HomeGrocer.com Puts Expansion in the Freezer

Online grocery store HomeGrocer.com(HOMG) is putting its fourth-quarter expansion plans in the freezer in what CEO Mary Alice Taylor claims is a response to the market's newfound taste for profitability.

The delayed rollout is part of a shift in strategy aimed at cutting losses and minimizing the costs of entering new markets. This is a sudden turnaround for a company that went public in a $260 million IPO only two months ago with forecasts of continuing losses as it builds out a national network.

"Change in the capital market prompted an intensive review of what they were doing and how they were doing it," said analyst Barry Stouffer of J.C. Bradford. "Given what looks like a tighter market for capital, it makes sense to conserve," he continued.

Taylor downplayed the delay in the fourth-quarter expansion, saying the company is still on target with its original plan of opening eight to 10 distribution centers this year.

Despite opening eight new distribution centers, the company is actually expanding into just six new markets. Already opened are facilities in Portland, Ore., Azusa, Calif., Carson, Calif., and Dallas. HomeGrocer's service was already available in Portland through its Seattle warehouse, and the Azusa and Carson facilities both serve the greater Los Angeles area. By the end of the third quarter, HomeGrocer will have new facilities in San Diego, Atlanta, Chicago and Washington, D.C.

Missing from the list is the San Francisco Bay area. HomeGrocer had planned to enter that market in 2000, but Taylor said the company postponed a move into the Bay area until after the first of the year. Competitor Webvan(WBVN) is spending aggressively to defend its home turf in that market, according to a HomeGrocer spokeswoman. Another online grocer already at work in the Bay area is troubled Peapod(PPOD). Given the competitive landscape, HomeGrocer has elected to hold off on the Bay area, instead concentrating resources on markets where it won't go up against other players.

"We have first-mover advantage in most of the markets," noted Taylor, formerly a vice president at Citigroup(C) and Federal Express(FDX). She joined HomeGrocer three months before it filed to go public.

To hasten and cheapen expansion, HomeGrocer has adapted its game plan to more closely resemble Webvan's. Rather than opening multiple facilities to serve a single metropolitan market, HomeGrocer has decided to expand the area served by individual warehouses.

"We would have opened two facilities in larger cities at once. Now each CFC will serve a larger geographic area," Taylor said. CFC refers to customer fulfillment center -- in other words, a warehouse.

"For a lot of markets, having just one makes sense. It will help them break even quicker," said Stouffer. He added that being able to demonstrate profitability on the unit level is important when HomeGrocer goes back to the capital markets to finance its further expansion.

With this month's opening of its Dallas facility, HomeGrocer will get its first taste of competition. Dallas is home to Groceryworks.com, a small Internet grocer that made headlines last month when Safeway(SWY) invested $30 million in cash for a 50% equity stake. Peapod also operates in Dallas, and Webvan has signed a lease in preparation for entering that market.

HomeGrocer will go head-to-head with Webvan for the first time when it opens its Atlanta facility this quarter. Webvan in turn will up the ante in HomeGrocer's home territory when it begins Seattle operations in October, and competition will be stiff in Peapod's stomping ground with both Webvan and HomeGrocer saying they will open facilities in Chicago this year.

Profitability remains elusive for the main online grocers. Peapod nearly went under in March after CEO Bill Malloy resigned and the company subsequently lost $120 million in promised financing. With only $3 million in cash, the company warned that it might not be able to continue operating while looking for more money. Royal Ahold(AHO) of the Netherlands came to Peapod's rescue in April, taking a majority stake in the company for $73 million.

Meanwhile, Webvan, based in Foster City, Calif., went public last November at 15 and now trades around 6 1/2. In the first quarter, the company posted a net loss of $38.7 million. The company had $540 million in cash on hand at the end of the first period.

HomeGrocer, at around 5 1/2, is trading at less than half its initial offering price of 12. Net loss for the last quarter was $35.3 million before stock-based-compensation charges. The company had $257 million in cash. By adjusting its game plan to generate operating profits more quickly, the company is hoping to conserve capital and reassure investors.

"We have recognized that what the market is looking for is both top-line growth and bottom-line performance," explained Taylor.

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