Sporting Big Revenue and Big Losses, Buy.com Prepares to Go Public

Buy.com seems to have what it takes: a dot-com name and solid growth. But some worry about the company's minuscule margins.
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SAN FRANCISCO -- Online shoppers may know

Buy.com

as a site that regularly sells gear such as

PalmPilots

below retail prices. Investors may find the company's IPO offers nearly as good a deal.

Buy.com boasts more revenue and customers than many of its publicly traded peers, despite having spent less money on sales and marketing. By skimping on those costs, Buy.com has been able to sell its wares -- which range from computer peripherals to videos to surplus equipment -- at cutthroat prices.

That trick has helped Buy.com grow quickly, but it has also meant steady, steep losses. As Wall Street grows increasingly disenchanted with the deferred profits of e-commerce companies, the pressures will grow for Buy.com to produce profits. That will mean the company must now pull off another, more difficult trick: beefing up margins without chasing away customers who have come to expect low prices from the site.

Buy.com plans to try to increase gross margins going forward by "raising prices," the company says in filings to the

Securities and Exchange Commission

. As a result, the filing admits, sales could decline.

Buy.com is used to surmounting hurdles. The Aliso Viejo, Calif.-based company filed for a $150 million IPO on Oct. 27, right as three analysts

downgraded

Amazon.com

(AMZN) - Get Report

because of mounting losses. Like Amazon, Buy.com expects to incur substantial operating losses for the foreseeable future. In retrospect, the timing seems boldly prescient. Amazon, which fell to 71 on the downgrades, has since recovered to 89.

At the end of the third quarter, 2-year-old Buy.com counted 1.4 million customers. That's 200,000 more than

Egghead

(EGGSD)

and nearly as many as the 1.5 million customers

Onsale

had accumulated in the 4 1/2 years before the two companies merged last month. And it's not far behind

Beyond.com's

(BYND) - Get Report

1.8 million customers.

What's more, Buy.com has managed remarkable sales growth. Revenue for the quarter ended Sept. 30 totaled $159.6 million. That's just $11 million shy of the

combined

revenue of rivals Egghead ($43.4 million), Onsale ($91 million) and Beyond.com ($36.6 million) for the same period. The merger between Onsale and Egghead was completed Nov. 19.

During the first nine months of 1999, Buy.com held spending on sales and marketing to just $44.1 million, amounting to just 11.1% of revenue. By comparison, Beyond.com spent $61.4 million, some 74% of revenue; Amazon.com spent $233.2 million, or 24.2% of revenue.

All those numbers are impressive, but by achieving them, Buy.com had to weigh down its margins. Between October 1998 and June 1999, Buy.com's cost of goods sold exceeded revenue from orders. Gross margins for the periods were relentlessly grim, ranging between negative 0.1% and negative 3.2% during those three quarters.

"It was their initial push and they can't survive long-term like that," admits Dan Ries, an analyst at

CE Unterberg Towbin

. Still, Ries is bullish on Buy.com. "They've got scale and effectively got their brand out there," Ries insists. "There is not a venture capitalist in the world who would not fund Buy.com's losses to date to have the business it's created." Because Buy.com hasn't gone public yet, no securities house has a rating on its stock.

Margins finally struggled into the black during the quarter ended Sept. 30, but just barely -- Buy.com posted gross margins of 0.5%. But even that margin seemed anemic by comparison to other sites.

Cyberian Outpost

(COOL)

had gross margins of 11.5%, Onsale 3.8% and Egghead.com 8%.

If recent IPOs are any indication, Buy.com won't fare too shabbily. In November there were 20 Internet-related IPOs, according to Richard Peterson at

First Call/Thomson Financial

. Eight have since doubled, and none is below its offering price, he says. "It's been a solid month," he says.

And Buy.com's IPO is being underwritten by some powerful cheerleaders:

Merrill Lynch

,

Hambrecht & Quist

and

Bear Stearns

.

But not everyone is convinced it's a sure thing. "If you have a model that is based on price, you'll never have loyal customers," says one hedge fund manager who used to short Onsale and Beyond.com, but no longer has a position in either.

Then again, sometimes it doesn't pay to discount market hysteria. "Investors don't care. They want to know if the stock is going up," says Gail Bronson, a senior analyst at

IPO Monitor

. "Anything with a dot-com is still doing well -- there's just an insatiable appetite for these IPOs."