Mergers and Acquisitions - JOINING FORCES TO COMPETE WITH INDUSTRY GIANTS, SEEKING REFUGE WITH A LARGER PARTNER

The rapid growth of dot.com upstarts in the latter half of the 1990s proved a fertile breeding ground for mergers and acquisitions. For example, between 1996 and 1997 the number of Internet service providers (ISPs) in operation skyrocketed from roughly 1,500 to nearly 4,000. Because smaller ISPs were able to serve local markets less expensively than larger rivals, the top contenders in the U.S. ISP market began consolidating in an effort to cut costs. America Online Inc. (AOL) played a key role with its September 1997 purchase of the consumer online service of CompuServe Corp. from WorldCom Inc. The acquisition boosted AOL's subscriber base to over 10 million, pushing rivals like Microsoft Network, AT WorldNet, and Prodigy to a distance second place. AOL's rapid growth allowed it to lower its prices to better compete with the upstarts. In turn, this prompted several up-starts to join forces in an effort to compete with industry leaders in terms of market share.

ISPs were not the only Internet players feeling pressure to grow via mergers and acquisitions, however. The intense competition between World Wide Web browser-makers Microsoft Corp. and Netscape Communications Corp. prompted both companies to seek Internet-related acquisitions as a means of keeping pace with the industry's continually evolving technology. Purchasing new technology meant neither firm had to spend the time and money necessary to develop its own products. In 1997, Netscape bought high-end Web server manufacturer KIVA Software Corp.; Internet commerce solutions provider Actra; Web graphics tools maker Digital Style Corp.; and messaging server technology vendor Portola Communications, Inc. That year, Microsoft Corp. acquired award-winning Web-based free e-mail service Hotmail; video streaming technology maker Vxtreme Inc; Java-based multimedia tools manufacturer Dimension X Inc.; Internet usage monitoring software vendor Interse Corp.; and WebTV Networks Inc.

In 1998, Netscape watched its share of the Web browser market fall from 62 percent to less than 40 percent. Microsoft's decision in 1995, when Nets-cape's share of the browser market had hovered around 80 percent, to bundle its Internet Explorer browser with its Windows 95 platform had been effective. People who bought new computers used Internet Explorer, simply because it was the browser software already available to them. In November of 1998, America Online (AOL) offered $4.2 billion in stock for the struggling Netscape. Netscape's managers believed a merger with AOL could potentially boost Netscape's share of the browser market, especially if AOL changed its default browser from Internet Explorer to Netscape Navigator. The deal would also increase both firms' positions in the e-commerce industry, which analysts predicted would be worth an estimated $4 billion by 2002. Netscape's Netcenter was already one of the leading full-service Web sites, offering users a gateway to the Internet, as well as online shopping and entertainment services, areas where AOL was looking to expand. Microsoft was also expected to compete extensively in these markets, and the merger would create a company that could potentially hold its own against the giant. The deal was completed in early 1999.

Mergers and acquisitions continued to take place as the e-commerce industry matured. Some companies continued to use acquisitions to gain quick access to new technology. For example, KB Toys purchased Brianplay.com in July 1999 rather than build its own online sales operation. Others merged with rivals as a means of gaining increased market share, as was the case with online auction powerhouse eBay, which bought Paris-based iBazar for $112 million in early 2001 to expand its presence in Europe. One of the largest Internet-related mergers, the $183 billion joining of AOL and Time Warner Inc. to form AOL Time Warner Inc., helped to ensure AOL's position as a leading Internet player in the future. Despite the varying reasons for mergers and acquisitions among e-commerce players, the majority of deals fell into one of two categories: mergers between dot.com s looking to increase their competitiveness and buyouts of floundering dot.com s by traditional brick and mortar firms.

JOINING FORCES TO COMPETE WITH INDUSTRY GIANTS

EGGHEAD.COM 'S MERGER WITH ONSALE INC.

Egghead, a traditional software retailer that converted all operations to the Internet in 1998, initiated merger negotiations with Internet auctioneer OnSale in July of 1999. Troubled by the decision by Amazon.com to diversify into both software sales and auctioning, the two firms believed a merger would allow them to better compete against the retailing giant. Along with giving the two firms access to one another's customers and allowing for cost cutting via layoffs, the deal would also enhance Egghead's site by adding auction functionality. OnSale and Egghead completed their merger in November, becoming an online retailer and auctioneer of discounted computer software, hardware, and related technology. The newly merged firm retained Egghead's more recognized name.

Although the merger fueled Egghead's growth into a leader in online software and consumer electronics sales by mid-2000, it wasn't enough to propel the firm to profitability. In the wake of the dot.com meltdown, Egghead's stock price began to tumble. At the same time, spending in the technology industry began to wane, slowing Egghead's sales. Cost cutting efforts included layoffs that eventually trimmed the firm's workforce by more than 65 percent. However, despite these measures, as well as $20 million in funding from IBM Corp., Egghead failed to stay afloat. The company declared bankruptcy in August of 2001.

JUNO ONLINE SERVICES INC.'S MERGER WITH NETZERO INC.

Under mounting pressure from shareholders to produce profits, Juno Online, an ISP known for pioneering free Internet access, began testing methods for persuading users to convert to fee-based services in 2000. For example, the firm began making it more difficult for its most frequent users to log on to the free service, hoping they might decide to pay for more reliable premium service. Also forcing Juno to reexamine its free ISP model was the fact that the North American economic downturn in 2000 and 2001 had prompted many firms, dot.com and otherwise, to tighten their online advertising budgets. With its main source of revenue drying up, Juno needed to find other sources of income.

In June 2001, Juno and rival NetZero announced their intent to merge. The $70 million deal was completed three months later. The newly merged firm, named United Online, was the second largest Internet access provider in the U.S., behind AOL. Because many free ISP rivals like Free Inet and 1stUp had declared bankruptcy, the only viable free ISP competitor to United Online was Bluelight.com, operated by Kmart Corp., which admitted that the free ISP model was inherently flawed. Analysts speculated about whether or not the newly merged firm would abandon the increasingly criticized free ISP model altogether in favor of a fee-based service.

SEEKING REFUGE WITH A LARGER PARTNER

PEAPOD INC.'S TAKEOVER BY ROYAL AHOLD N.V.

Founded in 1989, Peapod eventually evolved into an online grocer that allowed users to shop for groceries online and have the purchases delivered to their home. Although it got its start much earlier than most other Internet-based firms, Peapod found itself susceptible to the dot.com meltdown early in 2000. In March, the online grocer's stock was worth nearly 75 percent less than its peak price in 1999. Peapod's CEO resigned and investors balked at the idea of pumping more money into the unprofitable venture. As a result, Peapod was nearly out of cash.

In April, European brick-and-mortar grocery giant Royal Ahold agreed to pay $73 million for a 52 percent stake in Peapod. The reason for the bailout was simple, according to InternetWeek writer Scott Tillett. "To start its own U.S. online operation from scratch, Ahold would likely have spent more money over a longer period of time. Instead, its purchase of Peapod secured for Ahold 24 order fulfillment warehouses, 130,000 established customers, 1,000 employees, and existing information technology infrastructure. Peapod's sales in 2000 grew 28 percent $93 million, although its losses grew to $57 million, compared to $29 million the year earlier. However, Peapod's ability to use the warehouses serving Ahold's existing U.S. supermarket chains, such as Stop & Shop, allowed Peapod to cut its procurement costs in 2001. As a result, the firm's Chicago operation operated in the black for the first time ever, prompting management to predict that by 2004, Peapod would be the first online grocer to achieve profitability.

CDNOW'S TAKEOVER BY BERTELSMANN

Despite leading online music retailer CDNow's rapid growth in the late 1990s, rivals like Amazon.com and barnesandnoble.com began undercutting the firm's sales. In fact, Amazon surpassed CDNow in music sales in 2000 mainly because CDNow lacked the resources to compete with Amazon's customer service savvy and vast customer base. Merger plans with Columbia House, made public mid-1999, dissolved in March of 2000, and many analysts pointed to the bursting of the dot.com bubble and CDNow's subsequent stock price nosedive as the culprits. Others believed that Columbia House had balked at CDNow's $30 million debt, as well as the fact that the online music retailer had lost roughly $200 million since its 1994 founding. At any rate, news of the cancelled plans caused share prices to fall another 28 percent. Reports that the firm might run out of cash by September pushed stock to a record low of $3.50. CDNow was seen "as struggling to keep pace with market leader Amazon.com and as scrambling to find a partner with deep pockets before it runs out of money," wrote Brian Garrity in the March 2000 issue of Billboard.

To make itself more appealing to potential partners, CDNow pared down its advertising costs and shuttered its London unit. Rather than relying mainly on the sale of CDs, the firm also began pushing sales of advertisements on its site. To retain customers, CDNow launched reward and incentive programs. In July of 2000, German media giant Bertelsmann offered to pay roughly $117 million, or $3 per share, for CDNow. Bertelsmann had been growing its e-commerce operations since 1998, when it paid $200 million for a 50 percent stake in BarnesandNoble.com; the firm used its new assets to develop an online retail book site to compete with Amazon in Europe. By mid-2000, Bertelsmann had spent nearly $13 billion on its Internet arm. One of its investments—Terra Lycos, created when Spain-based Terra Networks paid $12.5 billion for U.S.-based Web portal Lycos—secured Bertelsmann access to the 50 million customers already using either Terra Networks or Lycos. Many analysts believed that Bertelsmann's extensive reach would increase CDNow's ability to compete with rivals like Amazon.

In October 2000, CDNow joined the newly formed Bertelsmann eCommerce Group. In the months following its takeover, CDNow continued to grow. For example, via deals with ViaFone Inc. and Sprint PCS, the online music retailer began offering wireless access to its site. In addition, things like film reviews and best seller lists bolstered the content at its Video Shop and video offerings were expanded to more than 70,000 titles. As a result, CDNow's video sales nearly doubled by early 2001.

FUTURE MERGER AND ACQUISITION ACTIVITY

Many analysts predicted that the pace of merger and acquisition activity would remain steady, if not increase, throughout the early 2000s. According to an October 2001 article in E-Commerce Times, "With stock prices at bargain basement levels, these and other dot.com s like them could make good partners for brick-and-mortar companies seeking to add online operations to their existing businesses."