One Year Ago: Honeymoon Over for E-Commerce Pure Plays

A growing number of investors have come to believe that pure-play e-commerce companies are burning their cash at an incredibly rapid rate and that these firms will be forced to dilute their outstanding shares with expensive rounds of new financing -- or worse.

According to Barron's, such companies as music retailer CDNow, Inc., Internet commerce firms Pilot Network Services, Inc. and Secure Computing Corp., and online grocer Peapod, Inc. are the most at risk.

Of course, some industry analysts and dot-com executives claim that the report grossly overstates the possibility of an imminent shakeout. Moreover, the methodology of the original research on which the report is based, conducted by Pegasus Research International, has been called into question.

"Although we agree with some of the conclusions of the study, we believe the study was fundamentally flawed as it just extrapolated fourth-quarter 1999 results," Salomon Smith Barney analyst Glen Santangelo wrote in a research note.

Additionally, in published reports, VitaminShoppe.com chief financial officer Ann Sardini said her company is not expecting to run out of cash, even though the report forecasts that VitaminShoppe's cash supply will be depleted in about four months.

Burn, Burn, Burn

Meanwhile, the Barron's report shows that startups and smaller e-commerce entities are not the only companies that are cash poor. According to the report, 60 Internet companies, including such huge players as Amazon.com, will run out of cash within the next 12 months. Amazon will be tapped out in 10 months, the report claims.

Other burnout candidates are E-Loan at about 7 and a half months, eToys at 11.36 months, and Shopnow.com at approximately six months.

While the study measured burn rate, it did not take into account that these companies plan to stage additional cash infusions through new rounds of venture funding or secondary offerings.

So, while the study may be overstating the dangers somewhat, the impact on investors cannot be discounted. New funding does not come cheaply.

Many of these firms will be forced to issue debentures that are convertible into stock at discounted prices, which dilute outstanding shares and depress current stock prices.

Pretty Picture?

Even efforts to sugarcoat the report cannot alter the fact that the vast majority of dot-coms -- including such giants as Amazon -- are not anywhere near profitability.

The study also points out that some potential cash burn victim insiders have sold 25 percent or more of the shares available in recent secondary offerings -- making one wonder if they know something the rest of us do not.

Worth a Thousand Words

So, while analysts and CEOs who have vested interests in these companies are crying foul, it appears to me that Wall Street should simply be taking a close second look.

Perhaps the cover of March's Fortune Magazine best characterizes what many investors are beginning to fear.

The cover features a caricature of a smiling CEO of a dot-com company as he makes a toast. The caption reads: "Here's to the Internet! It's made me wealthy beyond my wildest dreams!"

At the bottom is a caption coming from an unseen person that reads: "But what about all the little guys? The ones who believed your story and bought your stock? They weren't so lucky, were they?"