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These days, it's a challenge keeping up with the changing definition -- and business models -- of online retail sites. Even harder, especially for people such as Robertson Stephens' senior analyst Lauren Cooks Levitan, is convincing investors that some Web sites targeting consumers are more than smoke and mirrors. Business Week Online Reporter Stefani Eads recently discussed this volatile sector with Levitan over lunch in San Francisco. Between bites of tuna tartare, Levitan separated the few real gems from the fool's gold of 1999. She also assessed Amazon.com's challenge in the coming holiday shopping season, and what its deal with Toys 'R' Us to create a co-branded site really means. Here are edited excerpts of that conversation:
Q: You've recently renamed the focus of what your company covers as "e-consumer vs. e-tailing." Why?
A: The main reason [I changed the name] was that a lot of the companies I cover don't have the characteristics of retailers. When we coined the term "e-tailing" back in 1996, we wanted to say that e-commerce sites had to have the same strengths as good, traditional retailers in order to survive: They had to be able to build a relationship with a consumer, and they had to be able to pick product and merchandise it appropriately.
A lot of the companies I'm most enthusiastic about today don't have to do those things: right product at the right price. They've established platforms for exchanging goods and services. The best examples are eBay and Priceline.com. Amazon.com, for example, is a retailer with a portion of the business they're trying to develop as a platform. I still use the term "e-tailing" to describe a subset of my group, but the focus is on the consumer and not necessarily the retailer.
Q: What's the danger in labeling companies?
A: It's a huge danger. I try to avoid a lot of these labels because investors in the past couple of years have been investing by labels. Business-to-business (B2B) equals good. Business-to-consumer (B2C) equals bad. The reality is within all these categories there's going to be good management teams and bad management teams, good companies and bad companies. Fortunately, a shakeout is occurring. So within the next six months, we'll see people looking not for labels and themes to invest in, but for the good companies.
Q: So far, though, investors have followed "label" behavior. Do you really think they will change?
A: Over time, you'll see the best models emerging, and investors appreciating those models. The truth is in the B2C space broadly defined, there was massive overfunding. There was a distortion that cash created, and what we're now seeing is a cleaning up of that distortion. That's going to take some time, but while that's occurring, there's some new inefficiencies that are being created. Some good companies are being forgotten and left behind. A lot of these are small-cap names with fairly low cash flow and poor liquidity, so big investors won't go near these stocks now. That's also one reason why you'll see the problems prolonged for at least another six months.
Q: What do you think about Toys 'R' Us and its deal with Amazon to create a combined site?
A: Both companies clearly capitulated. Toys 'R' Us acknowledged that there was no way it was going to be able to continue funding its [dot-com] business. Management realized since August that it was going to blow it again this holiday season and needed another alternative. And, in many ways, Toys 'R' Us sold its soul to the devil.
Q: What do you mean?
A: The way the deal is structured. Here's the nuance a lot of people have missed, and it's the most important element: If you type in the [Web site address] www.toysrus.com, you go to this co-branded site. First, you've got to imagine the majority of the way consumers will get there will be through Toys 'R' Us driving them there -- through marketing in-store, or online. Once you get [to the co-branded site], a consumer might buy a product that Amazon is pushing that is not covered by this deal: children's books, children's software, certain educational toys -- all of these are items Amazon carved out for itself. Toys 'R' Us is shut out of these transactions.
So if you're Toys 'R' Us management, what incentive do you have to drive people out of your stores -- where you've got high-fixed costs -- and onto the Internet? Basically, you've got none. Now, if they're rational, they won't use their "Big Book" mailing, which goes out to some 30 million households, to drive traffic [online] this year. But I'm not sure they understand the risks created when structuring this deal.
Q: Do you think Amazon fears competing with eToys.com, despite its depressed stock price?
A: Amazon recognizes it needs to do everything it can to mitigate the factors that can erode its ability to demonstrate profitability. Amazon got creamed in the toys category last year. It took a big inventory write-down, and it didn't merchandise properly. That was painful. With so much scrutiny on its ability to generate profitability, a deal like this -- where it takes a hit on the top line but has fee-based revenues, which are more predictable in terms of inventory -- is something it recognizes to be in its best interest.
Q: Are investors missing out right now when it comes to online retail stocks?
A: It depends on the investor, but most noninstitutional investors shouldn't be anywhere near this stuff. A couple of months ago, before the crash, we identified three categories of e-tail companies. For the first one, we were saying, "Here's where it's worth looking for some bargains and investments." For the second tier, we believe there's something compelling in the brand, or the management team, or the relationships, but there's also something that makes it challenged. With the third group, we're saying, "Just stay away!"
Q: Are there any online retail stocks that are worth investing in?
A: Sure. But there's still a ton of risk and a ton of volatility in most of them. There are a couple of safe-haven stocks: eBay, Priceline, and Amazon. But I don't have a "buy" on Amazon right now, though I have a "long-term attractive," which is a "hold." The macro trends have never been better, and this holiday season will bear this out even more. The penny stocks such as FogDog.com or Pets.com are not going to be salvaged by any renewed investor enthusiasm. But other companies, such as Global Sports and Alloy, where there's an appreciation that they're doing something different, could benefit as long as they keep performing.
Q: What's the big investor risk going into the holiday season?
A: The news over the coming months is going to do more to scare people than to support [the market]. Everybody is waiting to see what Amazon does because they're looking to see if Amazon can be profitable. The fear is that if Amazon blows it, the whole sector will suffer. Unfortunately, that kind of decision-making is flawed, but it seems to be persistent across all retail sectors. I would argue that unless Amazon can get to the point where consumers expect them to have a specialty assortment as opposed to a big-box assortment, it's going to be impossible to have an efficient business.
Here's an example: I ordered some paper plates for $3.99, and apparently the only distribution center they were in was Delaware. But I ordered other things at the same time that came in a separate box from another distribution center. The paper plates came singly in their own box from Delaware. They don't have enough demand for some inventory to have it replicated in five distribution centers. At the same time, there's no way to optimize the inventory allocations and avoid those kinds of split shipments. They need real scale -- or they need to be rethinking their merchandising strategy in some of the categories that aren't going to be huge turners for them.
Q: So which companies would you bet on for the holiday season?
A: I'm encouraging people to stay focused on a very, very short list: eBay first, then Priceline. I'd look at Travelocity and Expedia in the first quarter of next year. Barnesandnoble.com probably gets interesting at these levels. In small-cap land, I would invest in Global Sports. And the risk-reward for Ashford.com and eToys is compelling, but it's for a very specific type of [risk] investor.
Copyright 2000, by The McGraw-Hill Companies Inc. All rights reserved.
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