Dot-com bankruptcies: Who will survive?

Can dot-coms survive bankruptcy?

While some lucky ones, like CDNow, get plucked off by buyers, and some manage to survive by scratching together band-aid financing, most dying dot-coms will end up in bankruptcy court.

According to statistics from the Gartner Group, up to 95 percent of today's e-tailers could go out of business, and bankruptcies are expected to accelerate in the first and second quarters of 2001.

But bankruptcy law for is still nascent in regards to failing Internet companies. Questions as to what a company with no inventory, property, or substantial staff can claim as an asset, and what dollar value can be put on ephemeral properties such as domain names and customer lists, have yet to be answered. Bankruptcy experts disagree on whether financially troubled e-tailers will even be able to restructure. Companies in proceedings now, like Value America, will set the pace of things to come.

What makes a dot-com different?

"Most of these companies won't exist. They don't have the kind of assets to support a recovery," said Stuart Hirschfield, chair of the bankruptcy practice of Dewey Ballantine, LLP, a New York firm. Hirscshfield has handled bankruptcies of major brick and mortar retailers such as Bradlees, which got back on its feet after 3 years, a radical change in business plans, the closure of 30 stores, and major management shifts.

"There's nothing special about Internet bankruptcies, except that they have a lot less assets,” Hirschfield said. The companies that have been able to recover are those that have infrastructure, and real inventory. "Those just based on intellectual property won't survive," he said.

Most Internet companies won't even have a chance to restructure, Hirschfield predicts. He expects most e-tailers will have to file for Chapter 7 bankruptcy, which is for liquidation. Only under Chapter 11 can a company file for reorganization.

The problem with Chapter 11

Richard Mikels, chairman of the bankruptcy practice at Boston-based Mintz Levin Cohn Ferris Glovsky and Popeo PC, is more optimistic. Though the general consensus it that without physical assets, most companies won't be able to restructure, Mikels disagrees; "We haven't seen the endgame here, people will find ways to use 11."

There are 4 main reasons why reorganizing under Chapter 11 is an issue:

1. Dot-com companies are brand new. If you don't have revenue, there's nothing to restructure. "Ten, or even 5 years from now, you'll see a lot more restructuring," Mikels predicted.

2. Technical employees, who are in high demand, have no reason to stay aboard a sinking ship. The loss of employees is a major stumbling block for a company trying to recover.

3. Financing is hard to come by now; companies can't just turn to the market for a second round of equity money. Normally a retail lender lends on the value of a company's inventory, which many dot-coms don't have. "In the future, I we'll see more lending on Intellectual Property," Mikels said.

4. Its hard to cut back on marketing, which is an essential, large cost that most brick and mortar retailers can shave off during restructuring.

The customer list controversy

The law is still nebulous in regards to what a company can claim as an asset in bankruptcy court. In the scramble to pay creditors, companies are trying to hawk anything they've got, including information that was supposed to be kept confidential.

Toysmart.com's imbroglio over its customer list is an example of the troubles that await bankrupt dot-coms.

Toysmart.com gathered the data while under an agreement to keep it confidential, and was planning to sell it to anyone who met the restrictions agreed to with the FTC -- one of which was that the buyer be "family friendly."

A federal bankruptcy judge rejected the Federal Trade Commission's agreement with the toy e-tailer, leaving the list of personal information on about 190,000 customers up for sale, but refused to rule on the case until a prospective buyer comes forward.

The state of Texas said Monday it has reached a settlement with Living.com, the bankrupt furniture e-tailer backed in part by Amazon.com (Nasdaq: AMZN), which should prevent it from selling its customer list. If approved by the bankruptcy judge, customer data such as credit card and social security numbers will be destroyed by a trustee of the court. Customer lists excluding that data could be sold only with the customers' approval.

What's left?

"There are still people trying to figure out what assets you need to value -- Web sites, addresses, contracts with third parties, copyrights, trademarks, intellectual property and customer lists," are all possible assets for companies trying to restructure, according to Mikels.

Mikels sees infrastructure as a major asset for bankrupt dot-coms; "say it costs a company 70 million to build its infrastructure -- another similar company could buy it for 20 million. I wouldn't be surprised if that develops as an occasionally used exit strategy," he said.

Boo.com, the London-based company that recently went bankrupt,sold its infrastrcture off seperately from its domain name and other assets, which included data on its 350,000 customers sold to Fashionmall.com.

Value America's trying to put its infrastructure to use in a different way. By operating its system for third party manufacturers and distributors, Value America plans to re-emerge as an e-services company. The company spent "millions" on the infrastructure, but only ever used 10 percent of its capacity, said Tyler Andrew, director of communications for Value America.
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