Stiff Competition Could Worsen PlanetRx's Favorable Prognosis

Although PlanetRx.com wants to be a pure Internet firm, its competitors are busily linking up lucrative partnerships.
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During the road show for

PlanetRx.com

(PLRX)

, the online pharmacy whose IPO was priced Wednesday night at 16 by

Goldman Sachs

, a potential investor asked CEO William Razzouk how many prescriptions the company had filled in the last month.

That's a standard question -- one that any traditional pharmacy would answer in a heartbeat. But Razzouk declined to comment, and his silence prompted the roomful of Wall Street professionals gathered at the

Four Seasons Hotel

in New York to break out laughing, according to one person who attended the meeting.

But investors who buy a piece of the IPO may not be laughing long.

Even with strong demand for the 6 million shares being offered, there are mounting reasons why PlanetRx may find life difficult as a stand-alone company.

At 16 a share, PlanetRx's market cap is $813.6 million -- not bad for a company that launched operations less than a year ago and lost $20,000 on $622,000 in sales for the six months ended June 30. Of course, nearly all Net companies have ridiculous valuations. With PlanetRx, the main trouble is that it's a loner in a business segment that's becoming increasingly about partnerships.

PlanetRx declined to comment, citing the quiet period preceding its offering.

Early entrants to the online pharmacy business like

Drugstore.com

(DSCM)

and

Soma.com

quickly realized that regulatory and insurance hurdles would be difficult to surmount without the aid of larger, more established players. Drugstore.com, which went public earlier this year with nearly four times PlanetRx's revenue, partnered with

Amazon.com

(AMZN) - Get Report

and

Rite Aid

(RAD) - Get Report

. Meanwhile, Soma.com sold itself to

CVS

(CVS) - Get Report

.

PlanetRx, by contrast, has insisted it can remain a purely online company, a strategy it reiterated during the roadshow. But its virtual nature only takes the company so far. Lacking a bricks-and-mortar partner, the company is building its own distribution system much the way Amazon has been forced to spend money on warehouses.

"PlanetRx's long-term Achilles heel is that they don't have an alliance with a real-estate channel," says John Ransom, a drugstore analyst with

Raymond James

, which isn't involved in the PlanetRx offering.

"As a stand-alone, they're limited," adds Irve DeGraw, who tracks IPOs as research director for

WorldFinanceNet.com.

For that reason, he expects PlanetRx shares to pop on their first day of trading but quickly give up those early gains. "I see it as a flip candidate," DeGraw says. "Grab it and sell it."

True, the company has signed portal deals with the usual suspects ranging from

America Online

(AOL)

to

Yahoo!

(YHOO)

. And while PlanetRx originally filed to go public without a third-party insurance alliance, it subsequently signed a deal with

Express Scripts

(ESRX)

, which will own 19.9% of PlanetRx following the IPO.

Yet those inroads pale compared with what incumbents like CVS can accomplish in a single stroke. Wednesday CVS said it had struck a co-branding agreement with

Merck-Medco

, a division of pharmaceutical giant

Merck

(MRK) - Get Report

. The deal, which gives CVS the exclusive five-year rights to sell over-the-counter drugs and personal-care items on Merck-Medco's Web site, acts as both a portal partnership and a managed-care alliance in one.

Rather than paying, say, AOL, millions to gain access to its coveted eyeballs, CVS gets to go fishing for Merck-Medco's 51 million members free of charge. At the same time, CVS tightens its relationship with one of the largest third-party insurers and makes it that much more difficult for smaller players such as PlanetRx to get a foothold. Merck-Medco customers will now have the option of picking up their prescriptions in CVS' 4,000 stores. And Merck-Medco will acquire as much as a 10% equity stake in

ProCare

, CVS' drug-therapy unit.

By contrast, PlanetRx's pharmacy-benefits manager, Express Scripts, has only 36 million members and is third behind Merck-Medco and

PCS Health Systems

, which Rite Aid is trying to sell.

News of the Merck-Medco deal sent CVS shares soaring 6 3/4, or 18%, to 43 13/16. Drugstore.com, meanwhile, saw its shares drop 4 3/4, or 11%, to 38 3/4.

Investors buying into the PlanetRx IPO may want to take two aspirin and call their broker in the morning.