[SmartMoney] Burn Rates Goldman Style

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From: Linda (joelinda1@home.com)
Date: Fri Jun 23 2000 - 11:02:24 PDT

[This is why I've stopped listening to analysts, particularly if their
firm has been involved in underwriting the stock.



June 21, 2000

Burn Rates Goldman Style
By Cintra Scott

REMEMBER WHEN THE Street seemed fine with growth at any cost?
The future for money-burning companies (read: dot-coms) looked
sunny — as long as Internet investors kept the faith and
companies' kept solvent via the capital markets.

But that was before both faith and solvency were thoroughly
shaken by April's big tech sell-off. In hindsight, the first
rumblings clearly arrived in March, when a startling cover
story in Barron's predicted that 59 valuation-bloated companies
could go flat broke within the next year.

This week, Barron's revisited the topic — and bumped up its
list of imminent cash-burn casualties to 66. With the venture
capital and secondary-offering markets much more discriminating
these days, that's bad news indeed. (Disclosure: Barron's and
SmartMoney.com are half-siblings through our mutual parent,
Dow Jones (DJ).)

But not everyone agrees with Barron's analysis. Goldman Sachs'
Tonia Pankopf, an analyst covering vertical (i.e., subject-specific)
portal stocks, promptly questioned the Barron's article in a
research note Monday. Pankopf griped that Barron's study (which was
conducted for the magazine by Pegasus Research International) is
flawed because it extrapolates future spending based on the most
recent quarterly results — not projections of future cash-flow.
And her criticism is yet another example that speaks volumes
about the troubled state of Wall Street stock analysis these days.

Pankopf labels Barron's research "inaccurate cash-burn analysis
as it fails to reflect diminishing net-income losses" that will
gradually take hold as cash flow improves. The key here is that
Pankopf believes that many of the stocks she covers are "nearing
profitability," because there are good reasons to expect that
spending will decrease in the future and revenue will grow.

Her epistemological beef seems fair enough — spending on, say,
advertising and marketing might indeed slow significantly,
especially with the outlook as gloomy as it is these days.
Far more curious, however, was the list of companies she
expects to turn profitable soon. In the note she names
HomeStore.com (HOMS) along with three more troubled outfits:
iVillage (IVIL), Ask Jeeves (ASKJ) and LookSmart (LOOK).

Step one toward understanding those choices is to note that
Goldman was hired to underwrite three of those four companies'
recent stock offerings (all but Homestore, that is). Step two
is to see that the powerful investment bank has underwritten
many other out-of-favor Internet stocks, as well — mainly of
the business-to-consumer variety that are currently poison on
Wall Street. As the market pummels Goldman-underwritten e-tailers
and vertical portals like iVillage, AskJeeves, Ashford.com (ASFD),
1-800-Flowers.com (FLWS) and Webvan Group (WBVN), the firm's
analysts seem to work harder than ever to defend them to investors.

It's certainly in their interest to do so. But is it in your

Let's take a look at iVillage, a company Barron's estimates could
run out of money in 15.4 months. Goldman says that's wrong because
iVillage will become profitable by then, thanks to tempered
operating costs, and higher advertising sales and other revenues.
According to Goldman's cash flow estimates, iVillage will generate
a slim $2.8 million in cash in the quarter ending September 2001
(about 15 months from now), and another $6.7 million in the quarter
ending December 2001.

But even the Street's most optimistic iVillagers don't see things
turning around that dramatically. US Bancorp Piper Jaffray's Safa
Rashtchy, who rates iVillage a Strong Buy, thinks the company will,
indeed, turn cash-flow positive in the third quarter of 2001, but
he predicts about halfas much earnings before interest, taxes,
depreciation and amortization (Ebitda), or $1.3 million. Renowned
Internet bull Henry Blodget of Merrill Lynch rates iVillage a
near-term Accumulate/long-term Buy, but thinks iVillage will only
break-even by the third quarter of 2001.

While Blodget doesn't break 2001 Ebitda down into quarters, his
annual total — including the cash bleeding first half — comes to
negative $6.3 million, compared to Pankopf's positive $1.4 million.
And in his sweeping 330-plus page research tome titled "After the
Fall," Blodget explains that the portal's ability to ever achieve
profitability a "key concern" for investors.

Blodget's caution brings up an important point: A lot of things must to
go right in a very difficult environment for iVillage to turn its red
ink into black. Remember, this is a company navigating uncharted waters,
already plagued by questionable business decisions and with executives
jumping ship.

Pankopf, who was unavailable to comment for this story, argues that as
advertising spending slows in coming quarters of economic slowdown,
"market leaders" will get the bulk of what money is spent by other
dot-coms. Yes, she has built growing — not falling — ad and
sponsorship revenue into her cash-flow projections.

Meanwhile, she believes iVillage will be able pull back its own
spending on things like marketing and e-commerce initiatives,
without disrupting traffic or revenue growth. In other words, to
squeeze out that slim $2.4 million in positive cash flow in the
third quarter of 2001, everything must go iVillage's way. Its
marketing spending must be increasingly efficient, its wireless
initiatives must pay off…and so on.

It's worth noting that Goldman led iVillage's March 1999 IPO,
selling $87.6 million worth of stock, and led its $75.6 million
follow-on offering in October 1999. The two deals added up to more than
$11 million in underwriting fees — with the biggest share going to

Now, consider this: Goldman has rated iVillage a Market Outperform
ever since April 13, 1999, according to Briefing.com. On that day,
iVillage shares fetched $113.75 apiece. Those same shares are
now worth $7.38 apiece — 94% less. Did that fully sink in? 94% less.
That is not a market outperformer.

If Pankopf's burn-rate analysis sounds familiar to Goldman clients,
it's because fellow analyst Anthony Noto ran the same test for his
universe of e-tailing stocks on May 31. His methodology also used
cash-flow forecasts instead of Barron's more conservative approach
to estimate how long current cash stashes will last. Based on a
company's projected "path to profitability" and a number of other
"key success factors" (such as market size, operational efficiency
and management expertise), Noto then divided his e-commerce stocks
into three tiers, as noted in Tuesday's Wall Street Journal.

In Noto's top tier were Amazon.com (AMZN), Ashford.com,
Barnesandnoble.com (BNBN), eBay (EBAY), eToys (ETYS),
1-800-Flowers.com, Priceline (PCLN) and WebVan. But, as the Journal
pointed out, most of these companies have something in
common: every one except Amazon had hired Goldman to be its
IPO underwriter.

Noto defends his calls, noting that his research criteria are similar
to Goldman's investment banking criteria. In other words, Goldman
decides which companies' IPOs to underwrite using methodology similar
to the process Noto uses to decide which companies'stocks to recommend.

The Journal notes that Goldman client Ashford.com, for example, has
just $46.5 million in cash on hand. Ashford.com is rated first tier
by Noto, but its cash supply is far below the top tier median of
$291.2 million and is even below the third tier median of $60.2
million. ("The third tier companies may have difficulty surviving as
stand-alone companies," Noto noted.)

Similarly, Pankopf says that three of the vertical portal companies
that she covers face troubles. "Based on our estimates of operating
profitability, we expect Expedia and Snowball to face cash constraints
in [the third quarter of 2001, the first quarter of 2001 and the first
quarter of 2002], respectively, necessitating a capital infusion to
sustain operations," the report says. (All three were also
underwritten by Goldman.)

But given that Expedia is majority-owned by Microsoft (MSFT), is it
really so likely that they would run out of cash before an independent
like iVillage?

Clearly, Goldman has an interest in improving the aftermarket results
of its IPO clients. But if it isn't careful, its unrelenting optimism
about these stocks may become even more embarrassing. The Chinese Wall
on Wall Street has become famously porous. But when white
shoe firms keep recommending stocks this shaky, one wonders whether
the wall exists at all.

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