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The Theory Economy

How is it that the markets can value a company at $11 million when its total cash holdings are over $35 million?
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Commentary: The Markets

How could a company like Fashionmall.com sit on more than $35 million in cash and be valued at only $11 million? Here's how

In late December 2000, the value players started to show up at the Internet table. In the last week of the year, Fashionmall.com received not one but two takeover bids as its stock wallowed below $2 a share. The sudden surge in potential takeover activity drove Fashionmall's stock up to more than $4 a share before it settled at about $3 in January. But the stock-price fluctuation wasn't the big news about the company. The salient fact was that people were beginning to realize that Fashionmall, like many other Internet companies, was a legitimate bargain. As with other such well-known players as Stamps.com and eToys, the company was trading at a substantial discount to its balance-sheet cash.

Until the recent activity, Ben Narasin, Fashionmall's CEO, might have justly asked of Wall Street, "What's the big idea?" As of mid-December 2000, Fashionmall had more than $35 million in cash and marketable securities on hand, yet it sported a market value of roughly $11 million, based on its price of $1.50 a share. That share price seemed to defy the company's potential to operate as a profitable portal delivering traffic to its customers. "Our business didn't change at all the day we went public, but our stock did," says Narasin. "There were no significant changes in anything we said we would do and what we have done. It's absolutely fascinating to me that you can tell the market that you are going to do x, and then when you do x, the market doesn't care."

Narasin said he would build the customer base of retailers and advertisers without threatening the long-term health of the company. And according to Catherine M. Skelly, an analyst at investment firm Gruntal & Co., Narasin has done just that. "The company is living up to the expectations Narasin laid out when he was going public," she says. "He said he would drive traffic cost-effectively to the site, and he has."

How could such a company be so undervalued? How could conventional wisdom seem so unwise? The prevailing logic behind much of the Internet economy has been a set of nifty syllogisms in which everything that was once solid wisdom was replaced with an alternate universe of business value. Amazon.com's cyberpresence gave it the potential for nearly infinite inventory turnover, a prospect that dazzled analysts and gave the company the financial assets to go out and open a real-world set of distribution centers.

At the same time, qualities that once counted for something shifted to the negative side of the ledger. While dot-coms enjoyed a huge run-up in the stock market, old-fashioned companies with real products and real assets had to sit on their hands and watch the stock market pass them by. Part of that shift could be attributed to a new role in the market for idea-based companies selling the promise of profits in the new world. Consider such high-profile players as Priceline.com or any of the E-tailers that claimed they would reinvent the world of shopping. Time was when conceptual companies had to show sustained profits before seeking the financial validation of public markets. Losses were considered a definite drawback.

The 2000 markets, however, proved the opposite. The speculative shakeout that usually took place before companies went public was now happening in the public markets, says Amar V. BhidÉ, a professor of business management at Columbia Business School.

BhidÉ believes that the pack mentality among investors -- as demonstrated by a clustering of public offerings by profitless companies -- was spawned by a market that increasingly valued companies on intangibles rather than on profit. He cites the Netscape IPO, in August 1995, as a watershed event on Wall Street. At that time, the nascent software maker, which had just booked all of $12 million in revenues for its last quarter, went public at $28 a share and saw that price peak at $75 on the first day before closing at about $58, for a market cap of $2.2 billion.

BhidÉ notes that in valuing a business that has an online presence, many investors have based their assumptions on the theory that underlies a company's model rather than on the profits it churns out. "I don't know how a market could value companies under these circumstances," he says.

Dot-coms are still being valued on the perception of what their business models can produce. The only difference now is that conventional wisdom has swung around 180 degrees to completely devalue the promise of what these businesses might deliver. So a company like Fashionmall, which, based on its early history, has the ability to operate profitably, is now being valued at less than the sum of its parts. That's because when companies go public based on the power of ideas -- rather than on profits and cash flow and other such quaint figures -- the market for their business becomes that much more volatile. Business ideas are and will always be far more subject to the rules of fad and fashion than plain old-fashioned income statements are.


In an ironic twist, the way the market values Internet companies runs contrary to the promise of the Web itself.


In an ironic twist, the way the market values Internet companies runs contrary to the promise of the Web itself. The Internet promised to customize information for individual users, but Wall Street analysts are hardly analyzing Internet companies individually. Rather, most are assuming that one Internet company is the same as the next.

James Whitehurst, a vice-president at the Boston Consulting Group, recently completed a study on how to value Internet companies. He concludes, among other points, that for now the whole process remains a conundrum. "It will be 25 years before we really understand whether the value one puts on a bookmark on Internet Explorer should be more than what one puts on the corner hardware store," says Whitehurst. "A year ago the market said that the bookmark was worth a ton, and today it says that the same company is worth almost nothing. And that pendulum will continue to swing."

Inevitably, when the theory market ricochets so wildly, companies like Fashionmall will get hammered along with every other company that has a similar business model. When every other online retailer and portal sinks with the weight of perceived carnage, then so too must Fashionmall sink.

Pegasus Research, an independent New York City­based research firm, has come up with a list of 20 companies that, at press time, were trading at a significant discount to their cash on hand. Among them were dot-com players such as Mortgage.com, Quepasa.com, NetRadio.com, and Ventro Corp.

No matter. In order for Fashionmall to earn a stock price higher than its cash per share, it would have to cater to the prevailing theory on the street -- which is that both size and profits matter. Says analyst Skelly, "Scaling up is the only thing that would get investors excited." (That is, it's the only thing that Fashionmall could do on its own; the December takeover bids spurred a temporary increase in its stock price.)

But guess what? The only way to realize a big bump in visitor traffic would be to squander the cash that's keeping the company going. And so Fashionmall finds itself in stock-market cloud-cuckoo-land.

Prior to the takeover attempts, Narasin announced a stock-buyback program of up to 1 million of the 7.5 million outstanding shares. Not surprisingly, he saw a bargain in the cheap price. Now, with 46% of the common stock in hand, Narasin has the power to reject virtually any offer, though as CEO he has a fiduciary responsibility to consider an offer that puts a premium on the company. He hasn't seen such a bid yet.


With no fanfare and little venture money, the companies profiled here are delivering real stuff to paying customers and making a buck in the process. There may not be any "new rules," but there are rules, and we suspect every one of them will look familiar.

DVD Empire: The Bootstrapper
SitStay.com: The Mom-and-Pop
Shoebuy.com: The Scorekeepers
Accuship.com: The Traditionalist
Fashionmall.com: The Conservative
Healthcommunities.com: The Underwriter

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