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The market took Webvan's decision to buy rival HomeGrocer for $1.1 billion of stock as a hedge of the bet Shaheen and investors made on Webvan last year -- but it's more like a doubling down. With both Webvan and HomeGrocer last week reporting big revenue gains -- Webvan hit $28 million in revenues and HomeGrocer $29.8 million, with bigger gross profit margins for the second quarter -- the deal begins to look more foxy than crazy, even if it was rooted in a certain desperation: Shaheen says Webvan couldn't otherwise have easily raised the hundreds of millions it needs for expansion. "This deal was about a couple of things," says venture capitalist Peter Currie, a partner at Barksdale Group, which invested in HomeGrocer. "First, cash and access to cash. Two, it was about speed to getting big." The math was simple: Webvan had $600 million to $800 million left to build distribution warehouses across the country -- one each in most metropolitan areas Webvan planned to serve -- and only $420 million remaining from last year's IPO and private financing. HomeGrocer had customers in Seattle, Portland, Dallas, Los Angeles, San Diego, and Orange County, Calif., all markets Webvan hadn't hit yet, and they were generating more revenue than Webvan was. It also had an additional $160 million in the bank, thanks to doing its own IPO on Mar. 9, weeks before the window to the market slammed shut. "We had 26 of those [warehouses] on the drawing board," Shaheen says. Each one will cost between $25 million and $35 million. "It was clear we weren't going to be able to get that kind of money." HEAD-TO-HEAD The great thing about the math is that it looks exactly the same from HomeGrocer's Seattle headquarters as from Webvan's base in Foster City, Calif. HomeGrocer CEO Mary Alice Taylor, who was lured from Citicorp to dot-com land, knew her cash would only finance expansion into the first quarter of 2001. That was the same time Webvan would run out if it didn't make adjustments. So not only would both companies need cash but they would have had to compete for it head-to-head. That was the backdrop when one director from each company -- E*Trade Group chief Christos Cotsakos from Webvan's board and HomeGrocer's Jim Barksdale -- first discussed the possibility of merging the companies in early May. They were acting initially on their own, sources at both companies say, but the power to decide rested with Taylor and Shaheen. "I thought it was interesting," Shaheen says, recalling his reaction when Cotsakos told him of the conversation in mid-May. "Do you think it would work?" There was only one way to find out: Shaheen called Taylor on May 19 and arranged to meet at the Microsoft-sponsored CEO summit in Redmond, Wash., the next week. "It made business sense when we looked at where we were in our rollout and the markets we could get into without spending our capital," Shaheen says. "Plus we wouldn't have to spend money to compete against each other." Instead, both companies could focus on the land-based supermarkets that dominate the $1.5 trillion U.S. grocery retailing business. PRAGMATISM. The deal was announced four weeks later, with each side abandoning some of its core beliefs in the name of a new, market-enforced dot-com pragmatism. Webvan had scorned HomeGrocer's business model, saying its smaller, less-automated warehouses would never generate the efficiencies of scale needed to build a highly profitable large company. Among Webvan's advantages: It can schedule times for next-day delivery within 30 minutes, compared with 90 minutes for HomeGrocer, and it could offer both morning and afternoon delivery. But Webvan will keep using HomeGrocer's facilities in Dallas and California instead of insisting on its own model, saving up to $140 million in the short term. "Whether it's a HomeGrocer experience or a Webvan experience doesn't matter" under the circumstances, Shaheen says. "A lot of consumers love the HomeGrocer experience and just hope we don't screw it up." Shaheen has learned nothing if not pragmatism in his 10 months on the job. Webvan was the brainchild of bookstore entrepreneur Louis Borders, Webvan's founder and chairman. Shaheen was brought in to bring order to a company whose complex logistics could have bred chaos: His consulting background gave him the information management and logistics background to make Webvan as sensible as Borders was passionate. "My sense is that both the diagnostic approach and the ability to regroup quickly are something he's comfortable doing," says Taylor, who will leave the company when the merger closes, which is expected to happen by early in the fourth quarter. Shaheen admits to some big surprises. On the plus side, he says that after leaving Andersen -- which has revenue of about $10 billion a year -- he has been amazed by the extent of talent at smaller companies. The downside: He underestimated how hard it would be to persuade shoppers to change long-held routines and trust Webvan to squeeze the tomatoes for them. "It's human nature to assume the public will see it and they'll come," he says. BAG OF TRICKS. That said, consumers are starting to come faster. Last week Webvan reported that revenue rose to $28.3 million in the second quarter from $16 million in the first. Most of the gain can be chalked up to new operations in Sacramento and Atlanta, but average order size -- a key measure of the operating leverage that could make Webvan profitable one day -- rose in San Francisco. Gross margins increased sharply: to 28% from 25%. Perhaps more important is that HomeGrocer's gross margins hit 25% compared with 17.4% three months earlier, reducing concern on Wall Street that it would slow down Webvan's long-term profit prospects. Analysts say Webvan has to hit about 32% gross margins to have a shot at making money. But operating costs are rising fast too: Both the revenue and the company's per-share loss were significantly bigger than bullish Deutsche Bank Alex. Brown analyst Jeetil Patel had predicted two days before the announcement. Shaheen is reaching deeper into his bag of management tricks to drive toward profitability. Instead of having radio and TV ad campaigns in the same city at the same time, look for Webvan to do one and then the other. Look for more personalized marketing, including e-mail offers based on data mining of customer buying habits. That's a strategy Shaheen says is effective and cheap. The idea: to apply the coddling airlines give frequent fliers to loyal grocery shoppers. "We're getting better at it," he says. And don't be surprised to see Webvan move administrative functions to someplace cheaper than Silicon Valley as the company gets bigger, he says. NO ROSE GARDEN. Will it work? Depends on who you ask. Benchmark Capital, which funded Webvan's launch, says it's still the company in Benchmark's storied portfolio with the most potential. Opinion on Wall Street is mixed. The propensity of analysts to be positive about every company is neatly rebutted by Shaheen's admission that Webvan couldn't access the capital markets right now. Says Prudential Securities' Mark Rowen, who rates the stock a hold: "It's an extremely unprofitable business on the core level." Certainly the last quarter spooked many: Webvan stock fell sharply, erasing some recent gains, after pro forma second-quarter losses rose to $57.1 million from $17 million a year earlier. HomeGrocer lost just over $50 million. Unlike most dot-coms, Webvan's problem isn't heavy marketing spending -- it's the cost of running those huge, famously efficient warehouses. Webvan needs 3,500 orders a day to make cash flow positive at each warehouse. Webvan won't say how many it gets, nor will it break out warehouse costs, but it lost $75 million in the quarter despite spending just $10 million on sales and marketing. "No matter how good the management team is, if the business model is challenged, the business model usually wins," Rowen says. But Webvan, more than other dot-coms, didn't promise Wall Street a rose garden. Everyone always knew it would take Webvan a long time and more than $1 billion in projected investment to make money. The immediate aim is to have the Oakland warehouse turn cash-flow-positive in the third quarter, though Shaheen says it's too soon to tell whether Webvan will meet that goal. But the uber-suit has no regrets about his walk on the wild side. If Webvan takes just 2.5% of the U.S. grocery market over time, he has a $40 billion a year business, he says. That's four times Andersen's size, enough to make him shrug off the hiccups. "Business has never stayed the same," he says. And Shaheen's doing what he has to do to keep up. Mullaney covers high-tech finance for Business Week in New York |
