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PeoplePC takes knocks but keeps fighting

The company's market value has plummeted, its operations lost millions in the latest quarter, and only one brokerage analyst still rates the stock--but it's not giving up.

    PeoplePC's market value has fallen 89 percent since shares went public, its operations lost almost $46 million in the latest quarter reported, and one of the two brokerage analysts following the stock just stopped rating it--but you might not want to count it out yet.

    Shares of PeoplePC have been trading at $1 depths for the past two months, and quarterly results released last week did little to change that, even though the company topped estimates. If anything, Wednesday's report resulted in more bad news from Wall Street: Robertson Stephens analyst Lauren Cooks Levitan on Thursday changed her PeoplePC assessment to "no rating" from "buy."

    Levitan sees an unclear picture for PeoplePC's next couple of quarters. The company sells three-year memberships and in return, customers receive a name-brand computer (replaced every three years) with a warranty, Internet access and admission to its buyer's club. PeoplePC has made a big business push, but the company needs to show investors it can attract more corporate partners, Levitan said. But others found encouraging signs from the company's latest financial numbers.

    PeoplePC debuted in 1999 with an advertising campaign heavily targeted toward individuals. Slogans such as "It's for the people" were designed to attract consumers to a three-year club membership that provided a new PC, Internet access and other services for $24.95 per month.

    That strategy shifted as investors began to shun consumer-oriented technology companies. PeoplePC shifted its focus to selling memberships by targeting workers through their employers, who subsidize most of the membership cost. For months before going public last August, the company was touting deals that let it market to employees of Ford and Delta. Those corporations received PeoplePC stock, warrants and options as part of their deals.

    Unfortunately for PeoplePC, August was also several months into the Nasdaq decline. PeoplePC closed its first day of public trading below its initial offering price of $10.

    Two of the stock's underwriters, Chase H&Q and J.P. Morgan Securities, merged soon after the initial public offering, eliminating one of the analysts covering PeoplePC. A third underwriter, Prudential Volpe Technology Group, began coverage with a "strong buy" rating on Oct. 3, but stopped following PeoplePC when the analyst tracking the stock left Prudential to join CMGI.

    "We had some tough luck. Most research analysts have not been covering new companies," CEO Nick Grouf said, adding that the general market downturn has discouraged other investment firms. "Given the greater macroeconomic environment, we are fortunate that people are covering us."

    With only two analysts actively following the company going into this week, Levitan's decision to stop rating PeoplePC comes as a further blow.

    Lack of affinity?
    "Visibility could remain cloudy until new partnerships are announced, and the viability of the company?s affinity marketing initiative is proven," the Robertson Stephens analyst wrote in a research note. "We believe investors may be challenged to give the company the benefit of the doubt regarding future partnerships and its unproven affinity initiative, which the company expects to contribute significantly to revenues going forward."

    Those affinity programs cover agreements not only with corporations, but also large organizations such as universities and Singapore's National Trade Union. Although a few large contracts have been recently signed--the most notable being an agreement to sell memberships to employees of the French company Vivendi--PeoplePC needs to do more, Levitan said.

    Adding to the analyst's uncertainty is PeoplePC's forecast for the current quarter. Company executives on Wednesday predicted net revenue of $43 million to $45 million, far below Levitan's projection of $75 million.

    However, PeoplePC proponents point to the company's new forecasts as a good sign.

    PeoplePC originally did not expect to start adding to its cash position until 2002. But like many new Internet firms recently facing pressure from Wall Street, PeoplePC has moved up its profit expectations. The company now expects to be cash-flow positive in the second half of 2001, or a year ahead of its original schedule. Its gross margins, although still negative, improved far more than predicted by Levitan or J.P. Morgan H&Q's Paul Noglows, the only other brokerage analyst following PeoplePC.

    "We believe the (fourth-quarter 2000) results illustrate that the PeoplePC model is working," said Noglows, who maintains a "long-term buy" rating on the stock.

    Despite Levitan's doubts about the company's ability to meet its targets, investors should remember that PeoplePC has never disappointed with its financial performance, Grouf said. The company has easily topped analyst estimates in both quarters since going public.

    "The best way to determine the performance of a company is to look at its performance history," Grouf said. "We're the same company we were three months ago and six months ago."

    Because members sign three-year contracts, the company can claim a relatively large amount of deferred revenue. PeoplePC already has $308.6 million in revenue that will be recognized over the next few years, Grouf said. "That creates tremendous visibility with our shareholders," Grouf added.

    Potential energy
    PeoplePC executives said their company has 4.5 million potential members around the world through current corporate partnerships, including 400,000 workers at Ford and 300,000 at Vivendi. "There's quite a bit of visibility that we have there that Robertson Stephens perhaps doesn't have access to," Grouf said.

    Potential doesn't count, in Levitan's view.

    "While we view the company's focus on marketing to affiliates of its enterprise partners as promising, we note that this initiative remains unproven, and we hesitate to give the company credit for this potential revenue stream before seeing evidence of its successful execution," she said. Levitan, however, did note that the company has a "substantial pipeline of potential new enterprise partners."

    Grouf declined to give out the company's overall rate of converting corporations' employees to PeoplePC members. However, analysts were generally expecting a 50 percent to 60 percent conversion rate, Grouf said, adding, "We have been very pleased with the results we have seen to date."

    Nearly every Internet-related company has said the same thing at some point in its history, but not many survived long enough to reach profitability. PeoplePC said it does not need additional capital to reach the point where it's generating cash instead of bleeding it.

    If PeoplePC can survive long enough to reach profits, its business model can work, said Roger Kay, PC market research analyst with IDC. If the company can build a sufficiently large membership--PeoplePC expects to have almost 1.2 million members by year's end--it can generate incremental profits from buying clubs, merchant fees and other revenues, much like America Online does, Kay said.

    The AOL model is the one that Grouf prefers to cite as a comparison, rather than a PC vendor such as Gateway or Dell Computer. "We're a service," he said. "We're not a hardware company."

    Grouf, who founded PeoplePC during a stint with Softbank, an investor in CNET Networks, might have the savvy to pull it off, the IDC analyst believes. "If anyone can do it, he can do it. It is a hard thing to do," Kay said. "But it's not a complete fantasy that it can be achieved."