O.C.’s Buy.com to Offer Public New Item: Stock

Heralding one of the most anticipated initial public stock offerings by a Southern California Internet firm, online retailer Buy.com Inc. on Wednesday filed plans to raise $150 million from the public markets.

The Aliso Viejo-based company is the fourth-largest Internet retailer by revenue and the largest one that is still privately held. The company, whose advertising slogan promises “The Lowest Prices on Earth,” pioneered the strategy of making money solely from selling advertising on its Web site. It sells its products at or below cost to lure traffic to the Web site. The idea has spawned an industry of computer giveaways, including free Internet access and computers.

But it’s an idea that has yet to show a profit. Over the past 12 months, Buy.com lost $93.7 million on sales of $459 million. The company’s strategy of selling at the lowest price possible meant that over the past year, the cost of the products it sold actually exceeded the amount of sales they generated by more than $4 million. In the past three months, however, Buy.com has reversed that trend.

“I don’t think it’s a sustainable business,” said Yobie Benjamin, chief global strategist for e-commerce at the Ernst & Young accounting firm. “They would have to have an immense amount of advertising to meet the requirements for profit.” Nonetheless, he believes the stock market is likely to embrace Buy.com’s offering.

The company, which was founded in 1997, appears to recognize that it may not reach profitability based on advertising alone. In its filing with the Securities and Exchange Commission, Buy.com said it has moved to a strategy of offering loss leaders to draw in traffic and promote the sale of higher-margin items.

“We have added higher-margin products to our stores and have also started to raise prices on many of our” wares, the company said. Buy.com appears to have implemented the strategy over the summer, and it has seen its margins rise without any decline in overall sales or customers.

Company officials declined to comment on the offering. In the SEC filing, Buy.com didn’t say how many shares it hopes to sell, or at what price. The company did say that founder Scott Blum, who resigned last month to form an Internet venture-capital firm with Japanese investment giant Softbank Corp., won’t sell any shares in the offering. Blum, 35, owns 56% of Buy.com.

Blum cut his teeth at Irvine-based Pinnacle Micro Inc., a manufacturer of optical drives that he and his father, William Blum, started in 1987. Although initially successful, the company ran into trouble and engaged in some allegedly questionable accounting practices that resulted in a now-settled class-action lawsuit and a federal regulatory inquiry into the company, the Blums and other executives.

Blum, who concedes he is not suited to run large companies, said last week that his stepping aside was not a prerequisite for the company’s initial public offering. Some had speculated that his troubles at Pinnacle Micro delayed the stock offering, which is a year late even by Blum’s predictions.

Blum handed over the reins of Buy.com to Chief Executive Gregory Hawkins, a former executive of computer distribution giant Ingram Micro Inc., Buy.com’s largest distributor. The company also last week brought in former Disney Corp. executive Mitch Hill to be its chief financial officer.

Analysts credit Buy.com’s management, with its experience in retail and distribution, for developing a new retail model that benefits from multiple revenue streams, while other online stores limp along selling commodity products at similarly negligible margins.

“It’s a very sound strategy, and it indicates a lot of smart people with very sound retail backgrounds,” said Allen Weiner, vice president of analytical services at NetRatings Inc., a market research firm.

“They’ve tackled the crucial issues of brand awareness and infrastructure, and infrastructure is 90% of the battle here. That means if you order it, you get it, and as farcical as that sounds, a lot of people aren’t getting that.”

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However, Buy.com has not executed that strategy flawlessly. It is facing two class-action lawsuits brought by customers who did not receive products they had bought.

Company officials said they have addressed those issues and point to a recent survey by Gomez Advisors, a market research firm, that ranks Buy.com No. 1 overall among online computer retailers.

In its SEC filing, Buy.com notes that more than half of its revenue in September came from repeat customers. By comparison, Amazon.com gets two-thirds of its business from returning shoppers.

But Buy.com’s growth in the number of shoppers has been substantial. The company gained 396,000 of its 1.3 million customers in the last quarter alone. Amazon.com has 10.7 million customer accounts.

Buy.com sells music, books, videos, computer games and consumer electronics, but the vast majority of its sales come from the first category it ever entered: computer hardware and software. That category accounted for most of the company’s growth over the past year.

The company’s pricing strategies have become more aggressive, not less. Its gross margin fell to 0.9% this year, down from 4.1% during the same period last year, as Buy.com cut prices even more to build brand recognition. It also began to offer products as loss leaders.

Key to Buy.com’s strategy is teaming up with a single distributor in each retail category to handle delivery, inventory and returns. Buy.com itself does not hold any products.

Almost all of the company’s distributors are related to one of the nation’s richest families, the Ingrams of Nashville, whose members control the country’s largest distributors of computer hardware and software, books, videos, DVDs and computer games.

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Buy.com Inc

* Business: Online retailer

* Headquarters: Aliso Viejo

* Employees: 196

* Management: Gregory Hawkins, chairman and chief executive; Mitch C. Hill, chief financial officer.

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Revenue:

1997* $878,000

1998 $125.3 million

1999** $397.6 million

Profit:

1997* -$390,000

1998 -$17.8 million

1999** -$80.5 million

* June to December

** Nine months ended Sept. 30

Source: Buy.com

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Top 10 Web Retailers

Here’s a look at the 10 largest Internet retailers, based on estimated revenue, for the 12 months ended July 31.

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Company Est. revenue, in millions EBay $1,100-1,300 Amazon.com 1,000-1,100 Dell Computer 500-600 Buy.com 350-400 Onsale 300-350 Gateway 250-300 Egghead.com 150-200 Barnesandnoble.com 125-175 CDNow.com 125-175 America Online 100-150

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Source: National Retail Federation