Webvan: Financial Engineering, Net Style

Baldwin Louie — Mon, 18 Oct 1999 18:00:00 -0400

The Internet economy is peppered with companies that made it big, really big, at breakneck speed - Amazon.com (AMZN), eBay (EBAY), Netscape and Yahoo (YHOO), to name a few. But even in frothy Silicon Valley, Webvan Group has set a new standard in size and speed, propelled by an unprecedented frenzy of spectacular high-stakes strategic moves and investments.

It was only three months ago that the Foster City, Calif.- based online grocer, which was slated to go public last week with a valuation of roughly $4 billion, opened for business. Yet Webvan has already raised more than $400 million, signed a contract for $1 billion to build 26 massive distribution hubs around the country, attracted Internet luminaries to its board and hired the chief executive of the world's largest consulting firm, a man once in charge of 65,000 workers. While it has become routine for Internet companies to go public months or years before getting in the black, Webvan has had few sales, let alone profits. In fact, Webvan at this point is little more than a daring, huge and unproven idea - hitched to a bunch of vans.

"I've never seen anything quite like it," says Internet veteran Jim Barksdale, former CEO of Netscape Communications and an investor in Webvan rival HomeGrocer.com. "It's amazing. I think they've done a great job."

If nothing else, Webvan has been stellar at selling itself in what is arguably the most spectacular example yet of financial engineering, Silicon Valley style. Many of today's biggest technology and Internet companies are the result of innovative ideas that were nurtured with generous funding. But it's because Webvan's idea is so big and will consume so much cash that it stands as one of the boldest and riskiest gambles in Internet history.

Already, Webvan is surrounded by an aura of success - at least that was the case until last week, when the Securities and Exchange Commission forced the company to delay its initial public offering. The SEC was concerned about the disclosure of information in the company's road show that was not in the prospectus for the IPO.

Even so, few dare to really question the company. That's because the upstart has played the Silicon Valley game like a master, a game in which bold ideas dazzle, money breeds more money, and money from the "right" backer is worth more than just plain cash.

Founded in December 1996, Webvan is the brainchild of retail veteran Louis Borders, former chairman of Borders Books. Borders set out to turn the grocery business on its head, promising convenient home deliveries within a 30-minute time frame. He hopes to fulfill the promise by building massively automated warehouses that trim real estate and labor costs, boosting the grocery business' razor-thin profit margins. But Borders has hinted that Webvan's endgame is to deliver much more for customers and investors. If local grocery distribution works, Webvan's fleet of trucks could be carrying everything from videos and pizza to clothes from the dry cleaners. In that sense, Webvan could become a new type of company, as much a FedEx as a Safeway.

By the time it started to get press early this year, Webvan had raised $122 million from top Silicon Valley venture-capital firms such as Sequoia Capital (dossier) and Benchmark Capital, along with Softbank, Knight Ridder (KRI), LVMH and CBS (dossier). Borders spent nearly half the money to build a massive 330,000-square-foot warehouse in Oakland, Calif., that's equipped with more than 4 miles of conveyor belts that automate picking and packing of everything from lettuce to bar soap. Webvan opened for business June 2, its van fleet bringing groceries to about 10,000 homes in the San Francisco Bay Area. Deliveries are free for orders above $50.

The buzz grew louder just a month later, when the company announced an order with the Bechtel Group (dossier) to build 25 more warehouses around the country based on the design of the Oakland facility. The price tag: a cool $1 billion that the company didn't have. Two weeks hadn't passed before Webvan raised more admiring eyebrows, and more cash. The company sold a 6.48 percent stake for a whopping $275 million to Softbank, Sequoia and Goldman Sachs.

Back in the early days of the Web, spectacular IPOs like Netscape's and Yahoo's became marketing events. Overnight, obscure startups turned into household names. With everyone in the Internet Economy hoping to pinpoint the next blockbuster success, the marketing opportunities are coming much earlier than the IPO. As such, financing on the scale, and pedigree, of Webvan's is more powerful than just about any ad campaign.

"Those are pretty smart people who have put together those numbers, and we would be stunned if they hadn't properly run the numbers," says Terry Drayton, president and cofounder of Seattle-based HomeGrocer, echoing a sentiment that drives much of the bull-market psychology.

Two weeks after signing the huge private investment round, Webvan filed for a $345 million public offering - one of the largest this year - led by Goldman Sachs. Other underwriters include Donaldson Lufkin & Jenrette, Merrill Lynch (MER), Robertson Stephens, Bear Stearns, Deutsche Banc Alex. Brown and Thomas Weisel Partners.

No one is saying Webvan is merely hype. The company has amassed a top-notch management team, capped by its recruitment last month of George Shaheen, former chief executive and managing partner of Andersen Consulting (ACN). Its board includes CEOs Tim Koogle of Yahoo and Christos Cotsakos of E-Trade, as well as venture capitalists Mike Moritz of Sequoia and David Beirne of Benchmark. In three months its customer base doubled to about 20,000. Like many Internet companies, Webvan's most abundant asset is its potential. And even Webvan's competitors call the opportunity "huge."

Still, success is by no means guaranteed. Although Webvan has racked up plenty of happy customers in the wired and affluent San Francisco area, it is unclear whether online grocery shopping will ever gain mass appeal. So far, sales have been miniscule: less than $400,000 for the six months ended June 30. What's more, the logistics of timely local deliveries are far from trivial. Currently, orders need to be placed several days ahead of time.

Webvan's older competitors, including Peapod (PPOD) and NetGrocer, have struggled and have been forced to reassess their business models. Streamline, which operates in the Boston area, hasn't fared much better, and its stock has languished since its June 18 IPO. Still, these competitors and still-private HomeGrocer are sure to give Webvan a run for its money. HomeGrocer has racked up its own roster of blue-chip investors, from Kleiner Perkins Caufield & Byers (dossier) and Amazon to the Barksdale Group, and has opened for business in Seattle, Portland, Ore., and Orange County, Calif.

On Oct. 6, Webvan unexpectedly postponed its IPO, following a report by TheStreet.com that suggested its road show may have flaunted government rules. Webvan refuses to comment on the disclosure issue, citing SEC regulations that bar companies from self-promotion at the time of their IPO. But the company issued a statement on: "In view of the significant amount of publicity with respect to Webvan's proposed public offering, the SEC and Webvan have agreed to a cooling-off period prior to the commencement of the offering."

Investors in Silicon Valley and throughout the United States are eagerly awaiting Webvan's IPO, and many are betting it will be a blockbuster. Yet some say privately that Webvan's aura of success is valid not only because its blue-chip backers can't be wrong; it's also because so many people have made so much money in the Internet Economy that no one wants to be the one to crash the party. Or worse yet, no one wants to leave early to later find that the party goes on without them.

Webvan's Path to IPO: A Timeline

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Webvan: Financial Engineering, Net Style