How Wall Street Stole E-Christmas

SAN FRANCISCO (01/04/2000) - Despite all the appearances of a banner Christmas season, online retailers got the cold shoulder from analysts and investors alike at year's end. How come? Many dot-coms ultimately couldn't satisfy customer demand. A Goldman Sachs-PC Data study revealed online sales dipped nearly 30 percent the week before Christmas, as sites could no longer guarantee buyers timely delivery.

Toy retailers had some of the biggest problems. Toysrus.com, for instance, couldn't promise Christmas delivery for online orders made after Dec. 10 and promised $100 coupons to customers who didn't get their toys in time. In general, analysts saw site hiccups, spotty selection and poor customer service as sobering signs that some dot-coms are not ready for prime time. And on the first trading day after Christmas, Robertson Stephens analyst Lauren Cooks Levitan downgraded the segment's star, eToys.

"The inability to fulfill orders shows weakness," says PaineWebber analyst Jim Preissler. "And that will be reflected in [sites'] gross margins."

Another early casualty was Value America, which last week said it would slash 47 percent of its workforce after fourth-quarter sales fell below expectations.

Also, Amazon.com was hit with a downgrade last week. First Call reported an analyst consensus rating of "buy" - down from "must buy" - on the stock amid whispers that its margins are falling.

Yet there was good news. Almost every dot-com retailer showed sizable revenue growth. Early Christmas sales figures hovered around $10 billion, according to trade association Shop.org. In some cases, online sales were four to five times larger than last year's overall tally. But traditional retailing stock stole some of the thunder, as companies in that sector reported sales jumps of more than 8 percent over last year - their best showing of the 1990s. Standard & Poor's Retail Index jumped more than 9 percent during the holiday period. At the same time, e-commerce bellwethers Amazon, eBay and eToys were all down during the same period.

Analysts caution not to read too much into the current downturn. They've seen this pattern before in the retail sector, where investors buy stocks ahead of the holiday hype and sell as the season ends.

Wall Street is certain, though, to hold online retailers to a higher degree of scrutiny. Until recently, investors measured success by assessing surges in sales, market share and customer counts. While good showings in those key metrics will continue to be essential, investors will also pay close attention to customer-acquisition costs, customer-retention rates and gross margins. And gross margin is the first place they'll look to see whether the dot-com's multimillion-dollar marketing campaigns paid off.

Companies whose gross margins suffer not because of operations but because they sell products at cost - or offer giveaways such as free shipping - are likely to be penalized the most. "The companies that miss on gross margins because of promotional activity will not get so much credit for their rise in sales," says Anthony Noto, a Goldman Sachs analyst.

Among the e-commerce companies whose stocks are down, however, eToys stands out. The stock, which hit an all-time low of $24.50 last week, has lost more than two-thirds of its value since its mid-October peak. Levitan downgraded it Dec. 27, citing that eToys' high customer-satisfaction ratings had slipped and that it might have to invest heavily in an additional East Coast distribution center, system upgrades and customer service.

Meanwhile, there are signs that the great e-commerce shakeout is already here, says Merrill Lynch analyst Henry Blodget. He points to the music category - in which Amazon has a market cap 90 times the size of its biggest rival, CDnow.

Furthermore, many second-tier online retailers are likely to see significant declines in sales in the coming quarters.

"Christmas is definitely over," notes Blodget.

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