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Can FreshDirect revive U.S. online grocery market?
April 9, 2010 / 11:09 AM / 7 years ago

Can FreshDirect revive U.S. online grocery market?

By Lisa Baertlein - Analysis

LOS ANGELES (Reuters) - FreshDirect, Manhattan’s online grocery darling, is seeking up to $100 million in funding to open in a brand-new market on the heels of its debut in Connecticut and an expansion in the suburbs of New York.

The company was founded more than six years ago and says it has built a profitable business delivering groceries to mostly car-less urbanites in New York and New Jersey.

FreshDirect’s expansion push comes a decade after the online grocery business spawned some of the notorious “dot bombs” of the Internet bust.

Its moves undoubtedly are being watched by leading players such as Kroger (KR.N) and Safeway SWY.N, which are seeking new areas of high-margin growth amid competition from Wal-Mart Stores (WMT.N), analysts say.

“It’s a challenge to make money in that business,” added Bill Bishop, chairman of grocery consultancy Willard Bishop.

“All the big name grocers did get into it and then they got out of it. They’re going to let another company be the guinea pig,” said supermarket consultant David Livingston.

They said the test of the new online grocery model will come as FreshDirect moves beyond Manhattan, where few people drive to stores and many are willing to pay a premium for the convenience of having groceries delivered to their door.

FreshDirect, which competes with Dutch supermarket group Ahold’s AHLN.AS Peapod, serves more than 600,000 customers in New York City’s five boroughs and parts of New Jersey.

This week it announced plans to add four Connecticut communities, including Greenwich and Riverside, to its delivery route. It’s also doubling its presence in New York state’s Westchester County to 21 communities.

Beyond that, Chairman and Chief Executive Rick Braddock wants to crack an entirely new market -- which he won’t name.

“We’re looking to raise between $75 and $100 million,” said Braddock, who was at the helm of travel site Priceline.com (PCLN.O) when pioneering online grocers Webvan and HomeGrocer had their spectacular falls from grace about 10 years ago.

“Capital was pretty much free on the Internet in that period of time and it spoiled people pretty quickly,” he told Reuters in an interview.

“Webvan and HomeGrocer went out and raised a lot of money and instead of perfecting their consumer propositions they did what I would call a land grab. They expanded quickly to a bunch of markets ... then within a couple of months they imploded.”

A HIGHER-MARGIN PROSPECT

Online groceries account for just a fraction of sales in the United States, where mom-and-pop and some publicly held grocers like Safeway are in the business. Web retailer Amazon.com (AMZN.O) is testing the concept in its hometown of Seattle.

Britain has a more thriving online grocery industry due in part to its higher population density, but leading British operator Ocado is running losses, even as it eyes an initial public offering.

It may take an outsider like FreshDirect to show U.S. grocery giants that online can work, experts said.

“If FreshDirect gets the money to open another market and proves they’re not a one-hit wonder, I think you’ll see everyone jumping into the space,” said Jim Prevor, editor of industry newsletter Perishablepundit.com.

Braddock says FreshDirect is more consumer friendly than its predecessors. More importantly, he adds that it is producing a net profit and has margins that outpace the industry.

FreshDirect expects 2010 revenue to grow to $300 million from $250 million in 2009. Braddock also said the company is close to reaching a 10 percent EBITDA (earnings before interest, taxes, depreciation and amortization) margin.

That would be better than the 6.2 percent EBITDA margin reported in 2009 by Kroger, the nation’s largest brick-and-mortar supermarket operator, and higher than specialty grocer Whole Foods Market Inc’s WFMI.O 7.2 percent EBITDA margin, according to research from Jefferies & Co.

FreshDirect has tapped the markets to the tune of $48.3 million since 2003, according to data from Thomson Financial. Investors include AIG Capital Partners, AIG Global Investment Group, CIBC Capital Partners and Maverick Capital.

Still analysts are skeptical as consumer habits in suburbs are less in sync with the delivery model and as huge players like Wal-Mart and Costco Wholesale Corp (COST.O) undercut the industry on price.

“If they get lots of competition it’s hard for them to be very efficient,” said Prevor, who added that another suburban challenge is that “people just hate waiting” for deliveries.

But Braddock said FreshDirect’s revenues are accelerating as it tacks on new sales that can be serviced from its existing infrastructure.

While fuel costs are higher for deliveries to the suburbs, for example, those residents tend to spend more and delivery trucks require just one person, rather than the two people needed in urban neighborhoods where parking and security are bigger concerns.

“Incremental growth is very profitable for us,” Braddock said.

Additional reporting by Alex Haislip in Los Angeles; Editing by Michele Gershberg and Steve Orlofsky

Our Standards:The Thomson Reuters Trust Principles.
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