Internet Sector: Acquisition Prospects

As per a recent comScore report, US online retail sales fell 1% over the year in the second quarter, following flat sales in the first quarter and a 3% drop in the fourth quarter of last year. Obviously, the unemployment levels, rising gas prices and increased savings are keeping consumers’ discretionary spending down.

The impact can be seen in the continual contraction of the luxury products industry. Within the jewelry industry, 2008 witnessed a 5% reduction in retail capacity. In the first half of 2009, the number of specialty jewelry bankruptcies surpassed the number for all of 2008. While traditional jewelry stores are finding it difficult to cope with weak consumer demand, players such as Blue Nile (NASDAQ:NILE) are finding opportunities to grow their market share.

Blue Nile’s revenues fell 5.2% over the year to $69.9 million, a significant improvement over the 11% drop registered a quarter ago. Compare that to reports of other high-end jewelers and luxury retailers that delivered first-half sales declines ranging from -20% to -30% or worse. EPS fell to $0.19 compared with $0.20 earned a year ago. The market was expecting revenues of $67.9 million with EPS of $0.19.

For the quarter, the number of orders fell 9% with average order value growing by 3% to $1834. Engagement sales contributed 73% of total sales compared to 70% in the first half of 2008. I guess people still want to get married, recession notwithstanding.

The improved margins were driven by falling diamond prices, which are 15-20% lower than previous year and are at levels similar to three years ago. Since traditional jewelers have high inventory levels, they are not able to either avail or pass on the benefits of lower prices to the consumer. Blue Nile, on the other hand, can do that and offers prices that are nearly 20-40% below those at traditional jewelry stores. In the current environment, such savings obviously matter greatly to the end consumer.

During the year, they have been focusing on improving the customer experience and are redesigning their website, which will be launched before the holiday season. The release is scheduled such that by Thanksgiving, when holiday buying usually begins in earnest, the company will have good idea of users’ reactions to the new site and of its usability.

Blue Nile is also focusing on international expansion and have already launched in 40 markets, which generate 10% of their total revenues. While many foreign markets are also troubled by recession and currency headwinds, Blue Nile still saw significant growth in emerging markets, and the company expects this trend to continue in the coming quarters.

For the entire fiscal, they gave a revenue outlook of $288 million to $295 million with EPS of $0.78 to $0.82. Analysts are predicting profit of $0.79 on revenues of $284.1 million.

The stock is trading at high levels of $54.07, taking its market capitalization to $785.5 million. With the $2.6 billion cash kitty that eBay has, it could pick up Blue Nile to build a verticalized offering. Amazon could be a stronger contender since they are more together than eBay, as was evident in their recent acquisition of Zappos. Besides, both companies are Seattle based. Blue Nile’s steady margin expansion may also make the company attractive to Amazon.

The photo-sharing site Shutterfly (NASDAQ:SFLY) is just one of several online retailers that managed to beat revenue estimates for the quarter. Revenues grew 10% to $38.9 million against an estimated $36.6 million and marked the 34th consecutive quarter of revenue growth for the company. They earned a loss per share of $0.22 compared to a loss of $0.16 per share a year ago. The market was expecting a loss of $0.21 per share.

Revenue growth was driven by 20% growth in the Personalized Products & Services segment, which contributed 61% of total revenue at $23.6 million. Revenues from Prints fell 7% over the year to $14.6 million. The number of customers grew an impressive 13% to 946,000; there were many defectors from Kodak Gallery, which had deleted the photos of customers who did not make the annual minimum purchase the site decided to require. Total orders at Shutterfly grew 6% over the year to 1.7 million, with the average order value growing 2% over the year to $23.09.

In continuing with their initiatives to become a personal publishing platform, the company introduced Shutterfly Video for Share sites to share videos with friends, family members, and groups. The service enables users to upload and post video clips to their own private or public Shutterfly share sites. They also launched their first premium service, which offers unlimited video storage for $29.99 per year. The company’s share site adoption remained strong, and they ended the quarter with more than 1.2 million sites and more than 271 million photos posted, up from 920,000 share sites and 181 million photos posted in the earlier quarter.

Shutterfly’s user experience is also improving: the site’s recently redesigned storefront focuses on improving conversion metrics from store pages to product creation while maintaining a smooth shopping experience. They were ranked 69 on Internet Retailer Top 500 for the year. In 2008, they had come in at the 76th position.

Shutterfly remained a leader in personalized product design services and recently announced a partnership with premier Hollywood baby boutique Petit Trésor to create new additions to their line of baby stationary. As consumers shift away from traditional prints, Shutterfly’s tie-ups, and accolade-winning options such as photo books, invitation cards and such premier stationery, will likely give them a bigger market share.

The company raised their outlook for the full year to revenues of $205 million to $220 million with EPS of $0.14 to $0.38. In the current quarter, Shutterfly expects revenues of $34 million to $36 million, representing a 5% decline to 0% growth over the year. Non-GAAP loss per share is expected to range from $0.20 to $0.30.

At present, industry penetration rates and growth rates are rather low, at sub-15% and 3% levels respectively. Analysts believe that once the economy picks up, growth should increase to 20% by 2011. Shutterfly, with its price and product options, will surely remain a leader in the field, making me reiterate my belief that Yahoo! needs to acquire it to better monetize their photo offering. However, given Yahoo!’s display of a lack of strategy, I wouldn’t mind if Microsoft or Amazon picked it up instead.

The stock is trading at $15.11, taking its market capitalization to $385 million.

Meanwhile, online health and wellness portal WebMD (NASDAQ:WBMD) continued to do good business. Revenues grew an impressive 15% to $98.6 million. EPS also grew to $0.04 compared with a loss of $0.11 per share a year ago. Analysts were expecting revenues of $98.4 million with EPS of $0.10.

By segment, advertising and sponsorship revenues grew 18% to $76 and private portal licensing revenues grew 4% to $22.6 million. In times when most companies are seeing a drop in advertising revenues, WebMD’s continued to grow. There is strong demand for their high quality and highly engaged audience, whose experience they are managing to improve through their new home page, and a better search results page.

The site maintained their leadership in the top 10 health and medical information websites within the US. The average of 59.8 million unique users per month grew 24% over the year, and 1.4 billion page views during the quarter represented 31% growth over the year. WebMDcompleted 1.6 million continuing medical education (CME) programs, 25% more than last year. Today, these programs constitute 62% of all online CMEs and 26% of all CME users as per a recent report.

WebMD is improving the personalization aspect of their site through their new digital platform, which integrates personalization, video and mobile messaging and are successfully running it for their WebMD Healthy Skin TV and BiPolar TV, which will create branded programs in the areas of skin care and bipolar disorder.

WebMD recently launched Medscape Mobile, which is their first mobile application for physicians. It provides comprehensive drug information, clinical reference tools, medical news and education on a mobile device. Initially launched for the iPhone and the iPod Touch, according to WebMD, “It’s the only medical application to deliver specialty-specific news and medical education”. Later this year, they will launch the application for additional mobile platforms as they see huge potential in this segment.

WebMD expanded their network advertising partnership with Yahoo! and will now fully represent Yahoo!’s inventory to advertisers who want to reach the Medscape physician audience. Further, they will deliver relevant marketing messages to their physician users whenever these users are on a Yahoo! property. I strongly believe that Yahoo! should consider acquiring WebMD to create a healthcare vertical. It could very well be the healing touch that Yahoo! desperately needs.

WebMD projects revenues of $420 million to $440 million for the year with EPS of $0.51 to $0.66. Analysts are expecting EPS of $0.57 per share on revenue of $423.5 million.

The proposed US government-sponsored healthcare reform agendas look at key opportunities in the health information technology and education about health and wellness. Technology funding will accelerate the adoption of electronic medical reports at a physician’s point of care, but it will still not connect records to the wider provider network. As the adoption of electronic medical records increases, WebMD’s ability to interconnect the medical world should make their products much more valuable. Also, given the company’s leadership in and experience with health and wellness programs, they should become a major contributor to efforts to improve medical education. These are enough reasons for the stock to stay on its growth path.

The stock is trading at $31.94 with a market capitalization of $1.8 billion.