Profits

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Investors Grow More Wary, but Earnings Still Not Key

Quick, how many local e-commerce companies are profitable?

The honest answer is, nobody knows. Most of them aren’t public and not obligated to disclose financials.

But a good guess would be few to none.

L.A.’s two most prominent e-commerce companies, eToys Inc. and Ticketmaster Online-CitySearch, both released their earnings last week and both are losing big money. For its third quarter ended Dec. 31, eToys reported a loss of $75.5 million (63 cents per diluted share), compared with a pro forma loss of $9.8 million (11 cents) in the year-earlier period. Ticketmaster.com lost $48.9 million (58 cents) for the quarter, compared with a loss of $16.9 million (26 cents) a year earlier.

Of course, any e-entrepreneur will say that to discuss profits at this stage in the development of Internet commerce is unfair, given that most of these companies are still staking their claims to space on the Web.

After all, goes the argument, companies in other industries start off losing money and only turn a profit after carving out a share of a given market. Starting a magazine requires a hefty amount of capital to attract the readership and advertising necessary to make an impact, and magazines aren’t expected to turn a profit for the first five years of their lives.

But only in the Internet world are six-month-old companies given $30 million in start-up money, only to go public and achieve billion-dollar market capitalizations by their one-year anniversary while still bleeding red ink.

On the face of it, it seems reckless to invest that much in an unproven entity, and there are plenty of old-school investors who keep shaking their heads. But few doubt the potential for online retailing, which has grown exponentially in the past few years. And given that no one knows which Web companies will be truly successful, investors are willing to put up the cash while things sorts themselves out.

“Right now markets aren’t putting a premium on profits, they’re putting a premium on other things, like revenues,” said Jon Funk, a partner at Media Technology Ventures. “It’s still a very open territory, and as long as you can grab more real estate, the harder it is for someone else to come in.”

Call it territory, real estate, space, market share, whatever. The need for these companies to get as much of it as possible continues to take precedence. Internet-savvy entrepreneurs and investors alike recognize that the vast majority of the e-commerce companies now in existence won’t be around in a few years.

“Profits are just part of the question,” said Sandy Climan, managing director of Entertainment Media Ventures. “It’s also how large can a business become.”

But there are signs that investors have become more rigorous in their evaluations of e-commerce companies.

The recent selling pressure of several high-profile e-tailers is one indication. EToys has fallen around 75 percent from its high since debuting last May amid concerns that it spent more on marketing than it needed to for the Christmas season.

Building brand loyalty is important, but if the cost for acquiring a customer is prohibitive, the business plan might not be all that it’s cracked up to be.

“Many companies are spending far in excess to acquire a customer than can be justified,” said David Sanderson, head of e-commerce for consultant firm Bain & Co. “The cost for acquiring a customer runs from $5 to $10 for Yahoo to hundreds of dollars for new companies. There’s no question there’s going to be a reckoning.”

But Sanderson also talks of the need to keep funding Web startups. Even if these companies never make money, larger companies may snap them up. Already, the market is seeing consolidation, in which young entrepreneurs are handing over the reins to more experienced executives who can take a company to the next level.

“There is such a frenzy to hire people with little e-commerce experience but with bottom-line business experience,” said Rohit Shukla, president of the Los Angeles Regional Technology Alliance.

Whether private or public, e-commerce companies acquired by larger entities have been fetching a pretty penny, giving their investors a terrific return on their investment. That’s reason enough to keep funding the new ones.

“The market, or investors in the market, have identified some very large opportunities,” said Jonathon Davidson, head of the e-commerce group at merchant bank Digital Coast Partners. “If you achieve these opportunities, you create exceptionally large valuations down the road. In most consumer categories there are two big winners and a lot of also-rans. In order to be one of those big winners, you have to spend money up front.”

Davidson and others see market expectations changing over the next 12 to 18 months, as results replace potential as the measuring stick. Meanwhile, many e-commerce companies will continue to find themselves showered with money despite having little more than a flashy pitch.

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