What’s Behind Fatbrain’s Stock Dive?

Last Friday, shares of online bookseller Fatbrain.com lost one-third of their value when three brokerage firms downgraded their investment rating on the stock.

Shares plummeted $6.87 to $13.87 (US$) on the Nasdaq Stock Market after an analyst call Thursday caused brokerages U.S. Bancorp Piper Jaffray and Banc of America Securities to lower their ratings from strong buy to buy, while Needham & Co. cut its rating to hold from strong buy. Fatbrain’s stock was at $15.31 in midday trading on Monday.

One main reason for the slide was that the company’s new online publishing foray, known as eMatter, has been limping along since its inception.

The Next New Thing

Before introducing eMatter, the Palo Alto, California-based Fatbrain focused on selling business and technical books via the Internet, and was considered one of Silicon Valley’s fastest growing companies. Revenues for 1999 were in the range of $30 million, with analysts expecting the firm to reach the $70 to $80 million range next year.

While already highly-regarded as a specialty book publisher that utilized innovative distribution techniques — such as cutting deals with high technology companies to make its store more accessible behind corporate intranets — Fatbrain debuted eMatter with the claim that it was destined to radically change the publishing world.

At the time, company officials touted eMatter’s service as a new way to sell unpublished material, including such documents as company research papers or notes from a conference. The service, Fatbrain argued, would allow authors to sell their work directly to readers, thereby eliminating the cumbersome filtering process of publishers and editors.

Wall Street reacted positively to the news. Investors pushed the stock up from $15 at the announcement to a high of $42.25 in mid-November. Now, however, the stock is back to where it began its climb.

Profits Split Down the Middle

Fatbrain.com contended that its new publishing model was to writers what MP3 is to musicians, pointing out that there had never before been an economical channel to sell the 10 to 100-page document.

At first blush, the innovation sounds appealing to any writer who has ever received a rejection letter or has had copy brutally edited. However, I believed in September, as I do now, that the service is actually a recipe for chaos.

Why?

Without the eyes of an experienced editor, I felt that any article could end up not just grammatically flawed — but even libelous. Then there were the problems of fact-checking, plagiarism and copyright infringement. What’s more, I predicted that eMatter would end up filling its site with reams of inappropriate, amateurish and non-selling digital drivel.

According to U.S. Bancorp Piper Jaffray analyst Tim Klein, the reasons for eMatter’s lower-than-expected sales were “slower than anticipated acquisition of titles and an inappropriate distribution channel for consumer-related issues.”

Additionally, even though Robertson Stephens analyst Michael Graham kept his buy rating on Fatbrain, he pointed out in his research note that eMatter was “seeing a bit of chicken/egg problem as authors appear to be waiting until commerce on the site reaches critical mass.”

No Surprise

eMatter is a very interesting concept. According to Fatbrain, 19 publishing firms have committed to providing content for purchase, including self-help legal publisher Nolo.com, Macmillan USA, McGraw-Hill Professional Books Club, and technology magazines Red Herring and The Industry Standard.

More than 5,400 writers have also signed up to self-publish eMatter content, which gets to the heart of the problem. How does a consumer know which materials are worthwhile, and which ones are not? While eMatter may sound like a great idea, to me, the way it is currently set up makes the concept unworkable — and Wall Street seems to agree.

What do you think? Let’s talk about it.

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