For serial entrepreneur Joel Ronning, the third start-up has been quite a charm.
Digital River, which Ronning founded with backing from computer giant Fujitsu in 1994, is a rare e-business success story. Managing Web sites, online sales and fulfillment for entities ranging from Major League Baseball to the Nasdaq Stock Market to antivirus software maker Symantec Corp., Digital River reported its first profit on an earnings before interest, taxes, depreciation and amortization basis in the third quarter of 2001 and its first net profit in the month of September. “We’re not looking back. We’ll be profitable from here on,” vows the 45-year-old Ronning, the company’s CEO.
What’s more, Eden Prairie, Minnesota-based Digital River is riding a wave of growth in business-to-consumer transactions, which many other companies and strategists had deemed just as hopeless as the fallen business-to-business sector.
“We were fortunate to be smack-dab in the center of outsourcing; there is tremendous pressure on corporations to outsource in this environment,” says Ronning, a lifelong Minnesotan whose previous start-ups were Mirror Technologies (1985), which sold data storage devices for Apple Macintosh computers, and Tech Squared (1990), a desktop-publishing catalogue venture.
Ronning folded both ventures into Digital River, which suffered its share of volatility; within six months of its August 1998 IPO at $8.50, its stock price shot above $50, only to plummet to $2.1875 in January 2001. But it has since recovered to about $18 for a market capitalization of $450 million - making the shares valuable currency for picking off weaker players in a consolidating market.
With 420 employees and more than 13,000 customers, Digital River now enjoys what analysts call earnings visibility. Ronning is projecting $80 million to $85 million in revenues this year, up from $57 million in 2001, and $10 million to $11 million in net income, or 35 to 38 cents a share.
“We’re not trying to do anything that blows everybody away on a quarter-to-quarter basis,” says Ronning. “We just want to do better all the time, and the plan is to be huge five years from now.”
Ronning discussed Digital River’s prospects with Institutional Investor Assistant Managing Editor Jeffrey Kutler.
Institutional Investor: You’ve said you plan to be huge - what do you mean?
Ronning: It’s hard to say exactly, but there’s a lot more opportunity out there than we can deal with. Forrester Research is projecting $135 billion in B2B and B2C Internet sales in 2002. We’ll probably manage $800 million of that for our clients, so we have a 0.6 percent market share.
How did you come up with the idea for Digital River so early in the Internet game?
We started focusing on software companies. It was obvious to me that they needed a mechanism for selling and delivering software via the Internet. We put together an e-commerce application with all the systems and processes surrounding that. In 1997 we extended the model to hard goods, where we fulfill package deliveries too.
What is the mix of digital (downloadable) versus physical commerce?
Three quarters of our business, in terms of both revenue and number of clients, is in software publishing; that revenue is split about 50-50 between digital and hard-goods delivery. The other one quarter is with manufacturers, distributors and retailers.
Was digital growth disappointing?
That sea change didn’t happen as fast as many people expected it would, but today we are pretty comfortable with the rate of change. We benefited by getting a greater penetration of the client base than we expected. A lot of our competitors have gone away - we bought some of them - and the field has gotten less competitive.
Weren’t overly high expectations a problem all across the Internet?
Sure. But we have a pretty good sense of the growth in this business. It’s not as monolithic as some commentators have made it out to be. There is very accelerated growth in certain areas. We see it at some clients that are 100 percent digital; others are only 2 percent digital. A lot of that has to do with the product, the sales price and the size of the file to be delivered. For big-ticket items, like a $3,000 computer-assisted design product, our client, Autodesk, wants to deliver the boxes, the books, which customers can wrap their arms around. Time-sensitive applications like antivirus programs are a different story, and a lot of that is being done digitally.
Now that Digital River is making money, do you have to manage expectations differently?
We’ve been thoughtful and cautious all along. It’s not a business you can build overnight, and it took some time to separate the wheat from the chaff. Remember, we were under the same pressure as all the other money-losing companies, and our stock suffered along with everybody else’s early in 2001. But we hit all our numbers. We said five years ago that we would be profitable by the fourth quarter of 2001. We increased our gross margins by 950 basis points over the past year, and we’re seeing more efficiencies in the business than even we expected. The lift in the stock comes from being able to see an EPS number.
What makes Digital River different from other young companies?
We may really be defining a new space as a company similar to what Automatic Data Processing was 18 years ago. At that time, outsourcing of payroll processing was an interesting idea, but not everybody was doing it. People were concerned about losing confidentiality or control. We run into those same issues with e-commerce outsourcing, but if you look at the numbers, the costs are overwhelmingly in our favor.
Do customers see those economics?
E-marketing success has a lot to do with the ability to do e-analysis, and we have a lot of statistics and analytics using technology from companies like E.piphany and SAS Institute. The bottom line is that clients come to us because we’re cheaper, and they stay with us because we help them grow their businesses and their margins.
How about international business?
We’ve sold into just about every country in the world; more than 20 percent of our revenues come from outside the U.S. We are currently managing 24 languages and 22 currencies. We are looking at significant opportunities in China and the Far East. And we expect an acceleration in European markets, which we see as a year to a year and a half behind the U.S. in e-commerce.
How do you make the case for optimism in B2C commerce?
We see 20 to 30 percent organic growth. By that I mean new customers coming on the Internet and buying product, and a lot of that is happening in Europe and the Far East. We also see our clients’ e-marketing sales - that is, “same-store sales” - rising at a 40 percent rate. This tells us that e-commerce as a whole, which is already very large, is going to get much bigger.
Are you ready for that?
We have a great management team that has been through this before. There is not a 26-year-old vice president in the bunch. They are seasoned people from retail, distribution and direct marketing backgrounds who understand how to make money a nickel at a time. As a group we are very thoughtful about risks and very focused on internal operations and efficiencies. Because of that, we were able to increase revenues 90 percent in the first nine months of 2001 while operating expenses fell about 1 percent.
Do your economies of scale portend more consolidation?
Acquisition of competitors is one of our growth drivers. There are 30 organizations running virtually identical infrastructures, each serving a relatively small client base, and many are underwater financially. We’ll be out making deals to gain clients and relationships. Last year, for instance, we bought Orbit Commerce of Chicago, which brought us FedEx, Gateway and VeriSign. There are bargains out there, but we tend to be cautious. We only buy companies that can be immediately accretive.
