Dot-Com Bargains Mean Mergers Ahead

A year ago only Internet companies could afford to acquire other Internet companies. A Yahoo Inc. could afford to spend US$5 billion on another dot-com, whereas traditional brick-and-mortar companies were left in the dust, under pressure to make an Internet play yet unable to afford to buy into the market.

But that may change over the next several months, according to experts who watch mergers and acquisitions in the Internet space.

"Now that Internet stocks are depressed, I'm expecting to see the revenge of the brick-and-mortar," says Tim Miller, founder of Webmergers.com, in San Francisco.

Indeed many dot-com companies are a bargain right now, reeling from the ongoing stock market correction that began in March. Doors to more venture capital money haven't been as open to the ailing dot-coms, either.

Traditional brick-and-mortar retailers, looking to maximize this year's holiday sales by tapping into the flow of online consumer dollars, may now do some shopping of their own.

"I think there's going to be a preholiday flurry in the e-commerce space," Miller says, whose company matches up distressed dot-coms with potential buyers. "We'll see a gradual increase in brick-and-mortars buying dot-coms."

So far, buyers of Internet companies have usually been other Internet companies because they could afford the high prices and already understand how Internet businesses work. For example, Amazon.com and Buy.com diversified their businesses by acquiring online retailers of many different goods and services: Amazon made an equity investment in WineShopper.com last April and a strategic partnership with Living.com in May; in August, Buy.com completed its acquisition of Telstreet.com, a purveyor of wireless phones, services, and accessories.

Dot-coms that formerly held dreams of big IPOs are now downgrading their hopes in the months since the markets have soured on their stock prices, making acquisition a more attractive prospect. Eighty-three companies, such as AltaVista and Kozmo.com, have withdrawn or abandoned IPOs this year and 98 others have used layoffs to cut costs.

According to Webmergers.com, a total of 45 dot-com companies have shut down this year, most likely because they waited too long before looking for a buyer; another 36 have been acquired or are for sale.

Perusing the bargain basement

A few brick-and-mortars have already begun their bargain shopping: British retailer Great Universal Stores acquired computer e-tailer jungle.com early this month for 37 million pounds ($53,846,065). Jungle.com, which sold primarily to IT departments, started hurting when the dot-com market collapsed. About 12 million pounds ($17,463,590) in debt, the company had boasted revenues of 75 million pounds ($109,147,425).

Another British company, Royal Ahold, provided the infusion of cash that Peapod, an online grocery service, needed to stay afloat by purchasing a majority equity stake in the stumbling dot-com. Royal Ahold owns several grocery store chains around the world.

German media giant Bertlesmann has also said it plans an aggressive acquisition strategy of dot-coms. One of the online companies it recently purchased is CDNow.com.

"In many cases it makes more sense for brick-and-mortars to buy rather than build their own because of speed to market," Miller says.

Acquisitions can also provide brick-and-mortars with access to staff, technology, and partnership deals, according to Elaine Ruben, president of EK Ruben, an e-commerce consultancy in Woodbury, N.Y., and chairwoman of Silver Spring, Md.-based Shop.org, a trade organization of online retailers. For example, a company that has a strategic agreement with AOL holds an important -- and potentially valuable -- asset that a buyer should take into consideration when contemplating acquisition.

"We explore a lot of partnerships that let us go into new markets," says Paul Pappajohn, president of e-commerce at JCPenney. "Partnerships can give us access to talent, new technology, a customer base, or a new business model."

Although the Plano, Texas-based retailer hasn't aggressively pursued an acquisition strategy, it is not something that they are ruling out, Pappajohn says, adding that the company is "always looking for opportunities."

You'd better shop around

Other analysts, however, believe that although pressure was on traditional retailers a year ago to create a Web presence, many of those brick-and-mortars have since made investments in their own buildouts and are no longer under the gun to get on the Web. With the pressure eased, they can be choosier shoppers.

"Brick-and-mortars will buy dot-coms, but valuations have to come down more," says Lauren Cook Levitan, a managing director of research covering e-tailing at the San Francisco office of RobertStephens, an investment bank.

"Companies are more likely to buy assets instead of businesses," Levitan adds. "As we get closer to Christmas, we'll see more of this."

For example, a traditional retailer may wait until a company's assets go up for auction after bankruptcy, then buy the company in its final death throes.

Brick-and-mortars should look carefully at what they are buying, Levitan says. If a company has been in trouble, most likely the good employees have already left -- and Web transaction figures don't necessarily indicate a devoted patron base.

"If a dot-com gives you free shipping and 25 percent off your first order, does that translate into a loyal customer?" Levitan asks. "Transactions do not equal customers."

Webmergers.com's Miller says retailers should be careful to check out a dot-com's assets before buying. Brick-and-mortar companies should look at the revenues, the customer list, the employee team, the technological infrastructure, and the size of the prospective customers list to help determine exactly what a dot-com will add to their own set of resources.

"You need to find a team that has worked together and that knows what they're doing," Miller says. "It's so hard to recruit nowadays."

On the other hand, Miller believes the time is now for brick-and-mortars to buy.

"It's clear that Internet companies are still doing the bulk of the buying," Miller says. "I would expect the number of brick-and-mortars buying to increase rather than decrease. We won't see valuations this good again."

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