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IPO Story
EXCLUSIVE INTERVIEW: Wine.com the Next Blue Nile? Chris Kitze is a veteran of tech. He founded Point Communications, which ultimately became Lycos, one of the hottest Internet companies of the Roaring 1990s. After that, he founded XOOM.com, which he also took public. His latest venture is wine.com., where he is Chairman of the board. Recently, Kitze spent time for an interview with Current Offerings. Current Offerings: Your latest venture, wine.com., looks similar to Blue Nile, which is one of the stand-out IPOs of 2004. Blue Nile caters to a higher-end demographic, but provides the consumer with lots of information and value pricing. In a way, is wine.com the Blue Nile of wine? Kitze: That is certainly one way to look at it -- others have called us the "Netflix of Wine" because of the recurring club model we are building. We certainly have a lot of respect for both Blue Nile and Netflix and admire the great businesses they have built. There are many similarities with Blue Nile that make wine.com. very attractive. First, we serve a high end demographic and many of these people already purchase online. Wine is also a difficult to purchase category, it requires lots of information and over half of all wine is purchased based on someone's recommendation. It turns out that selection and convenience are the main drivers for consumer purchase, but price needs to be fair. Like Blue Nile, you could probably go buy the same merchandise for a better price at Costco, but what kind of service will you get at Costco? Consumers need someone to show them the way on this kind of purchase. But I think there are a couple of things that actually could make wine.com. an even better business than either of those companies. First, we have a consumable item. Diamond rings aren't purchased every day and most people, with the exception of those marrying Elizabeth Taylor, won't need more than one or two in their lives. With movies, you generally watch them once and if you own the disc or have it in your posession, you can watch it multiple times without having to rebuy it. Once people start drinking wine, they keep drinking it and they will always need new bottles of wine and once it's empty, you have to buy again. Second, we have a very fragmented supply chain and competitive environment. There are thousands of wineries worldwide and hundreds of distributors. In the movie business, you have 5 or 6 suppliers and once you are successful, eventually, they will work hard to squeeze margin out of you and keep more for themselves. With many sources of supply, we should be able to maintain and even expand our margins as we aggregate the demand and become even more valuable to our supply chain partners. And the retailers are primarily Mom and Pops. The largest retailer, Costco, has about 6% of the retail wine market -- and those players are focused on physical retail, not services like gifting and clubs. Finally, wine as a product hasn't changed much in a thousand years. I don't expect Microsoft to announce Wine version 3.0 next week that will disrupt everything -- it's just not going to happen. And don't forget, we have a brand -- wine.com. -- that drives lots of free traffic that we don't pay a dime for. People hear our name and know immediately what we do -- you can't overestimate the value of that brand. We have licenses in 9 states to run a legal operation and that provides a barrier to entry as well. It's a big market ($22B in U.S. alone) without a lot of competition. And given the terrorism and economic recession threats in the world...people might end up drinking more wine no matter what. Online wine sales as part of the food and beverage category are one of the fastest growing categories, according to the latest report from Forrester Research. We have the leading brand and the #1 web site in terms of traffic. It hasn't always been easy, and we've been fortunate to have several predecessor companies who spent almost $200M and we have been able to learn from their experiences. We're excited about the opportunity and someday hope to follow in Blue Nile's footsteps in the public markets. Current Offerings: You have taken several companies from start-up to IPO � during the 1990s. What changes have you seen in the IPO market? Might companies look towards M&A;, because of the difficulties of going public? Kitze: I was involved in two IPO's from the earliest stages in the 90's; Lycos and Xoom.com (and the formation and public listing of NBC Internet from Xoom.com). All would be considered too early in today's market because neither had any earnings. In the case of Lycos, I think there were more bankers, lawyers and accountants at the org meeting than employees at the company! Most of what you see Google doing today was done by the original team at Lycos at the time of the IPO, it's just the scale that is 100x of what we had at the time because the Internet is a more mature medium and of course Larry and Sergey and their team have done a fabulous job with the technology and operating their business. Today, you are seeing the combination of growth with earnings as the formula for a public offering. So the times are definitely different. But there are always companies in any kinds of times that have successful strategies and need to either raise additional capital to grow faster or provide liquidity to their shareholders. I'll focus our discussion on these Internet and technology companies, as that is where my expertise is. Many of the companies from the Internet that are filing for IPO's today have been the survivors...the nuclear winter "cockroaches" that outlasted everyone else, controlled their burn, patiently adjusted their business models and survived until consumers and businesses adopted the Internet and their services. Many of these businesses focused on transactional models and hence are ecommerce companies. What many investors and probably your readers haven't truly understood yet is the power of these businesses models vs. traditional businesses. Blue Nile had $130M in sales and identical cash generation compared to the North American business of Tiffany's ($2B+ in sales). That is very powerful because the new models are able to eliminate two things all investors hate with retail businesses...real estate and inventory. The inherent automation and supply chain compression means that the sales per employee are far higher than what is possible in brick and mortar. And today, the Internet is one of the most cost effective vehicles to acquire new customers and this is a big, big advantage over the traditional retailer. These larger, dominant companies became complacent in the Internet bust, but they are going to wake up some day and realize that the upstarts are far better businesses to own when you look at the total return on capital. Dealing with bankers is much different today. In the "good old days", they would show up at your office with the analyst in tow -- that's over, and the analysts are basically independent now. But the need of Wall Street for more "product" has never gone out of fashion. The good news is that investment banks and bankers like to make money and they see a new opportunity. The phones are ringing again. Funds have billions sitting on the sidelines that need to earn a return and that fuels the need for new companies to go public. Not every company earns permission from the markets to go public. And right now, it's intimidating to go public. I talk to friends who have very good ecommerce companies that probably could go public and they don't want to. Running a public company is like adding a new product line to your offerings -- the equity in your business is for sale and you have a new sales channel called Wall St. to deal with. Not everyone enjoys that part of business, but for me that is where the real money is made for your investors. You also have to deal with the Sarbanes Oxley regulations (I call it "Sarbox" -- kind of like "Botox"). The auditors are fussy and people are just grumpy in general. But I think that's the same as it ever was and the operations haven't really changed for companies that operate in an above board, ethical manner in the first place. At my past companies, we wouldn't have changed very many company policies about insider sales, for example, or shareholder disclosures -- we already did that by the book. However, people are very risk averse, and that kind of situation makes having a public company that much more valuable because you provide a liquidity path for many companies that could otherwise go public. In today's environment, many of these companies are already profitable and the VC's got washed out or gave up (too soon in my opinion), so they are now owned by individuals, partnerships or families. These investors don't have the kinds of pressures to "go public" that the VC's had. With dividend tax rates low, in many cases it might make more sense to hang onto the business and take out dividends. The alternative is a private sale to a public company, but profitable companies owned by individuals don't feel compelled to get to a liquidity event unless there is some new competitive pressure or the partners have financial needs. In the ecommerce sector you are seeing companies that went public to get their owners liquidity. They don't need to raise capital, because they generate cash already, which is the irony of the public markets requiring companies to be profitable to go public. These businesses have not taken advantage of their public company status to accelerate their growth through acquisition and in my opinion have missed a major opportunity to make more money for their shareholders. Current Offerings: What kinds of changes have you seen in the venture capital community? Kitze: The traditional venture capital model is going to need to change and many of the VC's are very smart people and they realize this. The technology business as an asset class is maturing and more capital is now available for these growing businesses than ever before from places that traditionally would not have invested in these areas. The idea of backing a 28 year old Stanford grad isn't happening as much, as many entrepreneurs now have substantial experience and some of their own money. They just need money to grow their business and they can tap financing sources that didn't exist ten years ago at a lower price compared to traditional VC financing. These things have pushed down the returns at traditional VC firms and put pressure on the General Partners to look at areas outside their domains of expertise for a greater return. One thing I've noticed is the inability of funds to look at deals from a total return on capital perspective, as opposed to a "fixed" rate of return. Funds still value businesses with revenue, some profitability and management as if they were the proverbial 28 year old Stanford grad walking in the door with a business plan written on a napkin. They are searching for a 10x return and consider the IPO as the end of the story. Times are now different and these opportunities are being financed by private equity funds who think a 3-5x return in 18 months is just dandy and who view the IPO as a chance to own more of the company and grow the business even faster. I think it's going to be very difficult for some of the larger VC funds that don't have a Google in their portfolio to provide the returns their investors expect. When funds hit $1B, you have to do bigger deals and you are looking for "hits", just like the people in Hollywood. That one hit makes up for all the other zeros, but the risk of failure starts to go up. Another thing I have noticed is that these outsiders trying to get into Silicon Valley have realized that it is basically a "club". VC firms trade deals amongst themselves and are very insular and sometimes have interlocking directorships or investments. They all tend to invest in the same things, which of course increases the cost basis in their deals, and they tend to have a herd mentality, so anything outside the mainstream thinking gets missed. If you hire a prominent law firm there to represent you, because of all the business they do within this community, there are many, many conflicts and you end up wondering who they really are representing. I've heard this from numerous investors from the East Coast and they are concerned about being treated fairly in a deal. It's the old "if (fill in name of famous VC fund here) wants me in the deal, it can't be that good or they would keep if for themselves or their friends". This is going to have to change as the world becomes more earnings focused and access to New York money and capital markets becomes more important. You will also likely see a shift with VC funds starting to do turnarounds and restarts or taking on more mature businesses that may not have been previously VC backed. We ran wine.com. through what I call Chapter 10 (the chapter before Chapter 11 bankrupcy) and it was a lot of hard work. The potential upside could make it all worthwhile, but you can't have your white gloves and patent leather shoes on to do this kind of deal. It's nasty business and down and dirty -- most VC's think they are too busy with their portfolio of good deals to spend time on this kind of transaction (and it really is a lot of hard work), but I think in these kinds of times, you might make more money fixing things. We had to go to New York to get a good bankrupcy attorney for wine.com. -- most of the larger law firms based on the West Coast don't really have a bankrupcy practice except to "get rid" of non-performing companies in a portfolio for a VC. They look down at bankrupcy law, but it is an extremely important part of the business cycle everyone needs to understand. The East Coast firms have the experience of scraping serious rust off businesses and it shows. Roger McNamee's Silverlake funds have been spectacularly successful and I think that shows a way to make these deals work in the tech world. More fundamentally, in the ecommerce sector as an example, there is a mismatch of expectations of two different types of investors. Growth investors understand growth and are willing to pay for it with higher multiples -- they believe the companies will grow into and exceed these valuations because they have lived it before and made money doing it. They typically invest in infrastructure, not retail type deals although ecommerce has both components. Investors who buy retail type deals don't want to pay for the growth, they are looking at deals like their last brick and mortar specialty retailer where a 15% annual growth rate is good, but they are trying to get down the learning curve. When enough ecommercce deals have made people money, it becomes obvious and we're almost there, but the old VC dogs are learning new tricks. You can manage your fund driving in the rear view mirror only so much. Like any business where there is overcapacity, the strong VC's will survive and eventually thrive again. Current Offerings: wine.com. has continued to grow in a tough economic environment. What are some of the growth strategies of your company? Kitze: We doubled our business over the past two years mostly by fixing little things and I expect that to continue. I think there are still 100 one percent improvements left in our web site, the way we do CRM, etc., but that won't get the company public. But there are at least two other major opportunities for wine.com.. We are the last man standing in our category and we can use that to our advantage to drive significant amounts of traffic to our web site and profitably convert that traffic into revenue. There are partnership opportunities that need to be developed and we are now starting to do these with some very large channel sales partners. This alone has the potential to 2-3x the base business -- none of this has been done to date. You will see us doing a lot more business development work and partnerships going forward. This wasn't possible in the past because of the distress the business went through. We also have not done a great job on how we retain and cross and upsell our consumers. As an example, if you are a club member, we don't have an easy way for you to get more than two bottles of wine per month -- in fact, some of our members join two clubs just to receive more wine per month. Things like that don't require huge capex investment, just brain power, a little IT and execution to pay big returns. Any improvements in customer retention are huge when you look at the model and clearly we will expend cycles here. To accomplish this, we have made some major improvements to our team. We brought in George Garrick as the CEO. George has a great track record from places like AC Nielsen, Flycast and Placeware and he is worked quickly to enhance the team with sales, marketing, logistics and business development. He's real time, a real pro and understands the need to keep things moving -- and we have fun working together. And we are in the process of raising additional capital, which we will hopefully be able to announce soon. Current Offerings: What advice would you give new entrepreneurs about starting a company? No matter what the economy does, there will always be a need for new companies, new ideas and products and services. Big companies are structurally incapable of this kind of change and serving those new markets is the opportunity -- this is nothing new. But startups are never easy. I've done 5 now and about a year into each of them, realized all over again how difficult it is to change the world, even as a startup. You don't have the baggage of the past, but you don't have the asset base to work with. You have to hang on to your cash and build a business that doesn't require massive amounts of capital -- it just isn't available the way it was a few years ago. And that's OK. It think that makes for better thought out and run businesses since the discipline is there from day one. The business world is also running a little slower today, so we now have the time to be considerate and make better decisions and manage our risks more intelligently. It isn't for the faint of heart. I'll close with a fortune cookie I got the other day that I think says it all: "Risk may cause failure, but success cannot come without it." So true. |
