Beleaguered Idealab Needs to Hatch a Plan for Its Survival
Internet: The start-up incubator has fallen on hard times along with many of its dot-coms.
EToys Inc., one of the Internet's flagship companies, filed for
bankruptcy protection Wednesday, becoming the biggest online company yet
to fail amid the devastating dot-com shakeout.
More than the demise of a single company, the collapse of EToys shows
just how far Bill Gross and his Pasadena-based Idealab Inc. have fallen.
Besides EToys, Idealab churned out early Internet hits such as Web
search engine GoTo.com, free Internet service provider NetZero and online
guide CitySearch, generating at its peak more than 6,000 jobs and
billions in shareholder wealth.
All that activity put Southern California on the "new economy" map and
made Gross a high-tech celebrity, entrepreneurial hero and paper
billionaire. But the dot-com decline has left Gross and Idealab in a
precarious and unfamiliar position.
With an Internet turnaround nowhere in site, Idealab has been forced
to slash spending and lay off more than half its employees just to make
it through this year.
After pouring $800 million into a virtual black hole, Gross now finds
himself in the humbling position of fending off investors who recently
tried to seize control of his company. Gross also is facing several
lawsuits from a growing list of disenchanted former executives.
"We go through these cycles where we think there's a suspension in the
rules of business and we learn--pretty painfully--that there isn't," said
Frank Baxter, chairman of the Los Angeles investment bank Jefferies
Group. "There was a certain suspension of reality, and Bill responded to
it. It changed abruptly and maybe he couldn't adjust as fast as he might
have."
Gross' top lieutenant and girlfriend, Marcia Goodstein, acknowledged
that many of Idealab's ventures over the last few years amounted to
garbage and that the company's decline has cast serious doubt on Gross'
fundamental premise: In the right setting, Internet start-ups can be
hatched like eggs.
The incubator concept "is being torn apart, laughed at, degraded and
derailed," she said. "We need to prove that this model works."
Indeed, after thriving in an era that scorned business fundamentals,
Gross' survival now depends on his ability to do something he's never
done before: create a sustainable, profitable enterprise.
None of this appears to discourage Gross, an incurable optimist who
expresses no regret for leading his company into this trouble. True to
form, he still believes he can pull Idealab to safety by doing what he
does best: generate ideas.
"We have really, really great companies coming out," Gross, 42, said
recently. "Very, very bold, world-changing."
As recently as a year ago, Gross appeared to be churning out successes
at a record pace. EToys was his biggest hit, and many believed it could
push Toys R Us out of business.
Instead, EToys will shut down its Web site today after it was unable
to find a buyer or additional financing. The company, which lost $189
million last year, listed debts of $416.9 million and assets of $285
million. Its shares, which last traded for 9 cents on Feb. 26, will be
delisted by Nasdaq today.
Entrepreneurial Bent
That is a far cry from 16 months ago, when Idealab's publicly traded
offspring were worth a total of $10 billion and dozens more start-ups
were in the pipeline.
It was all almost effortless for Gross, the son of an Encino
orthodontist, who has been hatching moneymaking schemes since he was a
child. His first venture came in middle school, when he discovered he
could buy candy in bulk and resell it to classmates at a markup that
still undercut the local drugstore.
As a student at Caltech, he built stereo speakers and sold them to
classmates. He made his first real fortune when he started an educational
software firm, Knowledge Adventure, and sold it in 1996 for $100 million.
Then he had what many thought was his best idea of all: Idealab.
The premise was simple: maintain a staff of entrepreneurs, programmers
and managers who could swiftly convert Gross' inspirations into
companies. His first hire was Goodstein, who is as pragmatic and
tough-minded as Gross is starry-eyed. Though both were married at the
time, their professional relationship evolved into a romantic one.
Gross' companies enter their larval stage in the "pen" just beyond the
plexiglass wall of his office in the converted Old Pasadena warehouse
that serves as Idealab's headquarters.
The payoff comes when ventures go public or are sold. For a while, the
payoff was huge, as the stock values of EToys, CitySearch and other
offspring soared.
Gross made $7.6 million to $10.2 million selling his personal shares
in Idealab companies, according to First Call/Thomson Financial, a
company that tracks insider trading. He bought a Ferrari and began work
on a custom-built house overlooking the Rose Bowl, where he now lives
with Goodstein. He bought his own airplane and told friends of his
ambition to give Caltech such an enormous endowment that no student there
would have to pay tuition again.
Idea Loop
But the Internet mania that fueled Idealab's rise also masked its
flaws and, Goodstein acknowledged, clouded Gross' judgment.
Many of his companies started to have a cookie-cutter quality. After
EToys, Idealab launched start-ups selling cookware, cars, pet supplies,
homes and jewelry. His next idea sometimes seemed to reflect his latest
purchase.
While shopping for fixtures for his Pasadena mansion, Gross decided
the Internet needed a home furnishings store. He hired his builder, Steve
Jennings, as chief executive of the start-upMyHome.com. Jennings, who
spent four months at Idealab, describes the experience as chaotic.
Then there were the notorious strategic flip-flops. Three months into
MyHome.com, Jennings recalled, "I got a call from Bill in his car. He
said, 'Steve, I want you tonight to shut down the e-commerce Web site.
Have your tech team put up a basic portal page with links to other
furnishing companies.' "
The next day, Gross called back, upset that the site hadn't been
overhauled overnight. "It was flabbergasting," said Jennings, who quit a
month later, only to see Gross reverse course again and convert
MyHome.com back to an online store.
Last May, Gross brought in retail consultants from Meridian Ventures
to evaluate his e-commerce empire. The group, which had led turnarounds
at Macy's and Barney's, concluded the outlook was hopeless and advised
Gross that his only chance for profitability would be to fold all of his
e-tailers into an Amazon.com-style juggernaut.
Chagrined, Gross decided it was worth a try. But within months, as the
stock market cooled on e-commerce, the mega-site was shut down.
Gross acknowledges that he relies on others to point out the flaws in
his ideas. Much of that pressure falls on Goodstein.
"He's yes, I'm no," said Goodstein, 36, Idealab's president and chief
operating officer. In the midst of the market run-up, she now says,
Idealab needed more no's: "We lost all our filters. When the market was
investing in crap, we came out with crap."
Gross still has plenty of supporters and powerful allies, drawn by the
always distinct possibility that his next idea could be worth billions.
But Gross also confronts a growing list of detractors, including many
current and former executives at his companies. Their most common
complaints: Gross takes too much credit for ideas and Idealab takes a
larger stake in its companies than its assistance merits.
Toby Lenk, chief executive of EToys, resents Gross so deeply that the
two have not been on speaking terms for years, according to associates.
David Hoddess, chief executive of the struggling Cooking.com, said
there's "not a chance" he would replicate his deal with Idealab.
More than half a dozen former Idealab executives have sued the company
over what they say were deceptive practices. Richard Katz, who headed
Tickets.com, one of Idealab's first ventures, said Gross stole his idea
for a ticket-selling Web site and then simply fired him. The suit was
settled out of court and its terms weren't disclosed.
Gross said the suits and complaints by executives are both predictable
and unwarranted. Idealab has given dozens of unproven executives their
first crack at running a company, he said, and though they may wish the
terms were better, none of them joined against his or her will. "It was
completely opt-in," he said.
Such frictions were easy to overlook while Idealab's prospects were
soaring. By the end of 1998, the stock market was so receptive to
Internet companies that Gross started to consider taking Idealab itself
public.
Structural Flaw
But deciding to sell stock to the public set Idealab on a disastrous
course. In preparing to go public, Idealab discovered a glaring oversight
in its corporate structure. Under a securities law, Idealab's holdings
would cause it to be classified as a mutual fund instead of an operating
company, potentially blocking its plans.
"Nobody ever told us" about the law when Idealab was set up, Gross
said.
To comply, Idealab would have to either completely divest itself of
many of its companies or buy back enough shares in them to regain
operating control. By then, those shares had become quite expensive, and
Idealab needed cash.
In early 2000, Idealab found a group of investors willing to fork over
$1 billion. Idealab used $800 million of the proceeds to buy shares in
such offspring as GoTo.com and CarsDirect.com at what turned out to be
top-of-the-market prices.
By the time Idealab filed plans to go public in April, the market for
Internet stocks was on the front end of a harrowing decline. Gross waited
months for the market to turn around, but it only got worse. In October,
Idealab withdrew its plans.
New Investors
Chasing billions had put Idealab in a huge bind. The company was
spending cash so fast it was on course to run dry by the end of this
year, Goodstein said. Fearing that Idealab was about to collapse, the
outside investors tried to seize control of the company in November,
wielding a clause in their contract that guaranteed their investment
could not be diluted.
Gross said he offered to boost the investors' stake in the company
from 10% to 25% if they would agree to drop the clause. The investors had
another proposal: They would give Gross two of his favorite
start-ups--CarsDirect.com and Internet name registrar DotTV--if he would
give the rest to them for liquidation.
Gross and Goodstein rebuffed the offer, and they maintain that their
control of the company is not in jeopardy unless they raise new money.
Which means "we have to make this model sustainable without ever raising
new capital, ever," Goodstein said.
To conserve cash, Gross decided to scale back Idealab's four satellite
offices and slashed company spending rate from about $10 million a month
to $2.5 million. At that rate, Goodstein said, Idealab has enough cash to
operate for two years.
All of which leaves Gross essentially back to square one, with the
survival of his company dependent on his next crop of ideas. But the
market is looking for something that has never been Gross' forte: new
technologies that can be protected by patents or would be hard for
competitors to duplicate.
Among Gross' new offerings are companies to provide wireless Internet
connections in coffee shops and self-service laundries and to turn PC
monitors into TV sets.
"Within the next six months," Gross said, "we will have major
announcements of companies that will be dramatic, great companies."
Spinning Down
Idealab has spun off several companies since its inception, but stock prices for these once-highflying tech firms have quickly returned to earth.
*--*
Idealab companies Ticker IPO All-time Wednesday that have gone public symbol price high close Ticketmaster* TMCS $14.00 $80.50 $9.03 GoTo.com GOTO 15.00 114.50 9.41 Centra Software CTRA 5.00 40.38 6.38 NetZero NZRO 16.00 40.00 0.72 Tickets.com TIXX 12.50 32.00 0.69 EMachines** EEEE 9.00 10.00 0.34 EToys*** ETYS 20.00 86.00 0.09
*--*
** EMachines acquired Idealab start-up Free-PC.com in November 1999.
*** Stock ceased trading Feb. 26.
Source: Bloomberg News
Copyright © 2001 Los Angeles Times