ALLOY’S EVOLUTION GRIPS TEEN MARKET

Byline: Vicki M. Young

NEW YORK — In a sector where the majority of e-commerce players spend disproportionately on customer acquisition and advertising costs, at least one player in the intensely competitive online teen market appears to be beating the odds and moving from strength to strength.
Since Alloy Online’s May 1999 initial public offering, the firm has evolved to more than just a teen destination site providing community, commerce and content. Utilizing different media venues for revenue streams, Alloy is more like a “new, new economy” convergence media firm that just happens to have teens as its core audience. And the firm’s avant-garde approach, say members of the financial community, has kept the company at the head of the class in a number of key initiatives, be it as the first to incorporate chat or as a teen auction site for its users.
A number of analysts expect Alloy to be profitable in the fourth quarter ending in January 2001, roughly 18 months after going public. ITurf, a competitor that went public in April 1999, has projected publicly that it won’t be profitable on a cash-flow basis until the second half of 2001. Both target the 10-to-24-year-old Generation Y age group. At Alloy, slightly over half of its users are female.
Jeffrey Klinefelter, analyst at U.S. Bancorp Piper Jaffray, is projecting earnings of 2 cents per share for the fourth quarter. “The company has a first-mover advantage, building momentum and cash to drive brand equity. They have a compelling package to offer consumers and investors.”
Klinefelter added, “Assuming Alloy can hit profitability by the fourth quarter, its compelling content/commerce model will be validated. The company has a likely shot of hitting the mark, as management is relatively conservative in their estimates.”
Derek Brown, analyst at WR Hambrecht & Co., is also predicting a profit of 2 cents per share. “The reason I like this company so much is that it really does represent a very different product and story. Alloy’s convergence media model is unique and effective at building the company’s brand, driving revenue and customer acquisition.”
He added that the company’s multi-media platform approach, by using different media to build its business, helps drive advertising and sponsorship opportunities for Alloy. Brown has a “strong buy” rating for the company, with a $30 price target over the next 12 months.
So why haven’t shares of Alloy run up well past its IPO price? While the stocks of most business-to-consumer companies have been trading below their offering price, Alloy’s is one of the few that’s trading above it. Shares of Alloy, which were priced at $15 when they began trading May 14, are still in the mid-to-high teens range in over-the-counter trading.
Matt Diamond, chairman and chief executive officer of Alloy, said last week at the company’s new headquarters on West 26th Street here, “There are times when I’ve questioned why our stock hasn’t necessarily gotten the recognition it deserves, but we’ve stayed the course and the stock took care of itself. To us, that means revenue growth and profitability.”
Strong support from institutional investors has helped the stock. “That’s the irony of institutional support,” Diamond observed. “The bad part is if you have long-term holders that never sell your stock, it reduces the float and you don’t get a big run. The flip side is, with the crazy business [in the market] now, it doesn’t move very much” if and when the market drops.
Diamond and his two founding partners met while in Japan. James Johnson, president and chief operating officer, worked with Diamond at General Electric, while Sam Gradess, chief financial officer and corporate secretary, worked at Goldman Sachs. Diamond returned to the U.S. for Harvard Business School. The company, which had a fashion focus on snowboarding apparel and lifestyle, was formed in January 1996.
The original Alloy site was available in both English- and Japanese-language versions. A catalog followed in August 1997. The company later decided to focus just on the U.S. customer, but in November 1999, relaunched its Japanese version.
Like many start-ups, Diamond and his friends received initial funding from friends and family. According to the ceo, “We were a bootstrap operation. We did our own fulfillment from an apartment Jim and I were living in at the time in Boston. Sam was working in New York and commuted to Boston every weekend.”
The company evolved from a pure apparel play to a teen destination site by accident. “We backed into the market,” Diamond said candidly. “The feedback we got from our site told us our audience, at 15, was younger than we expected, and that they liked the street look of a snowboarder, but that it wasn’t their main interest.”
The company refocused, and also began its catalog to build a brand presence online. “We’ve grown tremendously in a very, very short period of time,” the chief executive noted. “No one else has grown as fast as us in gross margins. We have a very-long-term profit model. Not only are we getting them to the Web site cost-effectively, we’re circulating a catalog. Once there, the high margins are very quickly generated.”
Diamond’s proud of the company’s gross margins in the 55 percent range, with over 50 percent of its revenues from online sales. The catalog operation runs fairly close, with the balance from non-commerce advertising income.
“The reason I think we’re having so much success relative to the Internet space is because we have a very cost-effective business model, in a Web site, our catalog, different distribution channels. To me, it’s like having cash registers on floor two and on floor three, different ways for us to touch a teen,” Diamond explained.
To get the right merchandise, and the gross margins, Alloy’s site features a section where teens can voice whether they “dig or dis” an item. The firm also has its own merchandising team that conducts interviews with teens seasonally to help it decide what brands to carry. “The brands range from Mudd Jeans, popular this past holiday, Roxy and Quiksilver, great for spring and summer, and Station Wagon,” the ceo said. The company has also added third party vendors. Orders for Eastpak were filled through third-party fulfillment, while Nike and Fossil did their own.
“Our view is that you can’t predict what items teens want next or what they want to do, or even what’s the next hot thing. [Because of that view], we are distributing a brand, not dictating fashion. Our whole philosophy is to be very close to market,” Diamond said. He noted that the firm’s competitors often sell private label, which Alloy doesn’t do. Not doing so allows the company to be “very selective in our merchandise.”
Diamond continued, “We can change the merchandise more quickly and suffer less of a hit on the bottom line if the product doesn’t sell. We are selecting literally between 6 to 8, maybe 12 weeks, before we have to present it so we know what’s popular. We don’t have to try and predict 10 months in advance what to have.”
The ceo admits that the company’s approach doesn’t provide it with as high a margin on the first sale as it would if it was buying in advance using production in Asia. “But on the back end of excess inventory,” Diamond pointed out, “we save so much money on markdowns, write-offs. We don’t have so much inventory; that’s why our gross margins are so high.”
Beauty products account for 15 percent of the merchandise mix and apparel 65 percent, with shoes and accessories representing the balance. Roomware — accessories for one’s room — is under 10 percent, but showing substantial growth, Diamond said.
Alloy’s gross margins and low stock price caught the attention of Liberty Digital Inc., a company that is building an interactive television network. In a deal expected to close this week, Liberty last month agreed to invest $54 million in the firm, giving Liberty a one-sixth stake in Alloy. Analysts expect the deal will lay the groundwork for Alloy in terms of opportunities down the road as interactive television mushrooms.
A Liberty Digital executive told WWD that Alloy represented an attractive investment because “the company has shown a willingness to be adaptable. Alloy impressed us because they are unique in their ability to generate commerce with Gen Y, and their convergence approach leverages both online and catalog sales, which the [stock] market hasn’t given them full credit for. If a company isn’t a pure dot-com, the Street doesn’t know how to value it. They forget that online sales are just another distribution channel.”
For Liberty, the stock price was also a key factor. “The demographic is important to us, and if the market gives Alloy credit for what it has achieved, the stock price would be more expensive for us,” the executive said.
Including the Liberty investment, Alloy has $85 million in its war chest for future growth. “We’ll continue to look at acquisitions. We don’t have a need for cash from an operational perspective,” Diamond said.
Significant acquisitions in the past include 17th Street Productions, a developer and producer of media properties for teens, and Celebrity Sightings, which is the basis for Alloy Entertainment. In partnership with Penguin Putnam Books for Young Readers, the company also formed AlloyBooks to publish teen books. Diamond said his company would “consider anything that touches teens.” He doesn’t rule out acquiring a competing site, but added, “the problem is they’re so unprofitable.”
The founding owners, who range in age between 31 and 34, have largely impressed their investors and partners with their ability to stay ahead of the game. Jeff Stracka, business development manager at FairMarket, which provides hosting services for the Alloy teen auction site, said, “One of our sales staff called Alloy’s president. They signed up rather quickly, and we found them to be a very forward-looking company.”
David Yarnell, general partner at Brand Equity Ventures, noted, “We’ve always liked this management team. This triumvirate works well together, they know each other’s strengths and play that up in how they’ve divided their responsibilities. Matt [Diamond] is constantly challenging the organization to think six months to a year ahead. The company is always evolving, from a catalog selling apparel to a brand with entertainment, product and information for its users.”
Brand Equity Ventures invested $5 million in Alloy’s first round of financing in fall 1998, before it went public. “Our investment so far has generated a sixfold return rate,” Yarnell revealed.
He said his firm was attracted to the company because “management showed a smartness in analyzing where the money was, where the customers were buying from. We started analyzing their catalog response rate and found that they had a high rate of return on a sales-per-book basis from their prospecting.”
Steven Richter of Tucker Anthony believes that Alloy will continue to stay ahead of its competition. “This company is a well-positioned teen brand in the online world. It’s got a solid management team and a strong e-commerce strategy.”
Diamond is projecting $14 million in advertising revenue for the year ending in January 2001, and $50 million in e-commerce and catalog sales. The company’s staff totals 120. He is projecting an increase to 170 by yearend, with the bulk of the new hires in the advertising sales and business development departments.
“We’ve been lucky,” Diamond admits, crediting himself and his friends’ business experience as a plus in staying ahead of the curve. “We’ve also had good mentors, but mostly we’ve been very lucky in a lot of instances.”

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