IS eBAY'S STOCK TOO RICH FOR YOU? THEN TRY ONSALE

The less-ballyhooed auction site has more to offer investors than simply a cheap stock price

When eBay ( EBAY) went public last month, it was Internet mania all over again. The idea that the speculative highs of the dear departed bull market were gone was laid to rest when eBay's stock rose 163% in its first day of trading, on Sept. 24. Since then, it has more than doubled to $83.50 on Oct. 28, altogether a rise of 364% in less than a month.

No matter how impressive the site may be, few people can keep a straight face while making the argument that a online version of a glorified flea market really merits the $3.4 billion market capitalization that eBay now enjoys. Even if you consider eBay more a classified-advertising vehicle than a retailing operation, as some analysts do, it's still hard to justify the current asking price for its stock.

However, another auction stock has been thoroughly overlooked during eBay-mania: OnSale ( ONSL), which went public in April, 1997, way back in the Cretaceous Age of the Internet. On Oct. 28 it was selling for $18.75, which gave it a price-to-sales ratio of about 1.5. The price-to-sales ratio of eBay is 31.9.

WHAT KIND OF COMPANY? OnSale has a lot more to offer to investors than simply being cheaper than eBay. But in order to analyze its value, it's necessary to correctly classify the company. First of all, it is in a completely different line of business than eBay. The latter is more at home in the newspaper sector than the retailing sector, since it makes its money from interactive classified-advertising revenue as opposed to selling merchandise. OnSale, on the other hand, is more of a discount closeout retailer, similar to clothing retailer Loehman's ( LOEH).

OnSale has the potential, however, to be far more than its bricks-and-mortar cousin. "In reality what OnSale is and does well, and has the ability to revolutionize, is closeout discount merchandising," says J.W. Genesis retailing analyst Barry Sosnick, who has a buy rating on the stock. "With discount retailers, it's all about the treasure hunt mentality. OnSale is able to take the treasure hunt atmosphere and magnify it because of the Internet. It becomes a treasure hunt on steroids." In other words, OnSale offers more than just cheap merchandise. It offers the thrill of an auction, which adds to the shopping experience and brings customers back for more.

So if online discount auctions are such a great business, why isn't OnSale drowning in competition? Because it has cash on hand. Although it isn't making a profit yet, and doesn't expect to until next year at the earliest, OnSale has been around long enough and has been able to tweak its auctions to generate enough revenue to be the big man on the block among auction sites. Its sales for the past four quarters are at least four times those of any of its competitors, which means it has more available cash, at least $60 million, to make merchandise purchases.

"Retailing is a capital-intensive business," says Sosnick. "Maybe not like steel, but in order to be successful, you have to have a lot of capital on hand in order to make opportunistic purchases. OnSale has plenty of capital." Its competitors don't have as much because they're still in their startup phase. OnSale has passed adolescence and is pouring its revenues into big merchandise buys and brand-building just as the buying public is gaining an awareness of online auctions.

MORE TRAFFIC. OnSale also benefits from the same we-were-here-first phenomenon that has made Yahoo! such a success. While other auction sites are trying to build brand recognition, OnSale already has more than 800,000 registered bidders and lures millions of eyeballs to its site each week. So when a company wants to unload a big shipment, OnSale can promise more traffic than anyone else.

OnSale still faces challenges, of course. For one thing, now is not a good time to be a computer retailer, which is OnSale's core business. "The PC pricing decline has really squeezed their profit margins," says Steven Frankel, an analyst with Adams, Harkness & Hill who rates OnSale a buy. But Sosnick points out that the company has weathered other computer pricing downturns. And although dropping PC prices are keeping the company in the red in the short term, the lower prices have helped accelerate revenue growth. In the third quarter ending Sept. 30, the company reported $58 million in revenue, a 130% increase over the same quarter last year. Sosnick also points out that when the pricing war ends, OnSale will be in a good position to make money. Analysts expect it to lose $0.14 per share in the fourth quarter and to earn $0.04 a share for all of 1999.

Analysts did a double-take when OnSale announced an increase of inventory on the third-quarter balance sheet, from $8 million to $13 million. But Sosnick still isn't worried. "Retailing analysts aren't scared off by $13 million in inventory," he says. "It's the technology analysts who didn't understand that number. It's such a small amount that it was probably just a last-minute purchase right before they reported their quarter."

The biggest caveat about this stock, though, is that no one should expect it to be another Yahoo! The business of selling closeout goods comes with very low margins. Even if OnSale were to corner the market and sell billions of dollars worth of merchandise -- an unlikely scenario -- it might still only command an operating profit margin of 10% or less. But if you like the idea of owning a leader in a fast-growing business, OnSale might make a more sensible investment -- right now -- than a highflier like eBay.

By Sam Jaffe in New York