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My favorite IPO for 2000
I first mentioned FreeMarkets, Inc. (FMKT-NASDAQ) in the November 1999 issue of Taipan. Since then, FreeMarket has postponed its IPO until the week of December 6th. It's a bit troublesome to observe this postponement when we see a hot IPO market.
Nevertheless, FreeMarkets is in the right industry at the right time. And the company has positioned itself to be a world leader in the customized business-to-business online auctions for the world's largest buyers of industrial parts, raw materials and commodities.
The need for fuel
Due to inefficiencies in the markets that supply direct materials, there are times when buyers pay prices that are too high. Direct materials are often custom-made or adapted to the buyer's specifications. Unlike maintenance, repair and operating supplies, direct materials are often not standardized and therefore cannot be ordered from catalogs at list prices. Without catalogs or list prices, buyers cannot easily obtain comparative price information.
Also, supply markets for direct materials often contain hundreds of potential suppliers. This fragmentation makes it difficult for buyers to understand the entire supply market for the products they are buying and to evaluate and select potential new suppliers.
This complexity often leads buyers to rely on suppliers with whom they have dealt in the past, making it difficult for new suppliers to compete for business. Because competition among suppliers is limited by these factors, buyers may pay higher prices or obtain lower quality than they would in a more efficient market with better information.
FreeMarkets, Inc. combines their BidWare Internet technology with their knowledge of supply markets to help large industrial buyers obtain lower prices and make better purchasing decisions.
In a FreeMarkets online auction, suppliers from around the world can submit bids in a real-time, interactive competition. Their auctions are "downward price" auctions in which suppliers continue to lower their prices until the auction is closed. Before each auction, FreeMarkets work with their client to identify and screen suppliers and assemble a request for quotation that provides detailed, clear and consistent information for suppliers to use as a basis for their competitive bids.
FreeMarkets BidWare Internet technology facilitates competitive bidding by enabling suppliers to submit bids in real time and to view competing bids within seconds after their submission. Their technology is also flexible. They can easily configure their BidWare software in many different formats to address the characteristics of a particular supply market and to achieve the particular objectives of each of their clients.
They create online auctions for their clients in a wide variety of product categories, ranging from commodities to custom-engineered components. The number of product categories in which they have experience had grown to more than 50 as of July 31, 1999.
Still growing
FreeMarkets was founded in 1995 and did not generate significant revenues until 1998. They experienced losses for the partial year 1995 and in 1996 and 1997 and achieved a modest profit in 1998. But the company was incurring losses in 1999 as a result of their efforts to invest in the growth of their business.
FreeMarkets created online auctions covering approximately $1 billion worth of purchase orders in 1998 and US$630 million worth of purchase orders in the six months ended June 30, 1999. They estimate that the resulting savings for their clients ranged from approximately 2% to more than 25%. More than 1,800 suppliers from over 30 countries have participated in their auctions.
Their current clients include United Technologies Corporation, General Motors Corporation, Quaker Oats, Emerson Electric, Allied Signal Corporation and the Commonwealth of Pennsylvania.
It bothers me to see their dependence on two clients, United Technologies Corporation and General Motors Corporation, for a substantial portion of their revenues. These two clients represented 77% of their revenues in 1998 and 65% of their revenues in the six months ended June 30, 1999. We'll have to keep an eye on this.
They have a subsidiary in Brussels, Belgium, that serves their clients based in Europe and the European operations of their multinational clients based in the United States.
Making money
FreeMarkets sell their services through their direct sales organization. As of July 31, 1999, their direct sales force consisted of 12 sales professionals, organized along buyer industry lines. They plan to expand their direct sales force and the number of buyer industry sectors.
They typically target senior purchasing executives and other senior executives within a buying organization. When a prospective client is interested in working with FreeMarkets, they will analyze which portions of their direct material purchases are best suited to their market making process.
Throughout this analysis, FreeMarkets work with the prospective client to negotiate terms of a service agreement.
They participate in trade conferences and purchasing industry forums, and advertise in major airports and business publications. They intend to increase their advertising and marketing expenditures in an effort to become better known in their target markets.
Revenues are generated from fixed monthly fees, and may also include performance incentive payments, based on volume or savings, and sales commissions. The revenue structure in a particular service agreement may vary, depending upon the needs of their client and the conventional practices in the supply market where their client obtains its direct materials or commodities.
FreeMarkets' sale efforts are definitely working. Total revenues increased 336% from US$409,000 in 1996 to US$1.8 million in 1997 and 338% to US$7.8 million in 1998. During 1998, US$1.6 million of their revenues were attributable to a performance incentive bonus earned from a client.
Revenues increased 221% from US$2.4 million for the six months ended June 30, 1998 to US$7.7 million for the same period in 1999. The increase in revenues is primarily attributable to an increased number of new clients as well as increased use of their services by existing clients.
Internet-savvy masterminds
The co-founder of FreeMarkets has served as their president, CEO, and chairman of the board and a director since inception. Prior to co-founding FreeMarkets, from May 1994 to February 1995, he was employed as a manager in the Corporate Business Development Group of General Electric Co.
Another co-founder has served as FreeMarkets secretary, treasurer and a director since inception. From April 1995 to May 1998, he was Vice President of FreeMarkets, and since May 1998 he has been an executive vice president. He has also served as Acting CFO since June 1998. Prior to co-founding FreeMarkets, from March 1992 to April 1995, he was employed as a consultant and engagement manager at McKinsey & Company, Inc.
The Executive Vice President and Chief Operating Officer has served since March 1998. From October 1996 to February 1998, he served as Vice President of Market Making. Prior to joining FreeMarkets, from March 1992 to September 1996, he was employed with Dole Fresh Fruit International, Ltd., where he worked in key financial and management positions at Dole's Latin and South American headquarters and subsidiaries.
The Vice President of Market Making has served since May 1998. Prior to joining FreeMarkets, from June 1996 to May 1998, he was a principal with A.T. Kearney, a management consulting firm.
For more information after the quiet period, please contact FreeMarkets, Inc., 22nd Fl., One Oliver Plaza, 210 Sixth Ave, Pittsburgh, PA 15222, Phone: 412-434-0500, Fax: 412-434-0508; and http://www.freemarkets.com.
Getting in on an IPO
IPO allocations are controlled by the underwriters, with a large block of shares allocated to the lead underwriter. So the first step is to select a broker who underwrites a lot of deals, such as Morgan Stanley Dean Witter, Merrill Lynch, Salomon Smith Barney, Lehman Brothers, Robertson Stephens, just to name a few. You must establish an active account.
Another strategy is to work with regional underwriters like William Blair or Raymond James. Or you can choose an online broker such as Charles Schwab, Fidelity, and E*Trade. Each online brokerage has connections with big name underwriters. For example, Fidelity has an agreement with Salomon Smith Barney, Charles Schwab with Credit Suisse First Boston, J.P. Morgan, and Hambrecht and Quist, and E*Trade with Robertson Stephens and Goldman Sachs.
In reality, only a handful of individual investors actually receive IPO allocations. Whether it's a full, discount or online brokerage, firms want to allocate shares to the most active customers as a sign of good publicity and to create customer loyalty.
There are two main reasons why bankers would rather place IPOs in the hands of institutions rather than individuals. First, institutional investors tend to be long-term holders whereas individual investors tend to flip. Flipping is when shares are bought at the initial price and sold in the first few days or weeks when the price soars. This destabilizes the company currency.
Second, banks find that it's more efficient to allocate large blocks to a few small groups of institutional investors rather to a large group of individual investors. Even institutional investors do not always receive all the shares requested. They may buy in the aftermarket after the stock has already begun trading and this is where many individual investors will buy.
The big mistake many investors make is buying into the feeding frenzy, usually the first day or first week. Many investors will benefit from the aftermarket and remember the best buys are during the cycle with fear and bad performers.
How to become an IPO Trader
The crucial quality for successful and profitable IPO and aftermarket investing is timing. Public Offerings can be postponed or accelerated on account of market conditions... keeping investors in nail-biting suspense for weeks or months, only to whip them into frenzied action at the drop of a hat.
You may want to bookmark my IPO Update for a synopsis of each week's expected IPO activity.
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