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Venture Public Offerings

Last Christmas, I had dinner with some friends. One of those friends, who was in his early 80s, was no stranger to the IPO world. He had taken several companies public during the 1960s and 1970s.

While drinking some eggnog, I talked to him about his IPO experiences (okay, even on holidays I can't stop talking about this stuff). He mentioned such things as the need of an IPO company having at least five years of 20% profit growth, a broad customer base, a large product line, and so on.

I was puzzled. These ideas seemed so foreign to me. I had lots of questions for him: What about revenue multiples? Mindshare? Venture backing? Strategic relationships? Burn rates?

Well, the fact is that the world of IPOs has been turned on its head. For instance, the time frame in which a company goes public is compressing at a rapid pace. For example, Hewlett-Packard (HWP) was founded in 1939 and went public in 1957. Microsoft (MSFT) was founded in 1975 and went public in 1986. Priceline.com (PCLN) was founded in July 1997 and went public on March, 29, 1999.

Some feel that this trend is a bad thing. Well, the fact is that our capital markets are highly sophisticated and can handle this. Also, if your company wont do it, another one will and likely overtake you.

The IPO market is transforming into, in a sense, a public venture capital market. Actually, I call these new-style offerings: Venture Public Offerings or VPOs.

A classic example of a VPO is Drugstore.com (DSCM). The company was incorporated in April 1998; on February 24, 1999, the company launched its Web site; and, on July 28, the company went public, as shares soared 178 percent amounting to a $2.1 billion market capitalization.

What are the factors for a successful VPO? Let's take a look.

Massive Market Potential: Drugstore.com is divided into the following market segments: Health ($16.3 billion), Beauty ($12.8 billion), Wellness ($9 billion), Pharmacy ($103 billion), and Personal Care ($23.5 billion). In fact, according to Forrester Research, 31.6% of Net users (who were surveyed) shopped for healthcare products during the past six months.

Virtual Solution: Can technology improve on the brick-and-mortar approach? Usually the answer is "yes."

Let's face it, going to the corner drugstore is not fun; rather, it's a chore. It can also be embarrassing (you know, as the clerk says on the PA system: "Can I get a price check on the condoms?") There is usually a limited selection of items. Finally, there are not many qualified employees to answer your questions.

At Drugstore.com, the experience is private, as you can ask questions via email, in virtual anonymity. A shopping list makes it easy to reorder items (drugstore items typically require much reordering). There is a wealth of information resources. And there's unlimited shelf space.

Venture Backing: VCs provide not only money, but valuable expertise, such as in hiring executive talent, building the company's infrastructure and finding strategic partners. Kleiner Perkins and Vulcan Ventures were the VCs.

High-Bandwidth Management Team: The CEO was a former VP at Microsoft. The Marketing VP was a director of marketing and business development at Microsoft. The company also has an impressive board of directors: Jeffrey Bezos, the founder and CEO of Amazon.com(AMZN); John Doerr, a partner with Kleiner Perkins; and Howard Schultz, founder and CEO of Starbucks (SBUX).

Strategic Alliances: To achieve speed, partnering is critical. It makes no sense to reinvent the wheel.

Many prescription drugs are sold through insurance programs. It would have taken Drugstore.com years to build this database. So, it instead partnered with Rite Aid (RAD).

What's more, brick-and-mortar partnerships tend to validate the online company making it more palatable for institutional investors.

There needs to be partnerships with online companies too. This not only helps with product distribution, but also eliminates potential competitors. This is why Drugstore.com selected Amazon.com (AMZN) as a partner and investor.

Conclusion

As an investor, to analyze a VPO, you must look at the company as a VC would. That is, you are not looking at a business per se; you are looking at a business plan.

But keep something firmly in mind: VPOs are fraught with risk. It is not for the faint-of-heart, nor for a big portion of portfolio.


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