Online Commerce Draws First Wave Of Deals

To be sure, many Internet retailers do not have the necessary size and scale to be viable acquisition targets for sponsors. What’s more, “PE folks are still a little scared of e-commerce,” said Michael Petsky, a partner at investment banking firm Petsky Prunier. “If someone is doing what Amazon is doing, or could do at anytime, they don’t want any involvement whatsoever.”

But this may turn out to be the year that e-commerce finally clicks with private equity investors. Increasingly, the private-equity mindset is starting to change as online retailers mature, industry leaders emerge, and successful deals get done.

A growing number of firms like Clearlake Capital Group and Palamon Capital Partners are starting to get serious about the e-commerce sector. “For houses like ourselves that are interested in top line growth, e-commerce makes good sense,” said Daniel Mytnik, a partner at Palamon, which recently acquired a majority stake in online beauty products retailer Feelunique.com in a deal valued at about $42 million.

As more and more dollars shift online, Palamon is digging into dozens and dozens of verticals. The firm has looked at everything from online snacks and online ballet shoes to online sporting goods and online vitamin supplements in its quest to find the right deal.

Feelunique.com stood out for a number of reasons. First, online fashion and beauty sales have skyrocketed. Online now accounts for 10 percent of all sales in the fashion sector, up from just 5 percent a few short years ago. “Massive volumes are shifting from brick and mortar to online, and that is a secular growth trend that we want to participate in,” said Mytnik.

Additionally, the firm felt the beauty space in particular is still grossly underpenetrated as far as online is concerned. Mytnik said that only about 20 percent of the site’s target audience know they can buy brand-name beauty supplies online, and Feelunique.com aims to increase that awareness to more than 50 or 60 percent over time. To that end, Palamon has set aside about $16 million to accelerate Feelunique.com’s media presence, as well upgrade infrastructure and technology, including a more user-friendly front-end system.

Mytnik was also impressed with the company’s gross margins. The traditional knock against e-commerce is that, with a single click, consumers can shop anywhere, and thus merchants don’t have any pricing power. But that’s not always the case, argues Mytnik. “Some of these verticals have better margins than others,” he said. In the beauty sector, for instance, there is greater price elasticity and less discounting, especially since consumers are willing to spend more to feel better about themselves. Plus, beauty supplies tend to be light-weight and easy to ship.

Despite a slight uptick in activity, private equity investments in e-commerce are still few and far between. There were only five pure-play e-commerce buyouts last year around the world, compared with 173 venture capital and growth capital transactions in the space, according to Petsky Prunier. That’s up from just three private equity buyouts in 2011. To date, most of the private equity action has been in growth-stage financing deals. In particular, crossover firms like Summit Partners, 3i Partners and General Atlantic have been active backers of flash sales sites like Gilt Groupe, BuyVIP, and Vente Privee.

For Behdad Eghbali, founding partner at Clearlake Capital Group, e-commerce is an attractive sector for two main reasons: Its growth continues to far outpace traditional retail by a large margin, and it is still actively taking share from offline retail. At the end of last year, Clearlake Capital concluded its second e-commerce deal, the acquisition of Swiss Watch International, which operates a number of category-leading sites including WorldofWatches.com, eWatches.com, and TheWatchery.com.

“E-commerce is a long-term thesis for us,” said Eghbali. “We are looking for market leaders in verticals we think are ripe for consolidation. We want good businesses that can scale, that are good at merchandizing, but can benefit from a PE sponsor helping them become better at marketing, distribution and logistics to become better overall retailers.” The firm was particularly attracted to Swiss Watch International because penetration in the jewelry and watches category is still extremely low, with only 4.2 percent of all sales happening online, according to Comscore. That suggests there is still plenty of room for growth.

“The opportunity for significant upside is very real because growth can be explosive,” echoed Mytnik, who speaks from experience. In 2007, his firm, Palamon, acquired online fashion clothing retailer Dress-for-less. Three years later, after revenues had tripled, Palamon sold the company to a strategic buyer for $280 million, netting a tidy profit.

Of course, these deals also come with significant risk. “Online businesses are like speedboats. They can go very fast, but they are also very volatile,” warns Mytnik. “If you build a physical store, it’s hard for someone to build a competing store right next door to you. If you do something wrong online, people will migrate away from you quickly to somewhere else, and it can cost you a lot. The upside is big with e-commerce, but so is the downside.”

But for mid-market firms looking for fast-growth companies, the e-commerce space is an increasingly attractive option. Petsky said that e-commerce companies are maturing and developing profit profiles that make them viable candidates for buyouts. He adds a number of traditional catalog companies and direct marketers have now transformed themselves into 100 percent e-commerce companies, and have become legitimate targets.

Petsky said that just such an e-commerce company in the photography vertical was acquired in the first week of this year, though he was not at liberty to reveal the name as the deal had not yet been announced. “I would not be surprised to see more pure-play e-commerce buyouts going forward,” he said.

Tom Stein is a contributor to Buyouts.