THE DAY AHEAD: Ready, set, rollup

Larry Dignan
4 min read

COMMENTARY -- Do two money-losing dot-coms make a juggernaut when combined? Usually not, but it's worth a shot when the chips are down. Welcome to rollup season.

Rollups are not a new idea. They've been around forever. In a nutshell, rollups occur when one dominant player with cash sucks up smaller competitors to create a bigger juggernaut via consolidation.

Dot-coms may be putting a new spin on the rollup. Some dot-coms have a good amount of cash from their IPOs, and they're merging as a survival tactic. The logic behind the dot-com rollup is that two struggling companies may survive if they are combined. Simply put, there are no dominant players.

Executives would obviously be happier if a well-heeled player swooped in to buy their companies at a premium, but most dot-coms have lost any leverage they had.

A notable example of how these rollups will play out was this week's merger of iVillage (Nasdaq: IVIL) and Women.com (Nasdaq: WOMN). This combination of two near-equal rivals will create the leading player in women's Web content. The problem? Sales are still going to decline in the first quarter sequentially.

Ideally, Women.com's largest shareholder, Hearst, would have bought the company. Instead, Hearst now owns a big chunk of iVillage. Will it matter?

These rollups also produce some strange comments from analysts. "IVIL continues to trade as if it may go out of business," said Merrill Lynch analyst Henry Blodget. "At $1.72, the stock appears inexpensive relative to modest long-term EBITDA assumptions (if our current estimates hold, we believe IVIL could trade at $4 to $5 in two years). It is by no means assured the company is capable of achieving break-even, however." (EBITDA is earnings before interest, taxes, depreciation and amortization.)

Woo-hoo. iVillage could hit a whopping $4 to $5 in two years. It had a closing high of $113.75 on April 12, 1999. Who knows? iVillage could buy Oxygen Media too.

Is there any doubt that the slew of dot-coms reporting larger-than-expected losses this week will have to cook up a merger to survive?

NetZero (Nasdaq: NZRO) trades at a buck and change, but it has a decent amount of cash. What it doesn't have is a workable business model; online ad revenue, which was supposed to support free access, is sluggish. Luckily, NetZero, which had been a free Internet services provider, is starting to offer for-pay services, a move that makes it just another ISP.

The company, which reported a pro forma loss of 29 cents a share on sales of $16 million, could easily be combined with Juno Online and EarthLink. Oh, the money that trio could lose!

Ask Jeeves (Nasdaq: ASKJ), which lost 53 cents on sales of $23 million in the fourth quarter, could query LookSmart (Nasdaq: LOOK) or some other company about a merger.

And how long can companies like Liquid Audio and eMusic dance around the fact that they're losing gobs of money?

The scary thing for investors is that these rollups aren't going to produce any premium. Consider that Disney Internet Group (NYSE: DIG) was rolled into Disney (NYSE: DIS) for what ABN Amro analyst Arthur Newman described as a "Minnie" premium. Disney paid a 20 percent premium to Disney Internet shareholders only because it was stipulated in an old contract as a minimum.

Simply put, if there is a premium in a dot-com rollup, it'll be a few cents a share if you're lucky. These are mergers are marriages of convenience--you have to get hitched to avoid bankruptcy. And even then it all can unravel.

Webvan's (Nasdaq: WBVN) acquisition of HomeGrocer.com last year was all about conserving capital. After some cost cutting, Webvan recently reckoned that it would have enough cash to fund operations in 2001. It'll need to raise $40 million to $60 million to fund operations in 2002 and become profitable. Of course, Webvan will have to avoid being delisted by the Nasdaq first.

Blodget and Microsoft

It was odd that Merrill's Blodget took over coverage of Microsoft (Nasdaq: MSFT). After all, Amazon.com and Microsoft don't have a lot in common.

What was really notable was that Blodget downgraded Microsoft to an "accumulate" from Chris Shilakes' "buy" rating. What was even more notable was that Blodget has a higher long-term rating on Amazon (buy) than Microsoft (accumulate).

Blodget talked about PCs, Office sales and Microsoft's enterprise strategy in his research report. For a guy that is used to talking about the lifetime value of Amazon customers, it must have been weird leaving the realm of the theoretical dot-com business model.

But just that fact Blodget is covering Microsoft shows how the giant has to evolve. Microsoft's fate hinges on the Internet and Blodget is an Internet analyst. Of course, Microsoft's bread and butter is PC sales, but its future growth is tied to the success of .NET, X-Box and other new initiatives. These new businesses aren't guaranteed to work.

Luckily, Microsoft has billions of dollars to figure out how to make this Internet thing work. One change we'd like to see as Microsoft transitions from a PC-centric company to an Internet-centric one is more clarity. Microsoft's Net projects are often thrown into an "other" pile. We'd like to hear a bit more. TDAIN

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