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November 28, 1999

When .Com Doesn’t Spell .Profit

By Jason Stamper

If evidence were needed that calling yourself a .Com company doesn’t necessarily mean that you’re going to become The Next Big Thing, that evidence is provided by ConnectInc.Com Company’s acquisition by Calico Commerce Inc on November 22nd. It draws to a close Mountain View, California-based ConnectInc.Com’s considerable struggle since its IPO in June 1996 to break even.

It earned $12m from its IPO, but then managed to burn through cash like a Californian forest fire. As it failed to make a profit the market became less and less enthusiastic; its shares tumbled from their all-time high of almost $50 just after its IPO to around $4.60 by the time of its acquisition. So how can a .Com fail in this market of huge internet valuations and booming demand for Internet services and products?

ConnectInc.Com managed to generate a bid price of around $90m from on-line sales systems company Calico, despite the fact that its revenues were a measly $6.3m for its four trailing quarters (a bid price/sales multiple of over 14). But to really understand ConnectInc.Com you have to go back to its roots, when the company was talking up its ability to enable e-commerce between businesses rather than between a business and its customers.

Connect Inc – it didn’t add the .Com until later – was founded in 1987 to provide online information services to businesses. During the period 1987 through 1992, the company’s primary business was the operation and management of a private online service and the licensing of related client software. In 1993 and 1994, the company developed and launched software for the creation, access and operation of custom online systems. In late 1994, Connect began to shift its focus from providing online services to developing packaged software applications for Internet-based interactive commerce. In those days it derived a significant portion of its revenue from contract software development projects with two big customers, and these projects formed the foundation for the development of OneServer, the company’s core software application, which was commercially released in September 1995, and OrderStream, the first pre-configured implementation of OneServer, which was commercially released in June 1996.

With that money from its 1996 IPO you would have thought that the company had a good future in a market which was about to take off. Sales prior to its IPO had been small – in 1994 total revenues were $7.97, and in 1995 it achieved sales of $8.57m. That equated to net losses of $1.76m and $14.14m respectively. The company was going through a restructuring though, as it moved from providing on-line information to offering software for e-business between companies. But in 1996, the year of its IPO, there was little improvement. Sales were $10.18m – they seemed to be growing nicely – but that net loss had risen too, to $16.14m. 1997 brought no relief – sales were down this time to $9.36m and the net loss was $14.58m. By this stage the company’s shares had tumbled from $50 to $10, and the market was losing interest. It changed its name, adding the .Com to become ConnectInc.Com but it was no good – 1998 saw sales of $6.48m and the net loss was $7.9m.

"We are bound to our sins of the past," ConnectInc.Com’s executive vice president of sales and marketing Dave Wippich told us. "Our initial technology was proprietary, which is another word for early to market. But a lot of the supporting technology and standards had not come together; the market had not matured sufficiently."

He also says that targeting Fortune 500 companies meant long sales cycles. But the company’s losses mean it was always short of cash. It was even threatened with being thrown off the Nasdaq exchange for not maintaining sufficient tangible assets – it didn’t meet the $4m minimum. It managed to raise the necessary money from another round of funding, but with just $5m in the bank it realized that things were fairly bleak. It had come to market with a new product, however, MarketStream, this time with an open architecture and based on the eXtensible Markup Language (XML) standard.

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MarketStream is said to support key functions necessary for large-scale interactive commerce, including user registration, multimedia catalog and content management, dynamic merchandising, order capture and management, security, payment processing, customer service, procurement management, enterprise integration and systems administration. Calico Commerce – itself having an e-commerce ‘engine’ but lacking Connect’s particular functionality – was in talks to OEM ConnectInc.Com’s products when those talks turned to the subject of an acquisition. ConnectInc.Com knew it was time to give up the fight.

According to the companies ConnectInc.Com’s product will quickly be integrated with Calico Commerce’s offerings. The first stage of this will see Calico launching a product called Esales Market Maker, which will be sold within Calico’s Esales suite. It should be available by mid-December, and it’s apparently just a subset of ConnectInc’s MarketStream product. The companies are able to start integrating the products before the acquisition is completed because they signed that OEM deal just before they signed the acquisition papers. The integration of the products should be straight-forward as both lines are based on XML, says Wippich.

In ConnectInc.Com’s latest (September) quarter it made total revenues of $1.6m, up from sales of $1.1m for the same period last year. It made a net loss of $645.000, down from a net loss of over $3m last time. Things were arguably on the mend, yet there’s still the fact that the company hasn’t actually managed to win many customers. In that quarter 73% of its revenues came from just five companies.

So doesn’t the small installed base and the company’s propensity to burn through cash make a bid price of $90m (14 times trailing earnings) seem a little high? "I think it’s a fair valuation," Wippich told us. "In the Internet and e-commerce space timing is everything. Valuations are made not on profit and loss but on the opportunity and the time to market. Also the technologies were complementary and there was no overlap. Plus remember that ConnectInc’s shareholders still have to approve this merger."

San Jose-based Calico, meanwhile, is a lot bigger than you might think. Sales for fiscal 1999 were $21.41m, representing a net loss of $15.26m. That compares to sales in 1998 of $11m and a net loss of $5.5m that year. But those figures belie the story behind the headlines: the company only IPO’d in July this year (making a cool $55m) and since then its shares have rocketed from their $14 beginnings to $69 today. That gives it a market cap of $2.2bn and plenty of potential to snap up complementary technology. Before its IPO it had already swallowed FirstFloor Software Inc which had an interactive marketing encyclopedia. The encyclopedia can be used to answer questions, provide demonstrations and generally enhance any online sales tool.

Under the deal, Calico will swap 0.081 share for each ConnectInc.com share, for a total of about 1.2 million Calico shares. The deal is expected to close in the first quarter of 2000, subject to shareholder and various regulatory approvals. It will be accounted for as a purchase transaction. With its extremely positive valuation Calico can afford to buy several more ConnectInc.Com-type companies, and we expect it will.

But competition is stiff – direct competitors include Trilogy Software Inc, and Selectica Inc, both of whom are yet to go public. Another competitor, FirePond, has just announced its IPO, the date for its pricing is yet to be announced. FirePond shows that it’s not easy to make money fast in the on-line sales automation market: 1998 revenues were $30m but it posted a net loss of $8m. However in an Interactive Selling Systems (ISS) research note Gartner said that FirePond, will remain the only ISS leader through year-end 2000. In the same report Gartner found that Calico was a visionary but had a lower ‘ability to execute’ than FirePond. It also needs to improve its consulting business, Gartner says. Baan, Oracle and Siebel also have ISS offerings, though Gartner says their customization tools are still lacking.

"As far as Wall Street is concerned business-to-business e-commerce didn’t exist until a year ago," says Wippich. "If we’d have IPO’d today we would probably have been looking for in the region of $100m."

The trouble is, we get the distinct impression that ConnectInc.Com would have whacked through $100m almost as fast as it spent the $70m it raised in its 12-year history. Calico, of course, will be hoping that with its ConnectInc.Com buy it will have a more rounded ISS portfolio. The question is whether Calico can rev its business faster than the competition. If not, it may go the way of ConnectInc.Com, and make a tasty morsel for a Siebel or a Baan.

This article originally appeared in ComputerWire’s weekly M&A Impact news and analysis service.

UPDATE: PeopleSoft duly acquired Calico’s assets in 2002, before PeopleSoft was swallowed by Oracle.

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