and DLJ Kiggen's Jan 4th initiation note:
SUMMARY
· Initiating coverage of FreeMarkets with a Buy rating and a $550 6-12 month price target. FMKT
should be a core Internet holding.
· FreeMarkets' customized business-to-business online auctions enable large, industrial buyers of
direct goods and materials (like United Technologies, General Motors, Allied Signal, BP Amoco,
Quaker Oats and Unilever) to obtain lower, more efficient prices and make better purchasing
decisions.
· The market for direct goods (like coal or glycerin on the commodity side and metal fabrications or
injected molded plastics with respect to customized components) is enormous, with annual purchases
estimated at $1.3 trillion domestically and $5 trillion worldwide. Migration of just 1% of this activity to
the FreeMarkets purchasing system represents a $50 billion opportunity.
· FreeMarkets operates a highly scalable business model characterized by tremendous visibility, as
revenues are generated under service agreements and recognized evenly over each contract period.
We estimate the company has signed contracts for over 50% of our fiscal 2000 revenue estimate.
· We expect FreeMarkets to generate $20.0 million in revenue in 1999 and $42 million in 2000, with
operating losses (excluding non-cash charges) of ($17.2) million in 1999 and ($43.8) million in 2000,
with breakeven occurring by late 2001-early 2002.
· Our $550 6-12 month target price is based on a discounted cash flow analysis as well as FreeMarkets'
market-leading status within a huge and relatively untapped opportunity.
· FreeMarkets' Chairman, CEO and co-founder, Glen Meakem, will be presenting at the DLJ Internet
Conference in San Francisco, January 11-14.
IMPORTANT POINTS
· We are initiating coverage of FreeMarkets, a provider of customized business-to-business online auctions, with a
Buy rating and a 6-12 month price target of $550.
· FreeMarkets operates reverse (or “downward price”) online auctions on behalf of large, industrial purchasing
organizations for the procurement of direct goods. The company combines its proprietary BidWare Internet
auction technology with extensive knowledge of supply markets to help buyers obtain lower, more efficient
prices and make better purchasing decisions.
· The FreeMarkets solution provides huge benefits to just about any purchasing situation that cannot be handled
by a simple catalog (and potentially to those that can). FreeMarkets' auctions deliver substantial savings to its
clients, ranging from the low single digits on commodity purchases to more than 25% on customized parts,
creating a compelling value proposition for buyers.
· The market for direct goods (like coal or glycerin on the commodity side and metal fabrications or injected
molded plastics among custom-engineered components) represents a vast opportunity, which we estimate at over
$1.3 trillion in annual purchases domestically and approximately $5 trillion worldwide. If only 2% of those
purchases migrate to a FreeMarkets-like system and the company maintains a 50% share (down from its current
dominant market position), the result would be a $50 billion annual opportunity for the company alone
(assuming no growth in direct goods procurement).
· FreeMarkets enjoys critical first-mover advantage, having defined the role of the business-to-business online
auction beginning in 1995. Additionally, FreeMarkets' highly skilled management team provides a formidable
competitive advantage with a strong background in consulting and extensive industry sourcing expertise.
· FreeMarkets operates a highly scalable business model, characterized by tremendous visibility. Revenues are
generated under service agreements (calculated as a percentage of contracted volume) and recognized ratably
over the contract period regardless of the timing of auction activity. As such, FreeMarkets has potentially
unparalleled clarity on forward revenues (the company has signed contracts for over 50% of our 2000 revenue
estimate). Incentive fees relating to incremental auction volume and savings generated provide upside to the
model.
· We estimate FreeMarkets will generate $20.0 million in revenue and operating losses (excluding non-cash
charges) of ($17.2) million in 1999. In fiscal 2000, we project revenues of $42.0 million and operating losses of
($43.8) million or ($1.15) per share. Our estimates for 2001 are $83.95 million in revenue and an operating loss
of ($38.8) million, or ($0.97) per share. The company netted approximately $185 million from its IPO on
December 9
th
1999, at a per share price of $48.
· Our $550 6-12 month target price is based on a discounted cash flow analysis as well as FreeMarkets' market-leading
status within a huge and relatively untapped opportunity. While FMKT commands a premium valuation
(even among Internet companies), we believe the tremendous forward visibility of the model and huge market
potential, combined with its first mover advantage and industry-leading execution, make it a core Internet
holding and a foundation for any B2B e-commerce portfolio.
VIEWPOINT
We are initiating coverage of FreeMarkets, a provider of customized business-to-business online auctions, with a
Buy rating a 6-12 target price of $550. FreeMarkets operates what are known as reverse auctions (or “downward
price” auctions) on behalf of large purchasing organizations for the procurement of direct goods, in which suppliers
continue to lower their prices until an auction-winning bid is placed. The company combines its proprietary
BidWare Internet auction technology with extensive knowledge of supply markets to help buyers obtain lower, more
efficient prices and make better purchasing decisions. This unique market mechanism is applicable to a broad array
of commodities as well as custom-engineered parts and materials, providing a superior procurement format for any
good for which information is scarce and supply markets are fragmented.
Having defined the shape of the business-to-business online auction beginning in 1995, FreeMarkets enjoys critical
first-mover advantage within an enormous category. We estimate the market for direct goods (the raw materials that
are incorporated into finished products) at over $1.3 trillion domestically and approximately $5 trillion worldwide.
Since inception, FreeMarkets has created online auctions in over 50 product categories (representing billions of
dollars in volume) for a client list that reads like a who's who of the world's most diverse and powerful purchasing
organizations. These include United Technologies (also an equity investor in the company), General Motors, BP
Amoco, the Commonwealth of Pennsylvania, Delphi, Quaker Oats, Pepsico and Unilever.
In addition to its head start and powerful brand, FreeMarkets' highly skilled management team provides a formidable
competitive advantage with a strong background in consulting and extensive industry sourcing expertise. We believe
this to be as critical to the company's success as its proprietary BidWare technology, which is the only solution we
know of today enabling truly real-time auction activity, and which the company continues to enhance and extend to
new applications. We believe FreeMarkets will continue to forge the expansion of this compelling category, creating
considerable value for its clients in the process. In addition, FreeMarkets operates a highly scalable business model,
characterized by a tremendous degree of visibility. Revenues are generated under service agreements, calculated as a
percentage of contracted volume, and recognized ratably over the period of the contract regardless of the timing of
auction activity. Incentive fees relating to incremental auction volume and savings generated provide upside to the
model. We believe the company has secured well over 50% of our imminently beatable $42 million fiscal 2000
revenue estimate under signed contracts (many of which extend well into 2001 and beyond).
The company's growth strategy going forward will center around rapidly expanding its targeted base of Global 1000
corporate clients, entry into additional supply markets (involving different product types), and achieving deeper
penetration of its existing client base's total procurement activities. Increasing participation in clients' purchasing
decisions means increasing mind-share and barriers to entry as well as critical mass. International expansion is
another avenue the company is pursing (with an office in Brussels currently and plans to move further into Europe,
Asia and Latin America), which will help it to better serve multinational organizations as well as win clients abroad.
Finally, FreeMarkets plans to expand its portfolio of services to new types of auctions and exchanges for certain
types of goods.
We expect FreeMarkets to generate $20.0 million in revenue while generating operating losses (excluding non-cash
charges) of ($17.2) million or ($0.75) per share in FY1999. In fiscal 2000, we project revenue of $42.0 million and
operating losses of ($43.8) million or ($1.15) per share. Our estimates for 2001 are $83.95 million in revenue and an
operating loss of ($38.8) million, or ($0.97) per share. We arrive at our $550 6-12 month target price through a
discounted cash flow analysis that reflects the tremendous forward visibility and cash-generating power of the
model. While FMKT commands a premium valuation (currently $16 billion), even among Internet companies, we
believe the magnitude of FreeMarkets' opportunity combined with its first mover advantage, superior execution to
date, inarguably compelling value proposition and the tremendous visibility of the model make it a core Internet
holding and a foundation for any business-to-business e-commerce portfolio. |
