By Elizabeth Holmes and Spencer E. Ante
Gilt Groupe Inc. hasn't made a penny in profit since it was founded in 2007 as an online discounter of hot designer goods like Reem Acra gowns and Rebecca Minkoff handbags.
A recovering economy is drying up the flow of excess goods that supplied Gilt's inventory during the recession. The company needs heavy investments to turn into an all-purpose luxury retailer. And competition from a flock of high-fashion copycats is getting tougher.
Yet none of that deterred a group of sophisticated venture capitalists from injecting $138 million into the company, giving the small retailer a valuation of $1 billion.
Gilt is now valued at two times its sales, double that of luxury market stalwarts like Saks Inc. and Nordstrom Inc. and approaching the premium put on established online retailers like Amazon.com Inc., which the market values at 2.5 times sales.
Even as Web companies like Skype and Groupon Inc. continue to pull down unexpectedly rich valuations, there is brewing skepticism about how much longer the uplift can last. Gilt—with its highly competitive business—has become a litmus test for the new dot-com boom: Is this company really worth $1 billion?
"I'm a bit of a doubter," said Andrew Jassin, co-founder of Jassin Consulting Group, which works with brands that sell to Gilt.
Mr. Jassin's doubts center on the worsening fundamentals in Gilt's core business of selling designer goods at a discount. That was a thriving business during the recession, when luxury sales plunged and inventory backed up. Gilt took that inventory and sold it at reduced prices in time-limited sales that recreated online the frenzy of "sample sales."
"If they don't have a known source of brands and products into the future then they've somehow overstated their value," Mr. Jassin said.
Gilt Chief Executive Kevin Ryan said the company's valuation, double what it commanded in another capital raising a year ago, is justified by Gilt's ability to sell nonfashion merchandise and full-price products as well as its rapid growth potential.
Mr. Ryan, who previously led the online ad company DoubleClick during last-decade's dot-com boom, is welcoming a roster of notables including AOL's Tim Armstrong and Arianna Huffington to Gilt's "Second Annual Brand Summit" in New York on Wednesday.
More than half of the fashion items Gilt sells currently aren't excess inventory, but goods Gilt bought as first-run items, he said. About a quarter of the revenue from Jetsetter, Gilt's travel site, come from full-price sales, he said.
Later this year, the company plans to launch a full-price men's site. It is also considering full-price divisions for bridal wear, art and pet supplies. That shift could help it sidestep the pressures in the discount fashion business.
A group of nine investors, including Goldman Sachs Group Inc. and Japan's Softbank Corp., bought into Gilt's latest funding round. Nearly half of the funding came from Softbank, the Japanese conglomerate that was known for helping inflate the dot-com bubble when it invested heavily in technology companies during the 1990s.
Valuations of large, high-growth technology companies like Facebook Inc. and Groupon have exploded in the past year, as a surge in investor interest collided with a dearth of opportunities to put money to work.
Many of the companies are posting better sales and profit numbers than their counterparts in the first Internet boom more than a decade ago, but skeptics still worry that valuations are moving too far away from fundamentals.
When LivingSocial raised $400 million this year, the investment valued the daily deal site at around $3 billion, or three times its expected 2011 revenue of $1 billion. By comparison, Amazon.com's 1997 initial public offering valued the Internet retailer at $438 million, also around three times its net sales that year of $148 million.
With many of these companies now delaying IPOs, much of the action has taken place in fund-raising rounds and markets for private-company stock, where venture-capital veterans have found themselves competing with more mainstream investors like Goldman Sachs and mutual fund T. Rowe Price Group Inc.
Softbank didn't reply to a request for comment, but other Gilt investors explained their reasoning. Tony Florence, a partner with New Enterprise Associates, said his firm believes the valuation is reasonable considering that Gilt is selling in large markets and growing faster than many of the e-commerce companies he has reviewed.
Gilt generated around $400 million in revenue last year, more than double 2009 revenue of $170 million. Last year, Amazon.com's revenue grew 40% to $34.2 billion. Online discounter Overstock.com saw its sales rise 24% last year to $1.1 billion.
Randall Glein, managing director of the Draper Fisher Jurvetson Growth Fund, said his firm isn't worried about Gilt's lack of profit, saying the company is making the choice of putting its money into expansion—a typical choice for young companies.
"We are interested in seeing them maintain rapid growth," he said.
Nick Beim, general partner with Matrix Partners, a venture capital firm that had already invested in Gilt in earlier rounds, said the $1 billion value reflected the interest in the deal and the company's leading position in its market.
"The high end of e-commerce remains very open," said Mr. Beim. "That is the space that Gilt is seeking to fill."
Others are looking to fill that space as well. Online retail specialist GSI Commerce Inc. bought Gilt competitor Rue La La in 2009, and Nordstrom bought HauteLook earlier this year, bringing deeper pockets to the business.
GSI has since agreed to be acquired by eBay Inc.
Rue La La, profitable at the time of its acquisition, wasn't valued as highly as Gilt. It was bought for $180 million, less than one times its total sales, though the deal called for additional payments based on the company's performance that could push the sales price up to $350 million.
