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2HRS2GO: eToys never had a chance

    "We see a clear path to profitability. The largest of the quarterly loss is behind us. We're putting the stake firmly in the ground." -- eToys CEO Toby Lenk, April 27, 2000.

    COMMENTARY--eToys will mark the one-year anniversary of that proclamation with a fitting tribute for hubris: the company will shut down forever.

    The fate of eToys (Nasdaq: ETYS) has been obvious since December, perhaps evident since 1999, and probably inevitable since the company launched its Web site in 1997. Last night marked the last gasp, with the online company announcing that it will close in April and giving layoff notices to its remaining employees.

    Not that there were many left. Most workers were cut in January.

    I'm as guilty as anyone in thinking that eToys was doing everything possible to become successful. You can still argue that eToys put forth as good an effort as could be expected.

    Unfortunately, effort is meaningless if the basic idea is flawed. Pure e-tailers were founded on several false notions, many of which were delineated by eToys CEO Toby Lenk at various investment conferences, including one I attended last March. At the time, Lenk boasted of four "advantages" for eToys: online companies know the Internet, while traditional companies must learn new skills; online companies need not fear cannibalizing their own business; online companies attract the best talent; online companies aren't handicapped by the profit-and-loss accountability required of mature competitors.

    The first two points were irrelevant, because brick-and-mortar rivals learned rapidly.

    Old-time retailers quickly decided to eat their business online rather than have it devoured by someone else. Toys "R" Us (NYSE: TOY) acquired the skills needed by merging its online operations with Amazon.com (Nasdaq: AMZN). Other companies such as Kmart (NYSE: KMT) built their own operations, but used talent poached from failed or failing dot-coms.

    Lenk's latter points simply weren't true.

    An Internet company could only attract the best talent at the height of the bull market. In more sober times, Internet firms are less appealing than old-line companies, both for potential employees and potential shoppers.

    eToys underestimated the power of established brands and dismissed Media Metrix figures that showed the Web site of Toys "R" Us generating higher traffic during holiday seasons. Traffic doesn't equal sales, insisted eToys proponents.

    However, it does indicate brand popularity. During the busiest shopping days of the year, eToys never caught up to Toys "R" Us in that department.

    And eToys was not "capital advantaged," to use Lenk's words. It was Toys "R" Us, with hundreds of millions of its self-generated cash, that had the true capital advantage; Toys "R" Us had no need for further handouts from Wall Street.

    That's the big hurdle for any online company claiming a clear road to profits. Can you do it without another cash infusion?

    Lehman Brothers has been asking that question about Amazon.com (Nasdaq: AMZN) for the last several months. Amazon.com continually points to its increasing cash position--$1.1 billion at the end of the last quarter reported--but Lehman's bond analyst believes that is neutralized by the company's relatively large debt.

    Amazon.com insists it does not have to play Oliver Twist with capital markets. Whether true or not, the fact the company says it provides at least some measure of comfort.

    eToys, on the other hand, never provided that kind of cushion. On that April day when Lenk boasted of his stake, eToys CFO Steve Schoch admitted: "We are actively exploring opportunities to finance the company's growth until it achieves profitability."

    Most shareholders were savvy enough to interpret that statement as a sign to beam out. eToys' stock gradually drifted lower through the spring and summer, and it collapsed completely in the fall:

    So much for financing opportunities. The company was reduced to getting a $40 million loan from Wells Fargo.

    But a few eToys believers remained. Traders buoyed the stock for a moment after Thanksgiving, and as recently as this morning, a few folks on the Yahoo! Finance message board for ETYS were shocked ("ETYS will be DELISTED ??!") or still living in fantasy land ("Now there is only UPSIDE POTENTIAL"), hoping for a generous buyer that will take these worthless shares off their hands.

    Maybe the posters were joking. I hope so.

    If not, they live in a blissful world the rest of us can only hope to reach after we die. Until then, people have to deal with reality, pull up the dot-com stakes and clean up the campsite. 22GO

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