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Value America Forges Ahead with its IPO

Forget everything you've heard since Monday about the death of Internet initial public offerings. Value America, a startup Web retailer whose investors include Microsoft (MSFT) - Get Microsoft Corporation Report billionaire Paul Allen, is plunging ahead with an offering slated for the week of Sept. 21.

The Charlottesville, Va.-based company, which originally filed to go public in July, filed a revised S-1 offering statement amid the market bounceback Tuesday. (As did


, an online auction site that

Goldman Sachs

hopes to bring public the same week.) Although the amended prospectus clears up earlier questions over Value America's accounting and financial performance, it appears that the company and its lead underwriter, the newly renamed

BancBoston Robertson Stephens

, are hoping that investor tolerance for high-risk Internet-related investments remains unabated. Not much else would explain the company's generous valuation despite concerns over Value America's internal accounting controls and its rapidly escalating costs.

Under the terms of the offering, Value America hopes to raise between $70 million and $80 million, less about $6 million earmarked for the underwriters and offering expenses, by selling 5 million shares in the range of $14 to $16 each. Assuming $15 a share, the fledgling online retailer is worth roughly $493 million.

Not bad for a relative Web newcomer. Value America launched its online store only last fall and started advertising the site heavily in February.

Value America's rush to embrace the public markets may strike investors as a tad hasty. The company has at least one good reason to go public by Dec. 19, 1999. If it doesn't, it will have to pay $57.7 million to buy back preferred stock it sold in June and last December at half that price.

Value America's $500 million valuation amounts to more than 68 times revenue for the first half of the year. By comparison,

Cyberian Outpost


, which offers a similar mix of merchandise at its online store, is trading at 16 times revenues for its last


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months, not six months. (Half-year information wasn't available for Cyberian Outpost, which went public earlier this summer.)

Obviously, multiples based on half-year or quarter-year revenues aren't the standard yardstick for valuing companies, but Value America is so new that it offers few other measurements on which an investor can hang his hat.

The company reports revenues of $7.2 million for the first half of the year, a gross profit of $103,000, but an operating loss of $12.5 million. A year earlier, in the absence of its virtual store, Value America recorded zero revenues and a $355,000 operating loss. In the first quarter of 1998, Value America reported revenues of $2.2 million, a gross loss of $200,000, and an operating loss of $3.6 million.

Still, the online retail market is expected to mushroom from $5 billion in sales in 1998 to more than $17 billion in 2001, according to

Forrester Research

. Not surprisingly, products like computers, software, entertainment, books and travel show most promise.

Value America aims to be an online superstore offering a wide variety of products. To get started, though, it's focusing on business and technology goods; 93% of sales in the first half of the year have been of goods from


(IBM) - Get International Business Machines Corporation Report







There are no barriers of entry in online retail, which is one reason why Value America is advertising heavily to become a household name just like

(AMZN) - Get Inc. Report

. The company is spending more than $1 million a month to advertise its store in newspapers such as the

The Wall Street Journal


The New York Times

. For the first half of the year, Value America spent $8.9 million, or 125% of its revenues, in advertising and marketing expenses. By contrast, when went public in the spring of 1997, income from sales exceeded its advertising and marketing expenses. For all of 1997, Amazon's advertising and related expenses were about one-quarter of sales.

But Value America has no plans to cut back on its advertising spending anytime soon. In its filings, the company says it expects to spend the bulk of the proceeds from the offering on advertising and promotion.

Don't expect Value America to heavily publicize everything in its closet. For one, Craig Winn, the chairman and CEO of Value America, also ran

Dynasty Classics

, a lighting manufacturer and distributor which filed for Chapter 11 bankruptcy protection in October 1993. In its September filing, Value America adds the extra detail that Dynasty ceased to be in July 1994, a publicly traded company. The assets of the company, which reported more than $90 million in revenues in 1991, were expected to be sold for about $5 million in 1994 to satisfy creditors, according to a press release at the time. Just the thing that potential shareholders love reading about.

Another detail that Value America may not publicize too readily is that certain weaknesses in its financial and accounting controls had been raised by its independent auditors,


. In its first IPO filing in July, Value America admitted that auditors were concerned about the company's "inability to determine product shipment dates and order statuses on a timely basis."

That wasn't all the bad news. Value America was forced to report: "...the Company's independent accountants determined these matters constitute a 'reportable condition.'"

The "reportable condition" term is not a good sign. It means, according to the American Institute of Certified Public Accountants, that the company's methods of recording financial data is so badly designed or operated, one can't be sure that transactions will match with the company's financial statements.

"For it to be a 'reportable condition' is a very serious matter," said Stephen King, a CPA who's president of

Virtual Growth

, an outsourced accounting firm that serves businesses in New York's Silicon Alley., in comparison, encountered no such warnings when it went public.

In the amended September filing, where Value America reported June 30 financial statements, the issue of "reportable condition" appears to have been resolved.

But the company's internal accounting controls are still not fixed. Value America discloses that its order fulfillment system is not fully integrated with its accounting system, requiring "manual effort to prepare information for financial and accounting reporting." Not a very reassuring admission from a high-tech virtual retailer.

However, the absence of any reportable condition in the latest filing is a good sign, said King, who hasn't examined Value America's financials. "It appears, on the surface, that management has addressed the issue, at least to the point where the outside auditors feel the financial statements can be fairly stated," he said.

Yet, the accounting disclosure "seems to imply that they might not have all their ducks neatly in a row," said Kevin Landis, co-portfolio manager of

Technology Value

fund at

Firsthand Funds

. Landis hasn't studied the IPO in detail yet but noted that investors want to be reassured that accounting problems will not be an issue.

Value America's accounting difficulties aren't often seen in an IPO statement, said Randall Roth, analyst with the

IPO Plus Aftermarket

fund. In his experience, though, such disclosures tend to come not from startup companies, but from roll-up companies that have made multiple acquisitions and have difficulty integrating accounting systems of the different firms they have bought.

"It's not terribly surprising that there are accounting system problems in a high-growth company," King added. "There's so much going on that management doesn't have time to pay attention to internal accounting systems."