Perhaps if you wade through Internet IPOs long enough, this is inevitable.
Not so long ago, I would have scoffed at an offering such as Be Free (Nasdaq: BFRE), but nowadays it doesn't look so bad. The online marketer successfully debuted on the stock market today, at one point trading for as much as 36 1/4, more than triple its original price of 12.
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That's the kind of gain that should get my hackles up, but it doesn't seem so outrageous anymore, considering the unreal market capitalizations bandied about for other recent debutantes. Fretting about Be Free's price while every newly-public Tom-and-Dick networking company gets triple-digit valuations would be akin to a meteorologist worrying about a mild lightning and thunder storm in Alabama while a hurricane is pelting Florida.
Not that I'm saying Be Free's rise today is deserved. Be Free's revenue is miniscule at $1.3 million for the September quarter and $2.7 million for the first nine months of this year. Losses remain comparatively astronomical, running at more 433 percent or more of revenue for the last several quarters.
Although the company is gradually diversifying its customer base, Be Free still relies too much on three customers, with 30 percent of revenue coming from Barnesandnoble.com, and 10 percent each from Geocities and Network Solutions.
Most worrisome of all, this is a relatively small niche. Be Free develops many of those "affiliate" marketing programs you've probably seen, where you can stick something like a "Buy at Barnesandnoble.com" button on your website and get a (very) small cut of any sales that link generates. Be Free's IPO cites the usual market forecasts for the size of the e-commerce and online advertising markets, but no one expects Internet advertising to entirely turn into affiliate hyperlinks.
You can expect some growth in the industry, but if you want an idea of how tiny it is, consider Barnesandnoble.com. That deal generated about $810,000 (30 percent of $2.7 million) for Be Free in the first three quarters of this year. Barnesandnoble posted sales of $120.4 million over the same period.
I don't know Be Free's cut of the Barnesandnoble.com affiliate sales, but whether it's infinitesimally small or unrealistically huge, you can see by the numbers that the marketing partners don't generate much compared to what Barnesandnoble.com gets as a whole.
Judging by Be Free's other customers -- including Lycos (Nasdaq: LCOS), The Sabre Group, Egghead.com (Nasdaq: EGGS), Value America (Nasdaq: VUSA), Yahoo! (Nasdaq: YHOO), Priceline.com (Nasdaq: PCLN), Reel.com, to name some -- the company's approach is focused on the consumer space, which isn't as lucrative as business-to-business. And it's not alone in targeting that market, not with Commission Junction, LinkShare and Microsoft's (Nasdaq: MSFT) LinkExchange hanging around.
So you have a Internet company with an unproven business model, small revenue targeting a narrow slice of the advertising business, with interesting competitors. And somehow its supposed to be worth more than twice its starting price.
Yet today's admittedly illogical IPO performance isn't nearly as troublesome as it would have appeared earlier this year, because Be Free doesn't seem as questionable as some of its Internet IPO peers.
At least Be Free plays in a high margin segment -- cost of revenue was just 16 percent of sales so far this year -- with the expectation that margins could even go up a little bit as more companies come on board and create economies of scale. Losses, though still absurdly high, did go down in the third quarter as a percentage of revenue.
Be Free's service also isn't likely to go away, because it's all based on performance. If the marketing programs generate sales, Be Free gets paid; if not, it doesn't. For that reason alone, it's easy enough for a Barnesandnoble or a Geocities to sign onto the program.
So it's easy to see Be Free hanging around long enough to become a profitable operation. It may never be a giant, but at least it has a more decent chance of success than many of the e-tailers that might end up as Be Free customers. In today's Internet investing environment, that makes Be Free a bit more palatable.