eToys Should Find a Partner

Despite quadrupling its third quarter sales, online toy seller eToys, Inc. has rattled its shareholders’ nerves by continuing to post significant losses.

eToys went public in May 1999 at $20 (US$) a share, and the stock zoomed to $76.56 on its first day of trading. The share price hit a high of $86 in October 1999 before plunging to $16.87 on Thursday.

The sell-off followed eToys CEO Toby Lenk’s remarks to analysts that the company plans to bring its distribution centers in-house — a move that many observers believe would increase its short term costs even more.

Heavy Losses Despite Skyrocketing Revenue

Lenk also revealed that eToys’ quarterly loss had escalated to $62.5 million — or 52 cents a share — compared with a loss of $8.2 million, or nine cents a share, one year ago.

Despite these heavy losses, however, many industry analysts point out that eToys’ skyrocketing revenue of $106 million easily eclipsed such rivals as Toys “R” Us, Inc. and KBKids.com, with $39 million and $30 to $40 million in sales, respectively.

Concern Over Costs

Still, while no one is complaining about the spike in eToys’ revenue, investors are clearly concerned about the company’s effort to spend money on distribution centers — regardless of the long term outlook.

Third quarter fulfillment costs were much higher than eToys had estimated, according to company officials.

Business Model Under Fire

Some observers are going a step further by asserting that the market’s sudden aversion to eToys is about more than concern over current losses.

These pundits contend that many investors are beginning to question whether pure-play e-tailers like eToys and Amazon.com will ever be able to turn a profit in the competitive e-commerce landscape.

Exacerbating the problem is the expanding cyber-presence of such heavyweight brick-and-mortar giants as Wal-Mart Stores. KBKids.com filed last week to raise $210 million in an initial public offering.

Even hapless Toys “R” Us, with its brand name and multiple offline locations, proved to be a formidable competitor during the holiday season.

Change of Direction

Some analysts believe that eToys must quickly forge a relationship with an existing brick-and-mortar retailer if it hopes to survive. The feeling is that it would be pure folly to build a distribution center in light of its mounting losses.

One suggestion is a union with Toys “R” Us. Certainly, this scenario seems far-fetched, but stranger things have happened.

However, I think that there is another option that makes sense for the e-tailer: eToys and Amazon.com could strike some sort of deal.

After all, since Amazon.com already has the warehouse and distribution centers in place, eToys could avoid the additional costs by merging with the e-tail giant. eToys would bring millions of loyal customers to the party.

Best of all, the companies would be able to accomplish together what has long eluded them individually: Make a profit.

What do you think? Let’s talk about it.