Investors Begin to Punish Money-Losing ‘E-Tailers’

How do you sell $1 worth of goods on the World Wide Web? If you’re EToys Inc., you spend $1.75.

In order to win Internet shoppers in the hotly competitive toy category, the Santa Monica-based company this past holiday season focused all its efforts on the basics: aggressive advertising, attentive customer service, speedy shipment of gifts. Nothing else, including profit, mattered.

The strategy is a much-tried but still-unproven one in the nouveau world of electronic commerce. But investors are hinting that the end of these lopsided days may be nearing.

Some Internet retailers’ stocks have been hammered in recent weeks as one company after another posts or hints at red-ink results.

EToys, which released its Christmas shopping season numbers on Thursday, met analysts’ expectations--sales quadrupled, losses grew eightfold.

But the company that made its name selling toys online, long before Amazon.com and Toys R Us did it, saw its stock sink 20% on Thursday in Nasdaq trading. EToys plunged $4.38 to an all-time low of $16.88, below its $20-a-share initial offering price last May.

The drubbing is a mighty blow for what was once one of the brightest stars of electronic commerce and Los Angeles’ flagship Internet retailer. The shares had traded as high as $86 just a few months ago.

But EToys is not alone. In the last few months, the stocks--and business prospects--of several big online “e-tailers” have been in a free-fall.

Beyond.com, a Santa Clara, Calif.-based online software dealer, announced last week that it would lay off 20% of its work force and its chief executive resigned in the face of growing losses. Virginia-based Value America, which sells a range of products online, cut its work force by half in late December. Its stock, which once traded as high as $74.25, closed at $5.06 on Thursday.

Now, some e-commerce experts and venture capitalists--the Silicon Valley financiers that fund these start-ups--are openly questioning whether costly promotions in the name of building Web traffic are worth the steep losses.

“As a venture capitalist, I want to fund the first mover,” said Warren Packard, a partner in Redwood City, Calif.-based Draper Fisher Jurvetson, which has invested about $500 million in 60 Internet companies. “Today there are too many ‘me-too’ sites with promotions that are misdirected.”

Philip Anderson, a professor at Dartmouth College’s Tuck School of Business, said: “EToys is a culmination of a process that has been going on for months--people are concluding that e-tailing is not the most attractive or lucrative e-commerce play. E-commerce is hot, hot, hot--just not this part of it.”

Others might soon learn that lesson. KBKids.com Inc., a money-losing online toy seller, filed for a $210-million initial public offering Thursday. The Denver-based company is owned by Consolidated Stores Corp., which also has a chain of mall-based stores, KB Toys.

Anderson warns that the amount of venture-capital funding going to e-tail businesses, compared with other Internet companies, has plummeted to about a quarter of what it was just six to eight months ago. That trend may be the canary in the coal mine, he said.

Among 47 publicly traded e-commerce firms tracked by Yahoo, only two are making money: Web auction king EBay and Gaiam Inc., which sells health and environment-related goods. Even sites that enjoy substantial customer loyalty are losing vast sums of money and showing little hope of turning a profit soon.

“In the year 2000, basic market rationalization will come back to e-commerce,” said Tom McGovern, chief executive of Petsmart.com. “The days when you can write a business plan and receive venture capital money to go out and promote your site like crazy--those days are gone.”

Indeed, the first round of consolidation in this infant industry already has begun. Mergers and acquisitions among Internet companies more than tripled last year to 1,416, from a mere 456 deals in 1998, according to Thomson Financial Securities Data. Thomson predicts there will be a minimum of 2,500 such deals this year.

What many of the online companies originally shared was Wall Street’s confidence, predicated on the idea that gaining loyal customers now, in the Web’s infancy, would be far easier than later.

Analysts say that belief in a first-to-market advantage could still prove valid. The question now is whether the older Web sellers can ride out Wall Street’s impatience long enough to prove it.

“This is the make-or-break year for online retailers. Consolidation is going to be one of the leading themes for the year,” said Joe Sawyer, an analyst with Forrester Research in Cambridge, Mass. “The killer combination is spiraling costs and difficulty differentiating brand.”

In the meantime, online companies are likely to continue to be dogged by skittish investors, pressure from shopping-comparison sites that find buyers an item at the lowest available price, and customers’ quest for service, an area in which most Web players have had little success.

As a result of these trends, many industry experts believe, a number of e-tailers will soon run out of capital and throw in the towel. Many of those that do hang on could be snapped up by Web conglomerates.

Although shares of many smaller Net-related companies have fallen over the last year, EToys is one of the worst-performing issues in the sector. Overall, the Interactive Week index of 50 Internet stocks is down only about 9% from its record high set early this month.

EToys, by contrast, has lost 80% of its value since its October peak of $86. With $219 million in cash in its coffers as of Dec. 31, the company doesn’t appear to be in danger of running out of money in the short term.

If its shares remain depressed, the company may be unable to raise money by issuing new stock.

That said, many influential financial analysts remain positive about EToys, in part because it hasn’t lost any more money than analysts expected.

Anthony Noto, an analyst with Goldman, Sachs & Co. in New York, said the slump in EToys’ stock on Thursday was less a result of its holiday sales performance and more related to concerns about expenditures down the road.

As the most-visited toy site on the Internet, and with features including gift suggestions by age group and gift-wrapping services, EToys remains a powerful player, he said.

“EToys was highly successful on every key measure,” Noto said. “But there is uncertainty about its inventory and how much it will have to spend on distribution centers.”

In a conference call from New York with analysts before the stock market opened on Thursday, EToys said it plans to bring all of its packing and shipping operations in-house, which could translate into higher expenses.

The company also announced that net sales reached $106.8 million for the quarter ended Dec. 31 and that operating losses, including charges, were $76.4 million, or 63 cents a share. EToys spent $36 million on seasonal advertising.

“I think the market will continue to fund the leaders, and EToys is a leader,” Noto said. “It’s still got a pretty lofty evaluation, trading at seven times its revenue. People still think it’s a company that has value.”

“Three years ago, everyone said, ‘Toby, you can’t do this. Everyone is going to beat you,’ ” EToys Chief Executive Toby Lenk said in a telephone interview from New York on Thursday.

“We’re still here. We’re still the leader. The fact is that we’re the only company that’s just the kids and just the Internet. That’s what will allow us to win.”

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Times staff writers Jube Shiver Jr. and Tom Petruno contributed to this report.