Second-hand success: PC Mall unit that deals refurbished machines has fueled stock.

Shares of direct response computer retailer PC Mall Inc. have been on a year-long run up, fueled in part by the appeal of its eCost.com Inc. subsidiary, a four-year-old side business that has emerged as a spin-off candidate.

While most sales come from moving new products by companies like Hewlett-Packard Co. and Sony Corp., eCost.com has established a profitable niche selling refurbished consumer electronics items through limited quantity offers.

PC Mall reported that eCost.com's third-quarter sales were $25.6 million, 11 percent of the company's $232 million total. Its $315,000 in income from operations, however, represented 22 percent of the $1.4 million reported as a whole.

That compares with the like period a year earlier, when eCost.com sales were l0 percent of the company total and income from operations accounted for nearly 27 percent of the total.

Those continued high margins, coupled with two analysts' reports calling the unit a viable independent business, helped shares spike further in the second week of November.

Citing its contribution to the parent company's bottom line, brokerage Miller Johnson Steichen Kinnard Inc., based in Minneapolis, initiated coverage on Nov. l0 with a "Buy" rating.

"In our opinion," its report said, "PC Mail's two businesses could support higher valuation than the company's current market capitalization."

Two days later, Merriman Curhan Ford & Co., a San Francisco brokerage that makes a market in PC Mall, initiated coverage with a "Buy" rating that said, in part, eCost.com could be worth $13 per share if it were spun off.

PC Mall closed at $10.90 on Nov. 10, up 20 percent from the close of the previous trading day. It reached a 52-week high of $14.48 three days later, although it backed off to close at $13.59.

The company, said Stevens Monte, an analyst at Sky Capital LLC, a New York-based investment bank, could well be waiting for the IPO market to gather a greater head of steam before selling off eCost.com. "They were positioned by the company to go public," he said.

Ted Sanders, PC Mall's chief financial officer, would not address the prospect directly. "That is something we have not made any decision on one way or another," he said. "If we were to do anything, it would have to go through an announcement with the SEC."

Earlier sale

A spin-off of eCost.com would not be a first for PC Mall, which was established in 1987 as a mail order computer supplier. After it went public in 1995, it adopted a telemarketing-based approach and grew as it acquired smaller distributors in recent years.

In June 1999, an online auction business, uBid.com, was spun off through a share distribution to stockholders. UBid.com was purchased by Charleston, Mass.-based CMGI Inc. the following year in a stock transaction worth a reported $407 million.

PC Mall lost a combined $22 million from 1998 through 2001, largely expenditures in hiring sales staff and the recession. In response, PC Mall's stock nose-dived from a high of $16.72 a share in November 1998 to 50 cents a share in December 2000.

Costs were slashed all around, including a 50 percent cut in eCost.com's expenses in 2001 after the unit showed a loss of $9.4 million the year earlier. The cuts were focused on advertising costs, such as replacing Web banner ads with consumer email marketing campaigns.

The moves reduced total sales expenses to $7.3 million, down from $14.6 million in 2000, and led to a $900,000 operating profit in 2002. Its value apparent, management chose to keep the subsidiary tied to PC Mall instead of spinning it off.

"We have looked at different alternatives over the past few years for the good of PC Mall," said Gary Guy, president of eCost.com. "With the profits, we started to contribute, and it made more sense to keep it tied to the parent company."

Miller Johnson said it expected eCost.com to post a 50 percent annual increase in operating profit over the next several years, comparing it favorably with its largest competitor, Salt Lake City-based Overstock.com Inc. Overstock has roughly the same sales as eCost.com, but reported a loss of $3.7 million for the three months ended Sept. 30, compared to a loss of $377,000 in the like year-earlier quarter.

"ECost.com is worth at least half of the market value of Overstock.com's stock," said Monte.

Sales of refurbished products come to eCost.com via the manufacturers' refurbishing divisions, which typically take in equipment that has been returned by retail customers, left sitting in overstocked inventories or repossessed from failed businesses.

Though there are risks, eCost.com claims that there are very few cases of defective refurbished goods being sold. "They do a complete testing of every component before reselling it back to us," said Guy.

Helping eCost.com has been widespread acceptance of refurbished goods.

"We are seeing big companies getting into the refurbished marketplace," said Robert Davie, founder of ITParade.com Inc., a North Carolina-based refurbished computer supplier. "The manufacturers are guaranteeing this equipment, otherwise corporate America wouldn't buy it."

Trepidation over the life expectancy of used equipment has led to profits for eCost.com, which sells extended warranties to customers.

"We do make money on the warranty. It's a product like everything else," said Guy. "It enhances our overall margin."