Lashinsky's view on Chemdex (TheStreet.com)
thestreet.com
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For Investors Hungering for the Next Big Thing, Chemdex May Be It
By Adam Lashinsky
Silicon Valley Columnist
9/22/99 11:01 AM ET
Analyst-turned-venture-capitalist Bill Gurley likes to say that Internet valuations are based on two things: creative proxy metrics (that is, comparing a company to any measurement that adds to its worth) and the storytelling ability of the management and venture backers. Chemdex (CMDX:Nasdaq), the much-ballyhooed, business-to-business e-commerce "leader," so far has excelled on both accounts. As such, it provides a great window into the impending B2B craze as well as a view on how the window could crack.
Chemdex is the Palo Alto, Calif.-based electronic "market maker" for the life-sciences industry. In plain English, it has created a Web-based exchange that matches buyers and sellers of prosaic stuff such as chemical reagents and beakers. Funded by Kleiner Perkins Caufield & Byers, among others, Chemdex followed fellow Kleiner-backed Amazon.com's (AMZN:Nasdaq) first-to-the-capital-markets playbook to the letter. It raised $112.5 million at 15 in late July, despite being in the early stages of its development. The stock has since zoomed to 27 5/8. It bills itself, repeatedly, as a leader in the burgeoning B2B marketplace and occupies significant mindshare among investors hungering for this promised Next Big Thing.
"This is absolutely more than a Web site," says Robin Abrams, Chemdex's chief operating officer, at the beginning of a post-quiet-period press tour. She explains Chemdex's unusual business model, where "customers" like Genentech (DNA:NYSE) and DuPont (DD:NYSE) actually pay Chemdex almost nothing. Instead, large and small suppliers pay Chemdex a commission of between 8% and 10% to complete sales to the likes of Genentech and DuPont. In other words, Chemdex acts as a neutral, electronic middleman for transactions between buyers and sellers who, before now, had reached each other in much less efficient ways.
This is a great market, as Chemdex and its enthusiastic investment-banking-oriented analysts will tell you. "Chemdex is addressing a very large market opportunity that represents a new segment of Internet-based, business-to-business electronic commerce," wrote Morgan Stanley Dean Witter's Mary Meeker in an Aug. 31 report on Chemdex, rating the young company an outperform. Morgan Stanley was lead underwriter of the Chemdex initial public offering and adviser on the company's $340 million, all-stock acquisition of Promedix.com, a market maker for specialty health care products. (Chemdex announced that deal earlier today.) Adds Keith Benjamin of BancBoston Robertson Stephens, another underwriter: "We believe [Chemdex] is the leading provider of e-business solutions for an estimated $15 billion, life-sciences-products marketplace." Benjamin rates Chemdex a buy.
But just how big is this market? Benjamin guesses that eventually Chemdex can capture 15% of this "$15 billion market." He assumes that the company can earn 3% operating margins. (It currently makes 5% gross margins and loses money by the bushel.) At a 40% tax rate and a multiple of 50 times earnings, Benjamin awards Chemdex a potential $2 billion valuation. The market value current stands at more than $900 million.
But consider the fallacies in this argument. Despite having 5% gross margins -- worthy of, say, a steel company having a bad year -- Chemdex gets a futuristic multiple of 50. Microsoft (MSFT:Nasdaq), one of the most profitable companies on the planet, often trades between 50 and 60 times forward earnings. Forward, by the way, means the next four quarters, in Microsoft's case. To be fair, Chemdex is a growth story, not a profitability one. Benjamin, for example, expects revenue to more than double every year through 2002, no doubt based on company forecasts. That will be an easy measure to follow.
More, it's sheer folly to call Chemdex's market a $15 billion opportunity. That's the estimated total revenue in the life-sciences market. Chemdex gets, at most, 10% of that in commissions. And that's when it's not waiving those fees to established partner VWR Scientific Products, a distributor that negotiated an equity stake in Chemdex and the right to not share commissions on VWR's top 40 accounts.
So, at best, Chemdex is after a $1.5 billion opportunity. But that would be assuming zero competition, and both online and offline foes lurk. So perhaps Chemdex, with estimated 1999 revenue of $21 million and 2000 revenue of $130 million, can eventually get half that market and earn, say, $13.5 million, after taxes. That kind of profit at 50 times earnings (for a 5% gross margin company?) would yield a market capitalization of $675 million when it's profitable (in 2002 or 2003).
No one's saying Chemdex doesn't deserve the benefit of the doubt for being a B2B leader. It's just that it already has received it.
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-Eric |
