Joy Covey, CFO of Amazon.com Inc., isn’t one to stand still. Covey, who rode to her wedding on a snowmobile, decides to conduct the long-distance phone interview on the run. Rushing through Seattle traffic in pursuit of a double latte, she talks a mile a minute into her headset, drawing a few startled glances in the process. A leading apostle of the profitless corporation, Covey is getting used to surprised reactions. As she dodges other pedestrians, Covey expounds on her upside-down role as finance chief on the frontiers of E-commerce: growth first, profits later.
“It’s a different way of thinking,” Covey says. “In my case, it means thinking about a new kind of business model that hasn’t existed before. What we choose to do are the things that are most essential to the long-term leadership position [of Amazon]. By driving the efficiencies today, we would actually reduce the long-term value. It’s a lot about growing into– not cutting and trimming–and placing bets in the right places.”
Within a few days of the interview in late March, Amazon made a new bet, a move into the online auction business, crowding the space dominated by another E-commerce darling, eBay Inc. Validating Covey’s growth mantra, Amazon’s stock shot up more than 20 points following the announcement, pushing its market capitalization over $27 billion. This figure is for a company that famously lost $124 million last year revenue of $610 million and makes no promise of delivering profits in the near future.
Not all Internet finance chiefs are as defiant as Covey about short-term profit expectations, but there’s a long list of e-commerce companies leveraging revenue potential rather than net gains. Some Internet pioneers like Yahoo! and eBay are profitable, and proud of it. But in general, heading up finance at an Internet company means downplaying the traditional pillars and tools of financial management–like control, conventional performance measurements, or risk management. These CFOs embrace risk and rapid change, and much of their crucial work entails selling the company story to Wall Street or grabbing market share through acquisitions. Every one of them would agree that running finance in a .com company takes a very different head set.
And maybe a good pair of running shoes. Velocity is the unifying religion in the Internet space. Turn-on-a-dime changes in business models, sudden acquisitions, and rapid-fire partnerships shift the competitive landscape almost daily. Blink, and someone else will be there.
“Speed is life, as we say around here,” says Ted Philip, CFO and chief operating officer of Lycos Inc., whose aggressive acquisition strategy positioned the Internet portal company for its controversial planned merger with units of USA Networks Inc., a diversified media and E- commerce company. Last year, Philip helped Lycos make a handful of key purchases, including community site Tripod ($58 million) and search-engine company HotBot (part of an $83 million deal), that bumped Lycos from an also-ran to neck-and-neck contender for number one Internet portal with Yahoo.
“In the Internet, there’s a vacuum for time,” says Gary Bengier, CFO of Ebay. “I would say that technology companies move about 10 times faster than normal companies, and Internet companies move about 10 times faster than that.”
Bengier explains that when San Jose, California-based electronic auctioneer Ebay was close to acquiring community auction site Jump Inc. and its Up4Sale electronic-auction technology last June for $2.3 million, Ebay managers decided they needed to close the deal by the end of the quarter–just a week away.
But financial due diligence had not been completed, and the definitive agreement had not been hammered out. “Multiple teams were launched to complete financial due diligence, to negotiate the legal agreements, to [prepare for] a financial audit by our outside auditors, and to incorporate a new subsidiary in Ohio,” Bengier recalls. They got it all done, and in their spare time also managed to draft Ebay’s initial public offering S1 document.
That’s a leisurely pace compared with CyberCash Corp. When CyberCash, a Reston, Virginia, enabler of electronic payments for the Internet, decided it wanted to buy IC Verify Inc., a maker of software payment systems, it completed the deal (involving approximately $50 million in cash and stock) over a weekend. “We met for the first time on Friday evening, negotiated all day Saturday, and closed the deal on Sunday,” says CyberCash president and chief operating officer James Condon, who has also been serving as CFO. At a regular company, “if you take four days to make a decision, you’re doing pretty well,” says Condon. “If you take four days to make a decision at an Internet company, you’re a dead company.”
Of course, if you’re moving fast, you make decisions on the fly, out of the mold of traditional financial analysis. “That is the most challenging aspect [of Internet business],” says Dan Rabinowitz, CFO of online grocer Peapod Inc., based in Skokie, Illinois. “How do you make a sound decision with limited information?” He adds: “There is a time when you have to take a leap of faith.”
Due diligence, at least as practiced in the rest of the business world, takes a backseat. Amazon’s Covey says financial due diligence is not as critical in shopping for other E-commerce start-ups. “If we’re acquiring technology and people, then the diligence is about the people and the technology,” Covey says. “Their balance sheet may not matter that much.”
A Wild, Funky Ride
For now, Internet firms are engaging in a modern-day Gold Rush, where what matters most is who’s first to grab the most, and the most valuable, territory. When the dust in cyberspace settles, presumably the survivors will actually operate on a positive cash-flow basis. But these days, the profitless paradigm prevails.
And as Ted Philip learned, the challenge can be painful when Internet values collide with the hard-currency culture of a more traditional media company. When the Lycos/USA Networks merger was announced in February, Lycos’s stock plummeted 26 percent in a single day. The problem: Investors had bid up Lycos’s stock in anticipation of a premium from speculation about a merger, yet USA’s hard-bargaining CEO, Barry Diller, delivered what some saw as a discount. The infinite possibilities of an Internet company had suddenly landed with a thud with the prospects of a union with a safe, successful media cash machine.
A nonplussed Diller reacted by preaching practical profits. “The wild, funky ride that’s daily life on the Internet will be transformed by real businesses generating real profits in the course of providing real services that real people really need,” Diller told an audience at an Internet conference sponsored by Jupiter Communications in March. The common-sense approach didn’t work, and Diller backed out of the deal in mid-May.
Philip says Lycos has been a profit-conscious company. True, Lycos had a few profitable quarters before its buying spree, and analysts project the company will turn a profit in fiscal 2000. On the other hand, Philip’s road-show presentation on the company lists 10 objectives, none of which has anything to do with making a profit. And, in a statement that could be made only by a CFO in this particular industry at this particular juncture, he states, “It’s our fundamental belief that you can’t just lose money forever.”
But you can lose money for a long time with the support of the capital markets. In January, Covey helped Amazon issue a $1.25 billion convertible bond offering that pays 4.34 percent annual interest and can be converted into common stock with Amazon’s price at $156 a share. Says Covey: “Sometimes to have a lot of cash is the best way not to need it.”
An Apostle of Profits
Lycos’s rival in the Internet portal category, Yahoo, of Santa Clara, California, is a notable exception in the Internet sector, earning $16.4 million in the first quarter of this year on revenues of $86 million, on top of $25.6 million in fiscal 1998. Yahoo is expected to remain profitable in 1999 despite two major acquisitions, GeoCities ($4.6 billion in stock) and Broadcast.com ($5.7 billion in stock).
Yahoo senior vice president, finance and administration, and CFO Gary Valenzuela adds relatively short-term profit considerations into the company’s acquisition model, going after companies that are neutral or accretive to earnings within a year after the purchase. “We spend a lot of time understanding the business, running models, being conservative in our expectations, and then making sure [the acquisition] meets our objectives,” he says, “not only in growing market share, but also from the profit standpoint.”
Taking a position that is contrarian in Internet-land, and gospel everywhere else, Valenzuela says, “My mantra is: Profits do matter.” He adds, “We really did bake profitability into the culture. Early on, staff was given top line and bottom-line targets.” Yahoo, he explains, has been able to run a balanced model, one that invests in growth while giving a “fair return to shareholders. The further you stray from profit, the harder it is to find your way back,” he says.
Asked about the Amazon approach, Valenzuela says: “I have a healthy respect for Amazon. But they have a very different business model. They don’t enjoy 90 percent gross margins [as Yahoo does], so their model requires very, very rapid revenue growth. Yes, we’re growing our revenue rapidly, but given our model, we’re able to generate profits at a lower revenue [level].”
A Lot of Talk
The general absence of profits, or the remarkable multiples when there are no earnings, naturally puts the Internet CFO on the spot before Wall Street. “Traditionally, CFOs are concerned about getting enough analyst coverage,” says Ebay’s Bengier. “We have perhaps too much in riches on that score.” One can understand the careful attention. For much of the first quarter of this year, Ebay, which earned $2.4 million on revenues of $47 million last year, sported a presplit adjusted stock price of more than $300 and a price/earnings ratio of more than 4,000.
Bengier counts 12 analysts covering Ebay. Lycos has 20, and has yet to form an investor-relations department. (Philip shares the responsibilities with his vice president of finance and administration Tom Guilfoile.) “At the young stage our company’s in, we think it’s important that it come right from us, instead of the message going through an IR person,” Philip says.
Given that many of the E- commerce companies have a heavy retail base, with a lot of skittish stockholders, Internet CFOs have a lot of talking to do. “Investors tend to be smaller, and they tend to call a lot more quickly,” says CyberCash’s Condon. “It’s the nature of a booming marketplace and a lot of hype about the Internet.”
Another obstacle for Internet CFOs, says Philip, is the general lack of reference points in talking with Wall Street. “There are really no business models you can leverage off of,” he says. Moreover, he adds, at the same time Internet CFOs are coping with burgeoning interest from the investment community, they are also dealing with “hypergrowth,” where revenues and head count are skyrocketing.
Covey, who has been designated Amazon’s Wall Street point person, says that part of the company’s long-term growth strategy was to refuse to allow itself to be restricted by demands for short-term results. Covey says Amazon insisted from its inception that its “long-term value creation is so enormous that we want to make sure we have flexibility. [We said,] ‘Let’s be very careful about what expectations we set about profitability. Let’s not promise them something that we’re not absolutely sure we can deliver.’ We also said from the beginning that we’re not going to spend time thinking about the near-term stock prices, because our message is one that appeals to long-term investors.”
Eyeballs and Other Metrics
Valuations that defy common sense are supported by unknown potential and a new set of metrics. Amazon, for example, has a market value higher than all the bookstores in the world combined. Yet Amazon has ventured into compact discs, videos, pet food, and online auctions. Lesser-known companies, without Amazon’s revenue stream, also have amazing valuations. Theglobe.com, a Web site that creates Internet “communities,” has a market capitalization of more than $500 million on revenues of $5.5 million and a net loss of $14.7 million for 1998.
Theglobe.com’s CFO, Frank Joyce, can point to geometric sales growth–615 percent year over year. But more important, he can display one of the most important Internet metrics of them all– “eyeballs”–people who are habitual visitors to the company’s site, up from one million “unique users” in January 1998 to 9.3 million as of last December, according to Theglobe.com.
“Our business changes daily, and it’s my sense that in a year from now, we will have revenue streams that we haven’t contemplated today,” says Joyce.
Investors trying to make sense of many of these money-losing, but potential-laden, companies hunger for meaningful benchmarks to compare similar, competing companies. Certain standard measurements are emerging, such as unique visitors to a Web site, number of total page views, and number of registered users.
According to Media Metrix, a New York firm that tracks audience size on the Internet, there were 31.27 million unique visitors to Yahoo sites in March, slightly less than Lycos’s 31.91 million. Yet Yahoo’s acquisition of GeoCities, with its 21.3 million unique visitors, should make the new entity the king of the hill.
Media Metrix also measures average time spent per month and what it calls “reach,” or percentage of U.S. Internet users who visit a site. Amazon, for example, had a reach of 17.4 percent in March, an impressive figure given most of its visitors arrive with intentions to shop.
In a sector with a strong top- line emphasis, gross profit margins are a particularly telling indicator, says Abhishek Gami, an Internet stock analyst with William Blair & Co., in Chicago, because they display potential profit before inevitable marketing costs and acquisitions bleed the company. Both CFOs and analysts are increasingly focused on what Gami calls “cost per addition” (how cost-effectively a firm finds new customers) and churn rates (how successful companies are at keeping those customers).
But it’s not only metrics for outside consumption that Internet CFOs have to grapple with; it’s also finding meaningful benchmarks for simple internal needs, such as supporting traffic growth. “For instance,” says Joyce of Theglobe.com, “how much in IT spending will support x amount of page views? There’s really no one who can answer that kind of question precisely, as those kinds of metrics haven’t been developed. So you’re in uncharted territory in a rapid-growth environment, which makes planning interesting.
“We used to do five-year plans in prior companies, which were always a joke. And it’s even more of a joke here.”
Models of Efficiency
Onsale, an Internet auctioneer of closed-out computer equipment, in Menlo Park, California, radically altered its business model in a matter of months, explains CFO Labbett, by developing a companion site to sell new computers at cut-rate prices. “Figuring out the marketing angle [and] the engineering, getting the vendors lined up, and negotiating the agreements–the whole thing was done in three months,” he says.
A metric of particular interest to Labbett is sales per employee. Labbett arrived at Onsale from what he calls a traditional bricks and mortar retailer, House of Fabrics, based in Los Angeles, that had similar revenues, about $250 million. But with a total of 5,500 employees, its revenue per employee was about $90,000, Labbett recounts. At Onsale, with 200 employees, the figure is $1.18 million per employee.
“We had $100 million invested in inventory [at House of Fabrics]; we have $10 million here,” Labbett says. “In the finance department, I thought I had done a real good job of getting 130 people down to 70, and I thought we were really skinny.” Onsale, with close to the same sales, has 22 people working in finance.
Such efficiencies, especially compared with traditional competitors, and the ability of E-commerce businesses to grow without much corresponding cost, form the foundation for much of the Internet hysteria. E- commerce CFOs tend to adore their business models, especially their almost weightless and infinitely expandable qualities.
Of course, the speed with which a company can move into new businesses can be a double-edged sword. This same scalability–the ability to leverage existing infrastructure to expand–has enabled Amazon to expand its offerings and crowd into Onsale’s and Ebay’s auction space.
Nonetheless, Ebay’s Bengier remains enthusiastic. “This is the best business model I’ve come across in 20 years,” he says. “Ebay is efficient because of the things we don’t have to do. We don’t have inventory, we don’t ship product, we don’t have salespeople. We are not a capital-intensive business.”
On any given day, there are about 2 million items on sales through Ebay, which charges from 1.25 percent to 5 percent of the purchase price; its gross margins hover around 85 percent, clearly a factor in Amazon’s entrance into the category. While its margins are rich, one potential detriment to Ebay’s growth is the potentially limited supply of auction items, says analyst Gami, suggesting the company’s revenue stream may become stagnant down the road.
It was the fear of flattening revenues that drove Onsale into its AtCost venture. Largely dependent on an erratic supply of closed-out computers, strong computer sales deprived Onsale of enough inventory for its auction site. With AtCost, Onsale dove into retailing at wholesalelike prices–and the absence of bricks and mortar helped make it possible. “Frankly, if we don’t have to invest in inventory or receivables, we really don’t care if we sell $100 and make $10 on it or we sell $200 and make $10 on it,” says Labbett. “Our philosophy, particularly with AtCost, is that this is a transaction-oriented business. The more transactions we do, the more $10 we’ll get.” And there’s more than a transaction fee involved: there are also volume rebates from distributors, co-op money related to preferential Web-site product placement, and advertising potential from a more frequently visited Web site.
Gami says Onsale’s move to enhance its product line was sensible because it set up cross-sell potential with the auction site and gave customers a reason to return. “The value of someone coming to your site is not the first sale, it’s the second and third purchase,” says Gami. “If there’s not enough at your site, they won’t come back again.”
That’s a lesson Amazon understands well. With its emphasis on the customer and “the increasing returns cycle that derives from a great customer experience, Amazon is on its way to turning the classic high-service/high-price equation on its head, says Covey. “What we hope we can deliver is the best of all worlds,” she says. “We can have the best prices and use technology to bring a wonderful shopping experience.”
Striking it Rich
As the E-commerce sector matures, many innovative business models, despite their efficiencies, will be left in the dust. Internet CFOs at once face job extinction and extremely lucrative rewards from stock options. But the high risk/return ratio of the job isn’t a natural fit for some CFOs.
“If you don’t adapt rapidly in this environment, you will not survive,” says CyberCash’s Condon. “It’s kind of counterintuitive, because most finance people aren’t risk-takers by nature. I’m looking at a company that has enormous potential, but could fail. For some people, that’s a trade-off they don’t want to make. For me, it’s a trade-off I’m happy to make because I can make a difference here.”
Lycos’s Philip says when he joined the Waltham, Massachusetts- based company from The Walt Disney Co. in 1995, there was a sense of risk in the sector. But he saw an opportunity to “get in on what I thought at the time could be the next television, or the next car, or the next big invention; start a company from the ground up; and have as good a chance as anyone to build a big, successful company.”
Philip, along with some of his peers, has certainly been rewarded for having the brains and luck to be part of a sizzling industry. Valenzuela, who is a three-year veteran at Yahoo, filed to exercise options on some $37 million in stock within a 26-day period in February. “My philosophy is to have a regular pattern of diversifying,” says Valenzuela, “It’s just prudent financial planning.” Yet Valenzuela still has some 480,000 shares remaining.
Ebay’s Bengier, who joined the company about two years ago, recently filed to sell 70,000 shares of stock at more than $170 per share, a payout of about $12 million. Bengier has options for 1.5 million shares, more than 400,000 of which are vested, putting his current holdings in the company at about $80 million. Covey, who joined Amazon in late 1996, has also hit the jackpot, holding stock worth an estimated $125 million.
Philip, who has cashed out $7.9 million in options since April 1998, sees the Net space getting crowded with gold- diggers, convinced they’ve found the mother lode. He says people involved in the Internet early got into it because of the potential of the sector. “Now many get into it for the money. They just see the money,” he says. “Probably, at some point, this has got to end–when any company with a pulse can go public.” And many Internet entrepreneurs will learn that the sector is riskier than they had anticipated. Says Philip: “There are going to be a lot of skeletons out there when this shakes out.”
New and Old Metrics from the World of E-commerce
|Unique visitorsa (March 1999)||10.7 mil.||8.1 mil.||31.3 mil.||31.9 mil.||2.3 mil.d||1.7 mil.|
|Avg. minutes / month||13.1||130.2||67.7||18.9||8.7||24.4|
|Page views / day||NA||50 mil.||235 mil.||50 mil.||NA||1.2 mil.|
|Q1 1999 revenue||$293.6 mil.||$34 mil.||$86 mil.||NA||$3.2 mil.||$67.8 mil.|
|1998 revenue||$610 mil.||$47.4 mil.||$203.3 mil.||$89.5 mil.c||$5.5 mil.||$207.8 mil.|
|1998 net profit (loss)||($124.5 mil.)||$2.4 mil.||$25.6 mil.||($46.2 mil.) c||($16 mil.)||($14.7 mil.)|
|Gross margin % (trailing 12 mos.)||21.94%||85.52%||86.84%||77.93% c||59.37%||10.59%|
|Sales per employee (trailing 12 mos.)||$388,697||$546,239||$322,700||$196,252||$45,917||$1.18 mil.|
|Share price (April 30 close)||$172.06||$208.12||$174.69||$99.69||$60.12||$25.37|
aUnique visitors: number of unduplicated computer users who visited a Web site in 3/99.
bReach: % of total Web users in the U.S. who visited that site in 3/99.
cSecond half of fiscal ’98/first half of fiscal ’99.
dTheglobe.com disputes the figure from Media Metrix, claiming 10.2 million “unique users” as of last March.
Source: Media Metrix; companies
Can E- grocers Turn a Profit?
Not all Internet companies are rewarded while losing scads of money, even if they are marketing a hot concept. Peapod Inc., which sells groceries over the Internet in eight U.S. metropolitan markets, aims to remove the drudgery of supermarket shopping from the lives of busy professionals by delivering to their kitchens. Although Peapod has 70 percent share in the Internet supermarket space, this E-commerce pioneer has not enjoyed Internet-style stock buoyancy, trading in the $7 to $15 range in the past three months.
Unlike Amazon.com Inc., which can ship anywhere, Peapod, based in Skokie, Illinois, has strict geographic considerations when providing items like ice cream and eggs. It also operates in the notoriously thin net-margin supermarket sector. Peapod achieved margins of 6 percent last year on its grocery sales (compared with an industry average of about 25 percent). The company bolsters its gross margins through other revenue sources, such as membership fees, but lost $21.5 million on revenues of $69 million in 1998. Although revenues rose 21 percent, total membership declined year over year as the company revamped its distribution model.
One major problem was disappointing customer experiences from “stock outs,” or unavailable items, says Peapod CFO Dan Rabinowitz. “Our own success became our greatest obstacle,” he says.
To gain inventory control and drive efficiencies, Peapod has begun to adopt a central warehouse system, and is moving away from partnerships with local supermarkets, where Peapod personnel fill orders. In a warehouse, Rabinowitz says, Peapod can meet demand without the classic supermarket trappings, such as merchandising displays and appealing deli counters. “Because [the warehouse] is set up for industrial use, we can probably pump up the volume four times greater than typical retailers can,” he says.
Although Peapod doesn’t have cashiers and other traditional supermarket costs, it has its own built-in costs, including picking, packing, and delivery. The company should start seeing greater efficiencies from its warehouse model, says Arvind Bhatia, a senior equity analyst at Southwest Securities Group, in Dallas, who believes Peapod can achieve 22 to 23 percent gross margins on grocery sales by 2001. “But without having the right number of members, it’s not going to work,” he says.
With 95,000 members with median household incomes of more than $60,000, Peapod can leverage its high demographics, which demand “a product mix that can tolerate a higher margin,” says Rabinowitz.
The competition sees green in the massive potential of the supermarket sector, although others have also struggled. NetGrocer Inc.’s IPO was pulled back last fall when investors balked. The biggest threat may come from local supermarket chains that create their own online delivery systems. And, naturally, there’s competition from Amazon, which reportedly already has a stake in HomeGrocer.com, a Bellevue, Washington, company that services the Seattle area.
Who Are These Guys?
JOY COVEY, 35, soon to become chief strategy officer at Amazon.com Inc., joined the company as CFO in December 1996. With an M.B.A. and J.D. from Harvard University, Covey was a CPA at Ernst & Young and an associate at Wasserstein Parella & Co. before joining Digidesign Inc. as CFO in 1991 (until 1995). Just prior to joining Amazon, Covey was VP, operations, of the broadcast division of Avid Technology. Total stock options value: a reported $125 million.
GARY BENGIER, 44, CFO and VP, operations, of Ebay since November 1997. Previously, he was VP and CFO of VXtreme Inc. Bengier also served as corporate controller at Compass Design Automation, and held senior financial positions at Kenetech Corp. and Qume Corp. Holds options for 1.5 million shares.
TED PHILIP, 33, joined Lycos as CFO in December 1995 and has also served as COO since December 1996. Philip worked for The Walt Disney Co. from 1991 to 1995, where he served most recently as VP and assistant treasurer. Philip left an investment-banking job at Salomon Brothers in 1989
to attend Harvard Business School. Holds options on about 500,00 shares.
GARY VALENZUELA, 42, became Yahoo’s CFO in 1996. Previously, Valenzuela was CFO, SVP of finance and administration, and secretary of TGV Software Inc. Before TGV, he was SVP of finance and administration and CFO of Pyramid Technology Corp. Valenzuela, a CPA, holds a B.S. degree in business administration and accounting from San Jose State. At the beginning of 1999, he had grants for more than 1.35 million shares.
JOHN LABBETT, 48, has been SVP and CFO of Onsale since June 1998. From 1995 to 1998, Labbett was CFO of House of Fabrics Inc. From 1994 to 1995, he was CFO of The Petfood Giant Inc. He received his bachelor’s degree (equivalent) in accounting from the Institute of Chartered Accountants in England. Potential stock option value: granted options for 200,000 shares.
FRANK JOYCE, 46, joined Theglobe.com as CFO/treasurer in July 1998. Previously, he was CFO of Reed Travel Group, a division of Reed Elsevier Plc. From 1994 to 1997, Joyce was the CFO of Alexander Consulting Group. Granted options for 112,000 shares.
DAN RABINOWITZ, 36, joined Peapod as director of finance in 1995, and was promoted to CFO in 1998. He now serves as VP and CFO. He was associate director of Geneva Capital Markets from 1993 through 1995, and was director of finance at Technology Solutions Co. from 1991 through 1993. Granted options for 115,000 shares.
JAMES CONDON, 43, joined CyberCash as CFO in March 1997, and has served as its COO since March 1998, and as its president since January 1999. Before joining CyberCash, he was a director at KPMG Peat Marwick. From 1991 to 1995, he was corporate VP for financial planning and administration at Legent Corp. Granted options for about 255,000 shares.