Freeserve means business

Were you one of the lucky few who managed to purchase shares in Freeserve? More than 100,000 private investors applied, and because of this massive oversubscription Freeserve allocated a paltry 500 shares per person. Still, that would have made you a tidy profit of pounds 278 on the first day of trading, which is not a bad return on a pounds 750 investment.

Punters didn't do as quite so well as Freeserve's CEO, John Pluthero. He bagged a cool pounds 1m in free shares and share options. Unsurprisingly, the Freeserve share price has been volatile; it's jumped from the initial price of 150p to a peak of 237.5p and then settled down around the 200p mark. When the private investors get their share certificates today, analysts expect the figure to jump back up to about 215p.

So how does a company that made a loss of pounds 1.04m in its first eight months in business justify a market value of pounds 1.5bn? Have investors simply been carried away with the promise of pots of money to be made at the end of the Internet rainbow? After all, that's what happened in the States, isn't it?

The problem is that the Internet market is losing some of its appeal in the US. AOL, Amazon and Yahoo are all down by about 40 per cent from their 1999 highs, while some Internet shares have lost 50 per cent of their value in the last three months. But over here Internet stock flotations are a whole new ball game; Freeserve is the first major Internet company to float in the UK. We have no records to follow, no way of knowing whether the promise of e-commerce fortune in the future will come to fruition and, it seems, no sensible way of valuing the worth of an Internet service provider that is yet to have its first birthday.

The conventional way to value an ISP is on the basis of what each member is worth. This is how AOL is valued in the US. Freeserve has 1.3 million members and is valued at about pounds 1.5bn, which gives each member a value of pounds 1,153. That figure seems high when you consider the "churn rate" of Freeserve members; out of 2.15 million accounts opened, 830,000 are no longer active.

Some influential stockbrokers have already launched a backlash against the Freeserve valuation. Miles Saltiel, an analyst for West LB Panmure, reckons that Freeserve is worth about pounds 600m. This gives us a much more realistic valuation figure of pounds 461 per member.

The biggest challenge facing Freeserve is stopping this churn and getting its members to spend time on its site and to spend money with its clients. The subscription-free Internet access market is a crowded one and it's full of big brand names with massive marketing spends, including Tesco, BSkyB, BT and just about every major newspaper and bank you can think of. Currently, Freeserve is offering little to its members aside from free access; its content is adequate but ISPs such as LineOne and MSN deliver more. There's not a lot of loyalty in this market; what's to stop Internet users from skipping from one free ISP to another? The investment bank Durlacher produces a quarterly Internet report and Nick Gibson, a researcher, recognises the problem: "Most subscription-free ISPs, including Freeserve, offer little to differentiate themselves and provide little or no barriers to exit for subscribers."

The biggest test of the loyalty of Freeserve's members is going to come in September when AOL's free Internet access service, Netscape Online, launches. AOL isn't short of a bob or two and you can be sure that it will flood the market with millions of Netscape Online CDs. What's more, AOL has the skills and the people to deliver top-notch content.

Freeserve's promise of big profits is way down the line, with no predictions of break-even point. The business model is a simple one. At present, the company makes a sizeable chunk of its revenue from a cut of the phone calls made by each of its members. But Freeserve is betting on big money coming through in the future from electronic commerce, online advertising and sponsorship deals. John Pluthero admits, "We are in the investment phase right now." True enough, Freeserve's e-commerce revenues are predicted to jump to pounds 8.2m in 2000. But its members will need huge spending limits on their credit cards if they are to pull in the kind of e-commerce revenues that justify Freeserve's pounds 1.5bn valuation.

In the meantime, the hype over the Freeserve flotation has meant that the UK Internet industry is big news again, and that can only be good for home-grown Internet businesses. What's more, AOL's UK launch of Netscape Online shows that US companies are recognising that we're not some Internet backwater. They're realising that an UK Internet market, likely to be worth $1.9bn by 2003, is worth investing in.

Andy Hobsbawm, chief creative officer of Agency.com, one of the world's biggest interactive agencies, reckons that Freeserve "has proved that there is an appetite for Internet investment in Europe".

You can be sure that Freeserve is going to go on a bit of a spending spree once the money starts rolling in, and that will shake up the UK Internet market, too. Half of the money is going back to Dixons and half on expanding the service. Freeserve is likely to be spending most of that on developing unique content, in an attempt to keep its members happy. The chequebook has already taken a bashing. In the past month Freeserve has invested $15m in GlobalNet Financial.com to get a stake in its financial services website, UK-invest.com. Next came pounds 3.7m on Babyworld.com, a website for parents. And ambitious plans are afoot to introduce an Internet credit card in conjunction with HFCB.

There will be no shortage of Internet companies jumping on the flotation bandwagon now that Freeserve has shown the way forward. Gameplay.com, an online gaming site, is expected to be valued at pounds 52m when it floats today. QXL, the biggest online auction site in Europe, is looking to float next month, with a planned valuation of pounds 750m. This would make QXL the second-biggest public offering by a UK-based Internet company.

The eXchange, a personal finance site, will float this summer, and is valued at pounds 400m. Funmail, the novelty e-mail address company, was set up three months ago by a former MD of Lynne Franks PR, and it's now valued at a staggering pounds 30m. Hey, Freeserve is beginning to look like good value all of a sudden.