revenue grows, so do costs, which has many in the financial community worried. Though Loudcloud's stock has remained fairly stable since its $6 IPO pricing, it fell slightly to near $5 on Thursday.

If it can get its costs under control--a big "if" at this point--the company is well positioned despite the downturn in the economy, analysts say.

Although it had an early focus on Net customers, its recent financial statements noted that just 19 percent of revenue came from specifically Internet companies.

Moreover, large companies are still interested in the Net, even if the urgency has gone out of service purchases, analysts say. The days when "brick and mortar" companies worried about slapping a site online to avoid being "Amazoned," or immediately overtaken by a Net upstart, are gone. As a result, large companies are asking for more assurances and proof of technology from companies like Web hosters. But they're still buying, analysts say.

Web hosters "are not seeing a slowdown in the market, although they are seeing longer sales cycles," said Forrester Research analyst Jeanne Shaaf. Her firm predicts that the market for hosting and the kind of outsourced Web services provided by Loudcloud will reach $19.8 billion by 2004.

Loudcloud "has enough money to go through the next 12 months now," said Melanie Hase, an analyst with Renaissance Capital's IPO Plus Fund. "What happens then we'll have to see."