Too many Web integrators, too few customers. Who's going to go down the drain?
Forget the rumors about future consolidation among public Web integrators. Despite some dirt-cheap stock prices, takeover bids are nonexistent and they may never emerge. More likely, the most critically ill companies simply will fade away.
To be sure, some Web integrators will continue to thrive. Companies like Sapient have managed costs, grown organically and maintained profitability. But some rivals overestimated their staffing needs and spent lavishly on business travel, and forgot to build a sales force.
Just last week, Razorfish hatched a plan to dismiss between 6 percent and 8 percent of its staff, according to sources close to the company. A Razorfish spokesman declined to comment.
Razorfish is expected to stay afloat, but other companies won't be so fortunate. "If a company is losing money on a sustained basis, it probably is at risk of folding up," says David Cumberland, an analyst at Robert W. Baird & "It's not an attractive property for a more established player because it would dilute that company's performance metrics and earnings per share."
Why buy a company whose main assets are its people? It's a lot cheaper just to hire away its best staffers, many of whom may have one foot out the door because their stock options are under water. Sources say Zefer, for one, has recruited dozens of employees away from public rivals in recent months. The privately held Zefer has canceled its IPO twice this year but expects to go public as soon as the market regains some momentum. In the meantime, "it's nice not to have to explain why our stock price has gone down 90 percent," quips Zefer president and CEO Bill Seibel.
So, which firms won't survive the raids? No crystal ball is completely accurate. But the most vulnerable firms, say analysts, are those with severely depressed stock prices, low market capitalisation, little or no cash on hand, negative cash flow, and flat or declining revenue.
Analysts say some Web integrators may get thrown off the Nasdaq, where most trade, if their net asset value or working capital continues to fall. Moreover, large institutional investors often can't own these stocks because their capitalization is too low to qualify for their investment covenants, and the companies' float--the number of shares trading publicly--is too small to take a position without owning the bulk of the firm.
Among the companies most at risk are US Interactive and Luminant, which are both trading below US$2 per share--down from 52-week highs of US$92 and US$52, respectively, say analysts. OAO Technology and Xpedior also are in dangerous waters.
US Interactive doesn't have enough cash on hand to pay an US$80 million note that's due in March. Proceeds from the interest-free note were used to purchase SoftPlus, a privately held B2B solutions firm last March. The note was supposed to be paid off with the proceeds of a secondary stock offering in April. But that offering didn't raise nearly enough money, given the market's sudden turn to the south.
US Interactive is now in the process of negotiating with the noteholders to extend the due date. A later due date is expected to come through because the lenders, who were the previous owners of SoftPlus, are now part of the executive team at US Interactive. One other thing US Interactive has going for it: Safeguard Scientifics owns 10 percent of the company.
Meanwhile, Luminant doesn't have much breathing room or outside support. It had only US$8.9 million in cash and short-term investments as of the end of June. Its cash flow from operations at the end of June was negative US$10.4 million, and its current market capitalization is less than US$45 million. Last month, it announced that Q3 will show a loss due to the shakeout among dot-com customers. Luminant will release its final Q3 results on Oct. 26.
Luminant recently announced a "100-day" plan to get the firm off of life support. It calls for a 7 percent cut in staff, travel reductions and other efforts to cut costs. Similarly, Xpedior last month laid off 16 percent of its workforce, reshuffled management and announced that it would take a one-time charge against Q3 earnings. The news slammed shares in Xpedior and PSINet, which owns 80 percent of the company.
Also under the gun is OAO Technology, which had only US$10 million cash on hand at the end of June--and a negative cash flow of US$2.1 million.
The company says it has been profitable for six consecutive quarters and is in the midst of a transition that could increase profits. OAO Technology is moving from low-margin operations, managing data centres and network systems, to higher-margin e-business solutions services. It also has a US$35 million line of credit from NationsBank to finance acquisitions.
Investors will get a clearer picture about the health of these four companies, as Q3 earnings are released over the coming weeks. All but OAO Technology have issued third-quarter earnings warnings.
