eToys Fails To Impress Investors

Online toy seller eToys (ETYS)
released an earnings report before the market opened Thursday showing a
366% increase in revenue for the crucial holiday shopping quarter.

With $106.8 million in revenue for its fiscal third quarter ended Dec.
31 and figures from Media Metrix (MMXI)
showing it was the most-visited toy site on the Internet and the third
most-visited Web shopping site during the holiday quarter (behind Amazon.com (AMZN)
and eBay (EBAY)),
eToys has proven two things: 1) it can rise to the challenge of
increased competition, and 2) it is on the short list of e-tailers
winning the branding and traffic wars.

Investors aren’t seeing it that way, at least not initially. eToys
plunged almost immediately after the trading bell rang Thursday morning,
falling to 16 = — its all-time low – before 1 p.m., or 23% below
Wednesday’s closing price of 21 =.

It’s hard to believe that ETYS was trading as high as 86 a bit more than
three months ago, but with the exception of a brief November rally, the
company’s stock has been on a determined southern journey.

The slide started when eToys warned last fall that it would incur
higher-than-expected marketing and advertising costs during the holiday
quarter in order to maintain its market lead in the face of new
competition from e-tailer giant Amazon.com, bricks-and-mortar companies
Wal-Mart and Toys ‘r’ Us, and a number of other toy-specific e-tail
sites.

The very specter of increased competition was a huge drag on ETYS shares
during the quarter, despite a steady stream of weekly and monthly
traffic numbers showing the company’s site was outdrawing its rivals. In
fact, the entire e-tail sector performed poorly in the last quarter as
investors chose to wait for the numbers that count in January’s earnings
reports.

Now the revenue numbers for eToys are in, and if they fall short of some
street estimates of $110 million, they come close to equaling the
company’s projection for the entire fiscal year of $117 million.

Investors, though, are focusing on another set of figures in the
earnings report, which show a net loss of $75.5 million, or 63 cents per
share, compared to $9.8 million, or 11 cents per share, in the year-ago
quarter. Though the loss before deferred compensation and amortization
costs of $62.5 million, or 52 cents per share, met analysts’ estimates,
investors appear concerned that eToys is spending too much to maintain
its market lead.

It’s a valid concern, and one that continues to haunt Amazon.com. As an
uber-etailer, however, Amazon.com has far greater revenue potential than
eToys, which is trying to capture a more focused market.

At its current low price, eToys is valued at $2 billion, or 15x TTT
revenue. That’s about the same multiple as Amazon.com’s, and is better
than that of other larger-cap niche e-tailers such as drugstore.com (DSCM)
(37x TTM revenue) and Ticketmaster Online-CitySearch (TMCS)(32x).

If you like to bet on early-market leaders with strong revenue growth,
eToys is a relative bargain at its current valuation; investor
skepticism probably already has driven ETYS shares as low as they’ll go.
But barring a delayed post-earnings rally, it may be awhile before the
stock sho

ws strong upward movement.