Fool's Eye View

[ November 30, 2000 ]

Comment: QXL Ricardo

By David Kuo (TMFDragon)

Carburton Street, London -- Stuart Watson (TMFTiger) wrote six months ago that QXL ricardo (LSE: QXL) scared the willies out of him. It scares the willies out of me also, so that makes two of us. On the surface, the business model for QXL looks easy enough for anyone to understand. It's a bit like an online car boot sale, which hopes to match potential buyers with willing sellers through the magic of the Internet. And for the pleasure of operating this web-based service, QXL takes its cut and Hey Presto! Money for old rope.

More Money Please

Not so fast. This baby is burning cash at a rate of knots and the bigger it gets, the more it burns. This morning QXL announced the raising of a further £30m through the issue of £15m of convertible bonds and another £15m in the form of new ordinary shares. According to the company, the new funding together with its existing cash resources of £45m would ensure the continued implementation of the company's pan-European strategy. That would give the company a cash pile of £75m and if it continues to make a loss of £50m a quarter, then the money is not going to last that long.

Where's the problem?

QXL needs scale to survive. It has boosted turnover from £1.8m last quarter to just under £6m this quarter. This 233% jump in turnover resulted in an improvement of just 10% in gross profit to £486,000 from £442,000. In other words gross margins have declined from 24.5% to just 8% over the three-month period. That is one heck of a drop in margins and investors should sit up and take note.

But it gets worse. Even ignoring the goodwill amortisation of £44.8m, operating expenses for the last quarter came in at £22.7m. In other words QXL needs to generate a turnover of £280m a quarter in order to cover expenses. That translates to £1.1b a year, which is equivalent to the annual turnover of Debenhams (LSE: DEB). At this level of operation, the company would just about manage to break even.

Every Cloud has a Silver Lining

Whenever we look at Internet companies, the issue of scalabity is always raised when there is a gap between turnover and cost of operations. It is always possible, in the case of QXL, that gross margins could improve, in which case the scenario becomes that little bit less scary. There is also the prospect of a reduction in overhead expenses, which I am sure the company is addressing. Both of these options would accelerate QXL's move to a cash flow positive position. It is a long shot but as long as the company is able to raise cash, there is always hope.

I am not a fan of the company and this is an investment for those who are far braver than me.

Where Next?

• I've had my say, so why not have yours over on the QXL discussion board?