|
View graph. |
||||||
Since the Nasdaq market crash in March this year only one Latin American internet company, AOL Latin America, has managed to go public.
It is one of the few firms with a record of good performance, granted by its market-leading parent, AOL. Even that deal barely succeeded and the vendor and lead banks had to reduce the initial offer price of the shares by half. The feeling persists that if they cannot do it, who can?
Without a feasible exit strategy, venture capital, too, is hard to find these days for Latin American internet plays. Private placements of equity are the last resort, since valuations there also came down by up to 80%, in line with public equity values. The lucky few will be able to sell themselves to industry buyers. But many more start-ups will burn through their cash before any chance of raising new funds arises.
In Latin America, consolidation will happen sooner rather than later, since Latin internet businesses were late into the initial venture funding frenzy and did not manage to fill their vaults with cash. They simply cannot afford to turn their noses up at offers of mergers and takeovers, as the strongest US internet companies still can.
Bear market boosts mergers
Next year is widely expected to bring drastic consolidation. Investment banks have redirected their business away from pitching for IPOs to advising on mergers and acquisitions. A bear market is good for mergers, which will create more efficiency by converging offline and online value.
Old-economy companies are delighted by the prospect of acquiring cheap online businesses to get their own internet distribution off the ground. “The click-and-mortar approach will prevail in this situation,” says George Monserrat, Latin America internet analyst at BBVA. “We also believe that the negative capital market sentiment towards e-tailers will motivate the more successful e-tailers to ally themselves with established bricks-and-mortar retailers. Those that cannot marry themselves to a conventional retailer will end up going belly-up – just as we are seeing in the US.”
One example of old and new economy merger is that of Patagon, the popular Latin financial portal, and Banco Santander Central Hispano. BSCH bought 75% of Patagon at a sky-high price of $585 million just before the Nasdaq crash. Patagon has since expanded into the US via online broker Keytrade, and into Spain by acquiring Spanish online bank Open Bank, and aims to be a global player.
One would normally expect venture capitalists to invest in businesses at rock-bottom prices. Susan Segal, general partner at Chase Capital Partners, agrees that it’s “a good time for private equity investors to invest in valuable companies at reasonable prices. There is still some money for pure internet firms that will either develop into strong stand-alone companies or be acquired at a nice premium by a strategic investor.”
Venture capitalists hold back
But whereas in traditional industry sectors, venture capitalists seek to pick up struggling companies at bargain prices in a downturn, it’s not clear where the bargains are to be found in the internet sector, where venture capitalists have already suffered losses from providing early-stage and start-up funding.
That’s why Franz Bedacht, associate principal of McKinsey&Company in Rio de Janeiro, finds investors remain very cautious. “Most focus on their existing portfolio. And why should they pour in money now when they can as easily wait and see who is surviving?”
Thus, even though prices have been slashed by 60% to 80%, investors as well as industry buyers are in wait-and-see mode. Any Latin dot com on the look-out for investment needs some very convincing arguments to overcome investors’ suspicions about the sector. “What’s important for internet firms, in Latin America as in the rest of the world, is to show a strong business plan that can produce revenues and a break-even in the short term,” says Segal.
There are three ways of making money from the internet. An internet service provider (ISP) gets revenue from subscribers; a portal from advertising and an e-tailer from e-commerce transactions. So far, the first two have been predominant models in Latin America. Pure portals such as StarMedia, Yupi and QuePasa get 95% to 100% of revenues from advertising, and some additional revenue from links to e-tailers.
The more popular model is the combined ISP/portal, as followed in Latin America by AOL Latin America, Terra Networks and Universo Online (UOL). It has the virtue of mixed revenue – around three-quarters from internet subscriptions and one quarter from ads and e-commerce – which, in an environment of tight and volatile ad spending, puts an ISP/portal in a better position to survive. And, unlike their pure play competitors, they have the considerable advantage of having their sites set as the default on their software. Thus while shares of Terra fell by 37% after the Nasdaq crash in March, the pure portals, StarMedia and El Sitio, saw their values fall by 65% and 73% respectively. El Sitio is considered a pure play portal, though it has a small ISP operation.
None of these business models can get companies to profitability if they cannot achieve scale on the traffic and revenue sides – and quickly, says Segal. This makes Latin America a particularly tough market, as it’s incredibly hard to reach scale in a region with few internet users and the need, which arises from Latin America’s different cultures, to set up local content and operations.
Latin America’s average online population amounts to just 2% of total population, a rather meagre amount compared with Europe (15% to 20%) and the US (50% to 60%).
In fact, most of Latin America’s huge population will never access the internet. In countries such as Argentina, Peru and Venezuela initiatives by government, non-government and private sector bodies alike are considered crucial in avoiding a digital divide.
Investors also nurse longer-standing concerns about the volatility of Latin economies that have seen debt problems and devaluations with disastrous effects in the past.
Small market, big growth
Such worries have been brushed aside by internet businesses. They fight hard for market share in Latin America since this is the market that offers an exceptional high annual growth rate of 30% between 1999 and 2005, according to e-commerce research firm Jupiter. The estimated 16 million online users will grow to a population of 43.4 million in 2003, and Jupiter’s projections are likely to be adjusted upwards to reflect faster than expected adoption of the internet in Brazil and Mexico, says Lucas Graves, senior analyst for Latin America at Jupiter Research.
Thus in Brazil, the country that most promises large scale with a total population of 160 million, the market is the most competitive. ISPs have been striving to outdo each other in free-access packages.
In fact, when talking about the Latin American internet market, analysts refer almost exclusively to Brazil and Mexico. In all other countries – apart from Chile and Argentina that have at least a potential – there is simply no sizeable class of potential customers. The “good” news is that, in a region where 20% of the population owns 60% of the wealth, those who do access the net are almost exclusively the rich and educated.
This inequality lowers marketing efforts, but it also means that hopes of a proper mass market – especially important in B2C commerce – are slim. Vast masses of Latin American people still do not have telephones, never mind PCs. In Peru, for example, about a third of all internet users are thought to access the internet through special booths, for $1 an hour.
Brazil is by far the most populous, rich and sophisticated market in Latin America. Since 1997, Brazilians have been able to declare their income tax via the net and there are programmes under way to enable e-voting.
Jupiter Research expects 20 million Brazilians to be online by 2003 – twice the expected number of Spaniards. Mexico, with a population of 90 million, has great potential, too, though, for now, relatively high access charges prevent its fulfilment. In Argentina, the country with the highest per capita GDP, internet growth has lagged due to high telephone charges. But it is projected to take off now that the final stage of deregulating the telecom market has been completed.
Struggle ahead
The use of the internet may be encouraged by cheap internet access packages, a new Wap phone craze, and free access offers, which have swept through Brazil after Bradesco offered its customers 20 hours of free access in December 1999. It was quickly followed by other banks including Unibanco, Banco Itaú, Banco Bilbao Viscaya, and portals such as IG, BRFree and Super11. However, it’s questionable that revenue from advertising will, in the long term, compensate for the free access provided. UOL, the number one portal in Brazil, abandoned its free access offer three months ago because it “is almost impossible to be profitable,” says UOL spokesman Ricardo Florence.
| Lucas Graves | ||||||
But such incentives are very much needed, as access fees are relatively high at an average $55 a month in Latin America, compared with $25 in the US and $40 in western Europe, according to research by IDC Latin America.
Ageing phone infrastructure and lengthy connection delays further hinder online growth. Wap and mobile phones are, of course, a ready alternative and could become the main access in Latin America. “Wap phones are for many the first devices to access the net,” says Anna Kerr, research manager at IDC Latin America. “Already there are some deep pockets in Brazil and Venezuela. And it’s bound to happen elsewhere to facilitate access to the internet.”
Although the internet is growing rapidly, there are still not enough users to support the number of players active now. “Considering that there are all in all only 16 million to 17 million internet users in the whole of Latin America, the market looks very crowded,” says Fred Searby, senior analyst of Latin American internet at Chase H&Q. “And the internet is also a more cultural experience. Most people use it for email, which is very hard to monetize.”
Companies that derive their income from advertising are already struggling. Here critical mass is most important. BBVA’s Monserrat expects that, as in the US, the top three or four portals will attract about 75% of advertising spending. Total online advertising spending in Latin America, though growing from $52 million in 1999 to $1.16 billion in 2005, according to Jupiter Research, is only a fraction of the US total, estimated to reach $22.2 billion in 2004. “The ad spending pie is too small to support all the portals operating at the moment,” says Monserrat. “The consensus is that about three or four home-grown portals might survive in each of the major countries.”
The good news for the leading sites that do have traffic is that advertising revenue may now get a new impetus. Until September, the key link – the ranking of Latin portals by independent third parties – was missing, says Monserrat. “Before that, it was a murky playing field for advertisers. Every portal stated it was one of the top sites. They threw out a lot of statistics, but in the end it remained unclear who was actually generating the traffic.” Advertising spending was therefore split into smaller chunks going to a lot of sites. This is going to change now that MediaMetrics and Nielsen NetRatings have published figures for Brazil, the most important market with 40% of users, and Netvalue has figures for Mexico.
And the winners are…
What sites, then, are the biggest traffic generators – and thus the likely winners in the consolidation process? The unchallenged leader is UOL with a reach of 73% (unique viewers as percentage of total audience), according to Nielsen NetRatings, which translates into 3.7 million unique users.
| Franz Bedacht | ||||||
Uol.com is the most visited Portuguese-language site in the world, with 500 million page views in September. UOL’s other portal bol.com, the second most visited domain, attracts 157 million page views a month.
UOL, founded in 1996, is a portal and service provider in Brazil, where it has the bulk of its operations, including 700 subchannels offering news, information and entertainment. In 1999, it built portals – without an ISP business – in Argentina, Mexico, Venezuela, Chile and Colombia. And in 2000 it established sites for the Hispanic community in the US and a site in Spain.
The long-established US sites – AOL, MSN, Yahoo! – also did extremely well in Latin America, seemingly taking the cream with very little extra effort to expand. They rank two, three and five respectively in MediaMetric’s research, and a little lower in Nielsen’s, which puts Yahoo! third, MSN sixth and AOL seventh in Latin America.
The other big players are Terra Lycos and StarMedia Network – the latter being the biggest surprise. Some analysts suspected that its statistics were “full of hot air”, since it is the only pure player among the top portals. It turned out that StarMedia had 2.5 million unique users in September, which amounts to a 48% reach according to Nielsen, and attracted 3.3 billion page views in the third quarter according to StarMedia Network.
StarMedia’s traffic is generated through starmedia.com ranked number 10, as well as through more then 12 other properties, including Cade.com.br, the most popular Portuguese-language search engine, which itself is the number two domain in Brazil.
StarMedia has clearly profited from its first-mover advantage, having being in the market since late 1996. But though StarMedia is doing very well now, it is at a significant disadvantage over the three rich kids: AOL Latin America, Terra Lycos and, to a lesser extent, UOL.
Terra Lycos is about to become the showpiece of the new international hybrid internet play. The new company was formed on October 30 when Lycos shareholders gave the final go-ahead to a merger with Terra Networks, a subsidiary of Spanish telecom company Telefónica. Telefónica is the main telecommunications group in Spain and Latin America, as well as one of the five largest wireless telephone companies worldwide, with more than 21 million customers.
Spanish-based Terra Networks has been particularly strong in Spain and Latin America through its access business there. Lycos advanced to the one of the top players in Asia, US and Germany and gives Terra the global footprint it sought – this was worth $12.5 billion in stock to Terra. Terra Lycos will be operating in 37 countries and has 91 million unique users worldwide – a powerhouse that can take on AOL, Yahoo! and MSN. And it can rely on a $3 billion cash buffer, making it one of the best-capitalized internet business in the world. Telefónica has promised to inject $2 billion for more internet acquisitions, which will be part of a global and multibrand strategy. The cash will be more than welcome to help get Terra Lycos through the net loss phase, which will end in the fourth quarter of 2001, according to a Terra spokesperson.
In Latin America, Terra Lycos has the distinct advantage that Telefónica has already signed up millions of fixed line and cellular subscribers. It gets content through Telefónica, the main broadcaster and second operator of paid television in Spain and Argentina, and parent of Endemol Entertainment, the producer of Big Brother.
More content will be delivered by Bertelsmann, the world’s third-largest media group, which has also guaranteed Terra Lycos $1 billion in ad and e-commerce spending over the next five years.
Terra Networks has so far built ISP and portal businesses in Brazil, Mexico, Chile, Peru, Spain, Guatemala, and US and owns portals in Argentina (where it will enter the deregulated market as a service provider), Venezuela, Costa Rica, El Salvador, Honduras, Nicaragua and Panama.
Terra’s biggest competitor in Brazil, UOL, can also count on financial assistance. It is owned by Folha and Abril, two of the biggest media groups in Brazil, and has the exclusive content rights for the net. But even UOL has had some cash problems. Its previous plans to go public were aborted after the Nasdaq crash.
So it had to sell its internet backbone (i.e. the infrastructure assets that control its traffic) to Imbratel, the largest telecom in Brazil, for $100 million cash, as rumours have it. “Without that sale they would have been up the wall,” says one analyst.
The money should get UOL through to break even, but it is still very keen on an IPO to provide resources for expansion. UOL has given the mandate to MSDW, which owns a 12.5% stake.
The IPO was planned for this year, but is more likely to go ahead early next. Florence at UOL stresses that the company can wait until the market situation has improved. That could well take a while, but at least UOL can count on some demand. “It is one of the few IPO candidates that would be taken seriously by the market at the moment,” says Monserrat.
Thank goodness for rich parents
AOL Latin America can look up to cash-rich parents Cisneros and AOL – and is about to get big in Latin America. AOL Latin America went public in August, and hopes to have enough cash to finance its new operations in Brazil, Mexico and Argentina.
Those without deep-pocketed parents should beware. “There are many potential takeover targets in the region,” says Aisha Haque, director of the corporate and institutional client group at Merrill Lynch.
After El Sitio’s merger with media group IAMP in October, the only sizeable pure play left in the market is StarMedia. Other sites, such as yupi.com, are probably too small to arouse much interest. StarMedia has been Wall Street’s darling. It was the first Latin American internet play to get funding from venture capitalists, including from Chase in 1998, and was the first to go public in May 1999.
StarMedia does not comment on any speculation about a take-over, which is not a bad idea considering that rumours started as soon as it put up its site. StarMedia has defied sceptics so far in every single quarter, by producing smaller than expected losses. It promises to break even in the fourth quarter of 2001, and not, as was thought back in 1996, in 2003.
But sceptical analysts still wonder for how long it can continue to burn cash and ask how it might fund needed acquisitions. McKinsey’s Bedacht puts it bluntly: “As investors are looking more and more on the revenue model, they find a purely ad-based model unattractive. This model is in most cases unsustainable.”
Traditional media take over
But it’s not quite clear who would want to buy a Latin American pure play. Haque points out that the big US players would be cautious to do so since this would, almost certainly, have a dilutive effect on their earnings per share. “With investor sentiment so hostile, this could cause more damage than benefit,” she says.
Acquisitions may make more sense for another group – the traditional media players from the region. Having branding power to drive traffic, access to advertising clients, good sources of content, and cash resources, they could become dominant internet players. They generally got into the internet late and have not yet quite managed to work out how to do business. That’s possibly because it has not been the main focus of their strategy and because they did not have the right people, argues Pablo Burbridge, Latin America media and internet analyst at Salomon Smith Barney.
Mexico’s biggest media group, Televisa, once thought to have been interested in StarMedia, went its own way with disappointing results.
After consuming an estimated $80 million, its portal Esmas has stumbled through a considerable number of technical mess-ups. Televisa is now in talks with AOL to explore the potential of a partnership.
Todito, the portal of Mexico’s TV Aztek, was a “mild success” says Burbridge, but it’s not a real player yet. By contrast, Mexico’s Telmex pulled off a deal early in 2000, by getting together with MSN. Their joint venture, T1MSN, is the default setting on all Microsoft equipment bought in Spanish-speaking countries and the portal is ranked fourth in Mexico by Netvalue – after US sites MSN, Yahoo! and passport.
Argentina’s dominant media player, the Clarin group, has also done better in attracting users to its portal, Ciudad, though no numbers are available yet. And in Brazil, media giant Globo Cabo, which has a very strong brand name, is expected to become one of the major players. It has now sorted out some start-up difficulties after setting up Globo.com in March of this year, and made it into the top ten of MediaMetrics’ and Nielson’s reach indices.
Analysts expect the incumbent media players to expand pan-regionally, though it is not clear what priority that takes on their agenda. Some investors struggle to understand how more value can be extracted from such expansion – which seems especially difficult for Portuguese language sites. But at least the media players have the resources and content to drive portals into a variety of alliances.
Own the infrastructure
The other cash-rich players that could drive consolidation forward are the telecom companies. They own the infrastructure and ultimately the customers, and are able to bundle their services. Already they profit from ISPs through connectivity fees. “The telecoms will be in the best position to judge country developments. They have the strategic knowledge,” says Kerr at IDC Latin America.
Foreign companies including Portugal Telecom and Telecom Italia have already stepped into the market. Telecom Italia acquired 30% of globo.com, valued at $800 million in June, and Portugal Telecom purchased a portal, zip.net, for $365 million in February.
The most active and aggressive player is again Telefónica, which already owns many of the largest telephone companies, and an ISP with Terra. Together with Ariba, it has recently set up a B2B site that offers software to be downloaded by clients who can use it to create their own sites for selling and buying.
In the coming consolidation game, the mega-hybrids of media-portal-infrastructure will rule the market in Latin America, and perhaps show the rest of the world what strategies work best.
| Online growth 1999 – 2005: millions of users and penetration rates | ||||
| 1999 | 2000 | 2003 | 2005 | |
| US | 105 (38%) | 122 (44%) | 168 (60%) | 194 (68%) |
| Europe | 65 (17%) | 85 (22%) | 143 (36%) | 171 (43%) |
| LAmerica | 10.6 (2%) | 16.0 (3%) | 43.3 (8%) | 66.6 (12%) |
| Brazil | 5.8 (3%) | 8.4 (5%) | 20.1 (11%) | 29.1 (16%) |
| Mexico | 1.3 (1%) | 2.2 (2%) | 7.6 (7%) | 12.7 (11%) |
| Argentina | 0.8 (2%) | 1.3 (4%) | 4.2 (11%) | 7.0 (18%) |
| Chile | 0.5 (3%) | 0.8 (5%) | 1.9 (12%) | 2.7 (17%) |
| Source: Jupiter Research 2000 | ||||
El Sitio leads the convergence race
Now in its third year of existence, Buenos Aires-based El Sitio is one of the veterans among Latin American portals. It launched portals in November 1998 in Argentina, Mexico and Uruguay, expanded into Brazil and the US in 1999, and into Chile, Colombia and Venezuela in 2000. El Sitio’s local portals attract more than 600 million page views a month and 1.6 million registered users, says Roberto Vivo, co-founder and chairman of El Sitio. He is thus confident that “revenue from advertisers will continue to grow.”
| Roberto Vivo | ||||||
Others doubt it, on the ground that El Sitio has not even featured among the top 10 portals in the latest reach indices for Brazil and Mexico. Admittedly, its strongest market is in Argentina, according to management. But Brazil is by far the most important Latin market, and El Sitio has no hopes of getting established there, says one analyst. In the US, its position was also weak, and operations there were scaled back recently.
El Sitio’s IPO might have been biggest coup it has pulled off. In December 1999, it raised $150 million at $16 a share. Those shares trade at $1.50 now, down from a high of $44.88. Its shares have underperformed Nasdaq considerably, and the stock was much more badly hurt by the crash than those of its closest pure-play competitor StarMedia. “El Sitio had a challenging business model – based primarily on ad revenue,” says Anna Kerr, internet research manager at IDC Latin America. “It has also been losing intellectual capital pretty rapidly in the past weeks, which is one of the worst problems a dot com can have.”
Even after a successful IPO, El Sitio lacked the means to attract enough traffic to its sites and was therefore bound to be caught up in a vicious circle: restricted money for marketing meant less traffic, thus less revenue from advertisements. In the competitive market of Latin America, earning less revenue than its competitors is fatal. “El Sitio was not viable as a standalone entity,” says one analyst. “It would have died on its own.”
A partner was needed definitely before 2001, when cash constraints would have become painfully apparent. But even at $2.25 a share, potential buyers were not exactly queuing up for El Sitio. In October, the merger the company needed finally came in the form of a marriage to a second cousin, the main shareholder Ibera American Media Partners (IAMP). The merger should go through in the first quarter of 2001.
IAMP is a joint venture between US venture capital company Hicks, Muse, Tate&Furst and the Cisneros Group of companies, leaders in Venezuelan media. Assets of the Cisneros Group in Chile, including Chilevision and Radio Chile, will be merged with El Sitio’s. The resulting company, Claxson Interactive Group (CIG), can tap into Cisneros’ Pay TV subscriber base of 40 million.
“With this deal, El Sitio will be able to offer customers even more choice and interactive content, and will be saving through cross advertising,” says Vivo, who will be heading the new company as chairman and CEO. Co-founder Roberto Cibrian will lead the group’s internet division, while executives from Cisneros Television Group take on the PayTV and broadcast/radio divisions.
“CIG has a fully-funded business plan,”, says Vivo, “and should become EBITDA positive 12 months after the merger goes through.” The path to profitability will be further smoothed with the sale of its ISP, a rather small one with 84,000 subscribers. This is not a core business.
The latest third-quarter results indicate a decline in losses per share, strong advertising growth of 31%, as well as $2.2 million of transaction revenues from its Mexican e-tailer, DeCompras.
The merger seems an attractive bet for investors, who will exchange shares of a portal for a new media play. But as the merger did not put a generous value on the new company – it’s a 1:1 stock exchange – shares plunged to $1.81. Even the strong and better than expected third-quarter results did not attract investors. “The market is eagerly awaiting detailed pro-formas and guidance from management to provide a sound basis from which to value the new entity,” says George Monserrat, vice-president of equity research at BBVA. Meanwhile the stock is drifting further down.
Still, El Sitio’s boasts that “we are the first media convergence company and at the moment there are no regional competitors.” In fact, from its inception in 1997, “El Sitio had the vision that the internet was going to catalyze the convergence of traditional media and online content,” says Vivo. “We made a conscious effort in our first private placement round of June 1999 to pick strategic partners, such as Cisneros, Impsat, Hicks and Muse and the SLI Group.”
El Sitio did indeed show the way forward, though not so much by choosing a partner than by embracing the next-best opportunity that opened up – which may well be the fate of the luckier pure plays left in the market.
In this case, Cisneros may have seen El Sitio as an asset for its other sibling, AOL Latin America. On the same day the merger was announced, Cisneros Television Group (owned by IAMP) agreed to distribute the content from its two pay TV channels through AOL LA, and to promote AOL on various CTG properties throughout the region. Analysts regard this arrangement as phase one of a possible AOL-El Sitio relationship. El Sitio may yet be drawn into the AOL empire.
AOL’s late-mover advantage
Analysts and investors have pinned their hopes on AOL Latin America. Although a latecomer – it entered Brazil in November 1999, and Mexico and Argentina in July and August 2000 – it has two things most other players lack. Thanks to being AOL’s daughter, it has resources and a global platform, extending to 120 countries.
| William Landers | ||||||
AOL LA also has royalty-free access to all AOL-branded technology, and thus pays low costs setting up services in Latin America, the only expense being localizing its sites and installing billing processes. It is also able to tap into established links with advertisers, content providers and e-commerce providers, and may soon draw content from Time Warner’s media assets.
Through its second shareholder, the Cisneros Group of companies, AOL LA has a vast platform for advertising its site and a good source of localized brand-name content. Vene-zuelan media company Cisneros owns broadcast, satellite, pay TV and other media firms throughout Latin America. Yet, it is not a major player in the most important markets, Brazil and Mexico. So AOL LA must fight hard to compete with the large, local media players there. AOL LA has been busy establishing links with local content providers, such as Reuters, Jornal de Brasil, Gazeta Mercantil in Brazil and Cinnet and Mundo Socer in Mexico. The latest deal with Cisneros TV will give AOL LA content from Pay TV channels. The company is also in talks with Mexican media company Televisa. To get its content would be a big coup, since Televisa is one of the top media players in the region.
Yet content is not considered the key in AOL LA’s business model, according to a report by CSFB. AOL’s strategy is to provide inter-active user experience, which differs from the content driven ISP/ portals. “The underlying idea is to create a paradigm shift,” says William Landers, director for Latin American Technology research at CSFB. “AOL’s success will hinge on its ability to transform the way Latin American users perceive the net. We say this because AOL charges a premium over its peers for unlimited access – which users will only choose if they find value added in AOLs interactive services. The more users buy into content, the less valuable AOL becomes.”
It’s hard to say how successful AOL LA has been because of its short operating history. In Brazil it failed to gain the stronghold it expected because of the overwhelming competition from free ISPs, which took a substantial portion of market share. AOL had to reduce its unlimited access fee from $19.55 to $13.94 in Brazil, just two months after launch.
This makes the Mexican portal look more promising. Free access did not really take hold there, which ultimately might be either good or bad news. Mexico is a much less over-supplied market, with Telmex/ Prodigy having a grip on 50% of the market. But since “the majority of internet users in Latin America are still up for grabs”, Landers, for one, is confident that AOL can make it to the top in other markets. And Mexico, he says, probably offers AOL the best market opportunity, “given its proximity to the US and the large percentage of the US Hispanic population of Mexican origin”.
Now execution is the big issue. “It has worked before,” says Landers. “AOL carved out half of the market in the US, when it came in number four in 1992.”
In June 2000, AOL LA showed that it, too, can form the sort of strategic relationships its mother AOL is famous for. Banco Itaú became a minority shareholder, taking 12%, and will drive its 1.1 million online customers to AOL LA, as well as 6 million offline clients – a great asset, considering the still low penetration rates in Latin America.
Then in August, AOL LA eased potential cash constraints with a $200 million IPO.
Unfortunately, AOL did not get the full $575 million it expected when Salomon Smith Barney offered a share price of $17 to $19. One week before execution, a panic-stricken SSB cut the offer price to $8 to $10 a share, while co-lead Donaldson, Lufkin&Jenrette still valued it at $10 to $12. Investors got suspicious, and the shares sold at $8, went down to $7 after the deal, and now trade at $5. It was a poorly-executed transaction, but also an extremely difficult one. Demand was simply evaporating, something not only AOL had to experience. Activity in the Latin American IPO market – internet or not – is a fraction of what investors are used to elsewhere. There were only three IPOs in 2000, and the last really great year for Latin America primary equity markets was 1994.
Submarino gets that sinking feeling
Antonio Bonchristiano, president of Brazil’s Submarino.com, is in buoyant mood. “There are 12 million internet users in Latin America and there will be twice as many next year,” he says. “Online sales will go up from $300 million to $1 billion. This is a very attractive business.”
| Empty shelves at Submarino | ||||||
Bonchristiano is buoyant, but his critics reckon his company could soon be sunk. “It’s all talk,” says Luís Roberto Demarco, founding partner of InternetCo, a Brazilian internet investment firm. “The new economy doesn’t exist. The internet is a tool, it opens new possibilities for the existing economy.”
There are convincing arguments on both sides. But whether it sinks, swims or sprouts wings and flies, Submarino offers an illuminating example of the growing pains suffered by Latin America’s e-tailers.
It all started out with such promise. Bonchristiano is a partner of GP Investimentos, an investment firm with fingers in most internet pies in Brazil, so he didn’t have to look far for investment capital. He and a group of investors put together an initial $3.5 million to buy a pioneer Brazilian e-tailer called BookNet in June 1999. The name was changed to Submarino and new product lines were added. GP bought 40% of the company in October that year in a financing round that raised another $14.3 million. Gathering talent wasn’t hard either.
GP’s partners are also the owners of Lojas Americanas, a chain of popular department stores, and Submarino lured away their head of distribution.
But Brazil’s internet bubble has burst more quickly than any in the world. At the end of 1999, from nowhere, the internet was everywhere. Then, in September 2000 the first big casualty was recorded when Super11, one of a fistful of free ISPs in Brazil, ceased operations, having burned through about $15 million of its investors’ money. “The failures we’ve seen so far are the tip of the iceberg,” Demarco warns. “It’s going to be incredible.”
Submarino hasn’t hit the iceberg yet, but it has been forced to alter course. Its early forays into the US, Argentina, Mexico, Spain and Portugal proved an expensive bet. The US operation has been closed and the others pared back. Its image in Brazil took a battering last Christmas when it failed to deliver hundreds of presents in time.
The Christmas debacle put a lot of people off, and Submarino has had to invest heavily to shine up its tarnished image. Bonchristiano now says Sumbarino’s delivery system is “adequate” and stresses it’s not a problem.
But he admits it’s frustrating having to deal with a host of suppliers, many of whom are small, under-capitalized and uncomputerized.
Another reason why Submarino has not been doing better is that Brazilian con-sumers are still worried about using credit cards for online purchases. And with some reason: according to a report by the Boston Consulting Group (carried out in conjunction with Visa): “In Latin America, unlike in the United States, consumers have not had the guarantee of zero liability for credit card fraud.”
That’s starting to change in Brazil, at least, as banks offer cards guaranteed against fraud on the internet. Nevertheless, just 62% of online purchases in the region are carried out by credit card. Submarino offers customers the option of paying by bank deposit, but warns they may have to seek a refund if their order can’t be fulfilled.
Lucas Graves, senior analyst for Latin America at Jupiter, adds that there is also a more general mistrust of merchants among Latin Americans. “It is still common to have to wait for delivery longer than promised, to have no reliable customer service, and not be able to return goods. For these reasons the catalogue industry, for example, never took off so that people will find buying over the internet more alien.”
But the same fact also supports the opposite argument. “Latin America is the best market for e-commerce,” says Timothy O’Brian, Submarino’s chief financial officer. “The traditional retail market is so underdeveloped that choice and convenience is a huge attraction. In the US, prior to e-commerce, everything worked perfectly well – consumers had a shopping mall around the corner, as well as category killers and catalogue opportunities. But in Latin America none of that exists. So we have become the category killer and leapfrogged a development that would have occurred otherwise in the traditional way.”
But like Amazon, the e-tailing giant that is its inspiration, Submarino has been losing money since it was launched. Bonchris-tiano says he will break even in Brazil by the end of 2001, and in the other markets a year later. Meanwhile, his investors will have to chip in more cash to keep him in the water.
Why isn’t he making money? “It would be impossible for a one-year old company to make a profit in this market,” Bonchristiano says. “We need time, to bring down our customer acquisition cost and to increase our operating margins.” He’s not saying how much his customer acquisition cost is, though he claims it’s a quarter now of what it was nine months ago. But a recent study by BCG makes alarming reading. According to BCG, spending on marketing by online retailers across Latin America is an average of $34, or 64% of revenue, per order fulfilled. But for so-called pure plays like Submarino – that is, companies operating entirely in the ether with no real-world counterpart – spending is $65 per order, or 153% of revenue.
One way to avoid what looks like certain death would be to cut costs. But Bonchristiano says his operation is already as lean as it can get. What Submarino needs now, he says, is scale. “Today we are entirely focused on growth. We have to get the traffic, and we have to convert visitors into customers. Today our conversion rate is 4%, which is good compared to the industry average but bad compared to the leaders. Amazon converts 20% of its visitors.”
That growth will have to come soon if Submarino’s investors are not to run out of patience. Quick work is needed if customers in Brazil and in Submarino’s other markets are to make it their preferred online shop.
And that, according to Demarco at InternetCo, is Submarino’s biggest problem. He argues that any retailer of any size will sell part of its produce on the internet. “Submarino makes the mistake of thinking they can sell everything on the internet. The tendency [for virtual retailers] is either to die or to join up with brick retailers.”
Ironically, one of the online stores Demarco reckons least likely to fail is Lojas Americanas, Submarino’s close relation through GP Investimentos. Why? “In the reality of the business world, and not the fantasy of the stock markets, customers are much happier to buy from a shop they already know,” he says. “Submarino’s big proposition [to investors] was that they’re the first to the market, they’re creating the Wal-Mart of 2005, today. And that must be worth a lot of money.
But they’re wrong. The internet isn’t another world, you don’t jump from one to the other. The internet is parallel to the real world and is part of it. When Submarino stops advertising, nobody will remember it ever existed.”
For another reason, Fred Searby, senior analyst of Latin American internet at Chase H&Q, thinks that B2C as a model is likely to fail. “Even Amazon is not yet making money, but they eventually will. Whereas in Latin America you base your business model on a market without scale.” Total online spending was $194 million in 1999 in the region. This will grow to a more prosperous $5.8 billion in 2004, according to Jupiter – which is, however still nowhere near the US e-commerce spending pie set to be worth $122.8 billion in 2004.
Critical mass is far easier to accumulate in the B2B sector, where transactions are a multiple of B2C transactions. IDC Latin America research says that three quarters of the total e-commerce spending of $600 million in 1999 has been in B2B.
The B2B businesses in Latin America started in 1999, and has mushroomed in 2000. Companies such as Connect MAD, a healthcare and medical advice site; Viajo, a corporate travel company; Bolsa1.com, a marketplace for sugar, alcohol and other commodities; Mecador, a grocery marketplace; and Bidare, a reverse auction site are all fighting for a piece of the B2B action.
But warns Franz Bedacht, associate principle at McKinsey&Company: “A B2B model based solely on transaction fees, i.e. the e-marketplaces, is also not sustainable. B2B companies will have to offer value-added services such as consultancy work, logistical help, financial services, or advertising space and subscription fees for related research.”
And so the B2B space, too, is quickly becoming occupied by the bricks-and-mortar companies. Jonathan Wheatley
