Delaying the Inevitable

The trouble with survival strategies is they’re usually short-term,
designed to stave off imminent extinction while management frantically
casts about for some kind of turnaround strategy or, failing that, a
bolt of lightning.

But when neither fails to occur, the company in question soon finds
itself back on the ledge, peering down at a steep drop to oblivion.

That’s what I believe is the inevitable outcome of the merger between
limping e-tailers Onsale and Egghead.com. What began the year as two
struggling e-commerce companies will begin the new millennium as one
larger, struggling e-commerce company.

While the $400 million deal is being referred to as a merger of equals,
it’s a merger of weak equals. Egghead.com has had trouble getting
traction as an online seller of computer equipment since dumping its
retail stores almost 18 months ago. Revenue growth has been sluggish
compared to other e-tailers, and wasn’t going to get any better unless
the company cut prices, which would have further lowered an already
unhealthy gross margin.

After riding the Internet stock wave to as high as $40 per share early
this year, Egghead.com stock (EGGS) has fallen back to around $10, its
ballpark price during most of the moribund mid-’90s, when the company’s
bricks-and-mortar retail empire was atrophying.

Web auctioneer Onsale, meanwhile, was the subject of takeover rumors
itself earlier this month, with news reports saying that Amazon.com
might bid $30 per share for the company, a deal that would have been
worth $587 million.

Onsale was punished in April for missing earnings estimates as several
analysts downgraded (ONSL) shares. Though the stock enjoyed a brief spike
due to the Amazon.com rumor, it is trading today around $20 per share,
down from more than $100 per share in late November.

And revenue growth in Q1 was only 15% compared to Q4, and 69% above Q1
’98. Having waived transaction fees for its AtCost program, which offers
computer parts and software at wholesale prices, you’ve got to wonder if
Onsale can do anything to sufficiently accelerate sales and market share
in the hyper-cutthroat e-tailing sector.

Cash-poor Onsale supposedly benefits from the merger by gaining access
to funds from Egghead.com’s recent secondary offering — giving the
combined entity about $160 million in cash — as well as a better brand
name. But $160 million isn’t going to last long when your margins are
paper-thin and you’re spending heavily on marketing and promotions. As
far as branding goes, Egghead’s heyday was a decade ago.

The market reacted with appropriate indifference to the deal Wednesday,
as shares of both companies fell slightly, though Egghead.com
experienced heavier-than-normal trading activity. And Egghead.com was
downgraded by U.S. Bancorp Piper Jaffrey to “buy” from “strong buy.”

There will be similar indifference a year or so from now, when
Amazon.com, Microsoft, or some other giant buys up remnants of theunified company in a fire sale.


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