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THE DAY AHEAD: PeoplePC faces stiff odds

People say hindsight is always 20/20. Given that fact, you shouldn't find any reasons to buy into the PeoplePC initial public offering today. PeoplePC's business model sounds so 1999 -- sell products and services for less than you pay for them, boost market share and spend heavily to promote your brand.

The PeoplePC (Nasdaq: PEOP) saga could play out like a summer rerun -- you already know the ending. And it isn't pretty. This time next year PeoplePC, which provides cheap PCs and Internet services to the masses, will be awash in red ink and may be in need of funding. Sounds like a tired dot-com tune.

When you read PeoplePC's regulatory filings, you draw some quick conclusions:

  • PeoplePC's business model is familiar despite its gain-subscribers-through-corporations spin. Mix rivals eMachines (Nasdaq: EEEE) and NetZero (Nasdaq: NZRO) together with a dash of Buy.com (Nasdaq: BUYX) and you get the idea;

  • PeoplePC's heavy losses and big marketing budget will force it to raise cash about a year after its IPO;

  • The PeoplePC IPO may be an excuse for venture capitalists to cash out. (Disclosure: PeoplePC is backed by ZDNet shareholder Softbank);

  • A few individual investors will be left holding the bag.

Nevertheless, PeoplePC is planning to offer 8.5 million shares priced at $10, the low end of its already lowered price range. PeoplePC had initially planned to offer 11.5 million shares priced between $13 and $15. Chase H&Q, Robertson Stephens and J.P. Morgan are the underwriters.

PeoplePC has garnered a lot of media attention by inking deals with Ford Motor (NYSE: F) and Delta Airlines (NYSE: DAL). Under the pacts, PeoplePC would supply Ford and Delta employees with Net access, PCs and services on the cheap.

Sounded great, but PeoplePC reveals in its regulatory filings that it isn't making money off these pacts, which are just kicking off. In fact, PeoplePC subsidizes the Ford and Delta deals more than it does its service to individuals. Ford and Delta also get a truckload of PeoplePC stock, warrants and options for their time. The value of Ford's PeoplePC shares will jump nearly $100 million as soon as the IPO is priced.

Gee, I wonder why Ford and Delta picked PeoplePC over competitors Dell (Nasdaq: DELL), Hewlett-Packard (NYSE: HWP) and Compaq (NYSE: CPQ)?

In addition, PeoplePC has an accumulated deficit of $191.5 million as of June 30. For 1999, PeoplePC had sales of $3.4 million and a net loss of $66.3 million. For the six months ended June 30, it had sales of $18.9 million and a net loss of $107 million. As of June 30, the company had 113,000 members who bought a computer from PeoplePC and about 62,000 online members.

Here's the model that led to those financials. PeoplePC sells Internet access and PCs to "members" for $24.95 a month over a three-year term. The company hopes these members will become lifelong customers and buy from partners. PeoplePC will make up the difference via high-margin buying clubs and merchant deals.

But the company hasn't generated significant sales from merchants and suppliers. In fact, the company doesn't even track sales that occur between members and merchants in its buying club.

Meanwhile, PeoplePC spends willy-nilly on marketing. For the six months ended June 30, the company incurred $67.9 million in sales and marketing expenses. That sum includes a $26 million charge related to the warrants and rights granted to Ford and Delta and an issuance of preferred stock to Ford.

PeoplePC also has the costs related to providing a computer (including software), shipping, upgrades and peripherals and Internet access to its customers.

Simply put, PeoplePC is going public way too early. Given IPO investors are more picky, you'd think PeoplePC would go public once it gained more traction. And there's the rub -- PeoplePC needs cash. PeoplePC said it doesn't have enough cash to last 12 months without an IPO. With an IPO, PeoplePC's cash will last about 12 months. However, PeoplePC doesn't project profits until at least 2003, meaning it will need more financing in a sketchy market. Do you want to wait until PeoplePC turns a profit per subscriber?

"Without the net proceeds of this offering, our capital resources will not be sufficient to meet our expected needs for working capital and capital expenditures for the next 12 months," the company said.

Translation: We have to go public now whether we're ready or not.

"In the future, we anticipate the need to raise additional funds, which may not be available on acceptable terms, if at all," the company said.

Translation: We'll need more money so the company may be forced to seek those dreaded "strategic alternatives."

"If we are unable to raise additional funds as needed or the expected sources of additional borrowed funds are not available, our ability to operate our business will be materially harmed," the company said.

Translation: Don't come crying to us if this stock unravels. You've been warned.>