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2HRS2GO: FreeMarkets still solid long-term

3 min read

COMMENTARY -- FreeMarkets (Nasdaq: FMKT) investors were spooked by a few clouds in the company's crystal ball.

Shares of FreeMarkets dropped more than 20 percent this morning as one of the biggest decliners on the Nasdaq. The company reported better-than-expected fourth quarter results yesterday afternoon, but shareholders were quick to react badly; FMKT dipped immediately in afterhours trading and failed to recover after the analyst conference call.

The problem? FreeMarkets' future growth doesn't look as clear as it did.

"The company didn't fall off a cliff, but when a stock is trading at six times revenue, I think people would want to see some revenue upside," Merrill Lynch analyst Edward McCabe said on the telephone this morning.

McCabe, who lowered FreeMarkets to "accumulate" from a "buy" rating, was one of two major brokerage analysts to downgrade FreeMarkets. Goldman Sachs' Jamie Friedman cut FMKT to "market outperformer" from "trading buy".

Analysts pointed to a lower rate of converting pilot programs to long-term contracts, fewer new customers than the company has added in past quarters, and a lower-than-expected total for the value of transacations conducted through FreeMarkets.

Adding to worries was the fact that FreeMarkets executives on yesterday's call did not raise financial targets beyond the first quarter. And they backed away from their original forecast for growth in software licenses.

Now let's take a broader look.

Everyone who follows FreeMarkets -- including the analysts who slashed ratings -- believes the company is well-run. One look at the company's improving margin lines underscores the quality of its operations.

The biggest perceived threats to FreeMarkets are the economy and competition.

FreeMarkets can't do anything about the former. At any rate, anything that saves corporate buyers money tends to thrive even in a lousy economic environment.

As for competitors, FreeMarkets so far has co-existed with the sector exchanges touted as the main alternative to the company's core business. Executives yesterday noted many of their customers signed on with FreeMarkets after joining an industry buying consortium.

That makes sense, because no corporation will funnel all of its purchasing through one channel.

Competing global exchanges are several quarters away from reaching any kind of noteworthy size. FreeMarket's other business, software, is a tougher field. But it's also not as critical to the company's overall growth.

All in all, things haven't changed much for FreeMarkets. Today's reaction seems to be a trading move, more than anything else.

You might point out that FreeMarkets still has plenty of ground to make up after falling off sharply from last year's highs. But that's just reality coming home to the entire stock market; all B2B specialists tumbled in December, including Ariba (Nasdaq: ARBA) and Commerce One (Nasdaq: CMRC).

Yet FMKT in recent weeks posted stronger gains than other online B2B stocks. Between Dec. 21 and yesterday, FreeMarkets had gained 58 percent.

Given that kind of run-up going into the fourth quarter report, profit-taking following the news should come as no surprise. Some murkiness stemming from a few metrics simply exacerbated the sell-off. 22GO>