Collateral Damage From Webvan/HomeGrocer

The conventional wisdom of the Internet era has been that the folks selling "picks and shovels" for the Web economy would survive long after the gold-rush thrill seekers went home. That theory certainly looked good this spring, as Internet infrastructure companies climbed out of the April Nasdaq crash, leaving their e-commerce customers in the hole.

But if you examine the details of Webvan's (WBVN Quote) acquisition of HomeGrocer.com (HOMG Quote) on Monday, you can see why the conventional wisdom may be due for revision. What Webvan CEO George Shaheen told analysts (and later the TV masses) about his postmerger plans should put fear in the hearts of anyone selling anything to any dot-com -- or Internetizing Old Economy company, for that matter.

In short, Shaheen disclosed that by buying HomeGrocer -- 1.076 shares of Webvan for each HomeGrocer share, a little more than $1 billion after Webvan's shares fell 16% Monday -- the company will be able to cancel $200 million of capital outlays by the end of next year. Webvan also said during its conference call that it will be able to save $20 million to $30 million in "headquarters and marketing expenses" during 2001 because of efficiencies gained by the combination. (It was a little weird later in the day when Shaheen deflected a question from CNBC about layoffs, saying that the combined company would be in a growth mode; saving on "headquarters" expenses is usually a euphemism for management layoffs.)

But what's important in today's lesson is that $230 million will not be spent on new distribution facilities, software programs, telephone lines, computers and the like. There will be other effects as well. For example, one, rather than two, major online grocers buying full-page ads in the San Francisco newspapers and the seven industry trade publications covering the so-called Internet economy. The budget for Internet-focused consultants just went down.

Investors should take careful note of this. It's hard to quantify just how much the brisk sales of Internet picks and shovels comes from all of those start-ups that, collectively, had budgeted billions for the stuff they needed to set up shop in cyberspace. But when they start disappearing or merely merging, those budgets evaporate. It can't be a good sign for companies such as Cisco (CSCO Quote), Oracle (ORCL Quote), Sun (SUNW Quote), Inktomi (INKT Quote), Akamai (AKAM Quote), Exodus (EXDS Quote), or even WorldCom (WCOM Quote), which does a nice business in Internet access through its Uunet subsidiary. Coincidentally, on Monday Scient (SCNT Quote) fell more than 20% after an analyst questioned its health precisely because two of its customers have already slid into bankruptcy.

Meanwhile, Back in the Grocery Aisles...

What does the Webvan deal signify about e-tailing? As my colleague Katie Hobson reported Monday, Webvan's purchase of HomeGrocer produces as many questions as answers. Surviving CEO Shaheen said he hadn't decided which business model will survive, Webvan's highly automated, large-scale approach, or HomeGrocer's less-capital-intensive, smaller-scale model. He said the integrated company will evaluate such matters as it goes, and will determine which approach is best in a given market. "As we go forward we're going to be looking at both business models," he said.

Of course, the world could get considerably worse between now and the end of the third quarter or the beginning of the fourth quarter, when the companies expect to close the deal. Shaheen said it will be six to nine months before the integration is complete. So during that time, all of Webvan and HomeGrocer's suppliers will be biting their fingernails wondering how decisions will be made. Privately held Bechtel, for example, which is building Webvan's distribution centers, likely is wondering if it really wants all that equity on which it loaded up before the Webvan IPO.

Investment bankers on both sides aren't losers, of course. They keep their fees from both companies' IPOs. What's more, they get to ponder ways to get the new Webvan more cash. Shaheen told CNBC "we'll have to be back in the [capital] market" in the second quarter of 2001.

Mary Alice Taylor, HomeGrocer's CEO, emerges a huge winner here. She'll be leaving the combined company. According to HomeGrocer's federal filings at the time of its IPO in March, Taylor purchased 1.5 million shares of HomeGrocer at 45 cents a piece, and she exercised options on 4.5 million options at the same price. Assuming she sticks around until Sept. 1, Taylor will be able to keep 3,125,000 of those options and Webvan will have the right to repurchase the balance. They loaned her the money, of course, so they'd simply be paying back their own loan. Even at about 7, Taylor's pretax profit of roughly $30 million won't be bad for a year's work. She joined HomeGrocer last September.

Reality Check on Inktomi

So, Jim Cramer's friends Buzz and Batch are upset because their shares in "Stinktomi" are down -- 18% in a day -- after Yahoo! (YHOO Quote) shifted its business away from Inktomi to a start-up with a funny name. And yet, Inktomi CEO David Peterschmidt tells TSC's David "Pulse" Shabelman that the Yahoo! business represented about 2% of Inktomi's annualized revenue.

What gives?

This sort of thing needs to be repeated over and over. At Inktomi's Monday morning market valuation of $15.5 billion, the search-technology-software company was grossly overvalued by traditional metrics, considering its sales for the last four quarters have been $129 million, and losses have been $16.6 million. Inktomi is barely profitable, and at Friday's close of 140 3/8 it was worth 638 times Wall Street's estimates of earnings for the year ending in September 2001. Guess what? At $12.7 billion, Inktomi remains far overvalued, again, by metrics that make any sense. Now, at 115, it's at 523 times forward earnings.

Stocks like this go up too much when investors are excited and fall too much when investors are disappointed. To say either that the news of the Yahoo! loss was overblown or that it's a sign of trouble to come is balderdash. This is just one go-go technology company that's still going. It is neither a value nor dead.