Outlook: Freeserve's new investment dawn

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The Independent Online
IS THIS about Britain at last entering the twenty first century, or rather a question of the Internet bubble finally and dangerously intruding on our British shores? Whichever view you take of Freeserve's sensational stock market debut yesterday, there's no doubt that something fundamental has happened with its coming.

Just consider; a company with minimum revenues, no profits and little track record, goes to a premium of more than 40 per cent in first dealings (without apparently attracting a murmur of complaint from the vendor), sees more than half the shares floated change hands in the first few hours of frantic trading, and settles at a stock market value of more than pounds 2bn. This is nothing out of the ordinary for a US internet IPO, but for the British stock market, it is a whole new ball game.

Nobody has any idea whether Freeserve is worth this amount of money. How could they? Freeserve is a new company in a new industry and it is as likely to fall by the wayside as succeed. Nonetheless, by being first into the "free" internet service provider market, and by being now the first to float in the UK, Freeserve has gained an important first mover advantage in an industry which promises to change the world.

Unlike most of Britain's other fledgling internet companies, Freeserve now has shares to use as a currency for acquisitions. Since nobody in their right mind would use cash in such an endeavour, such are internet valuations, this should enormously help the company in its ambitious expansion plans.

If companies are not prepared to pay these apparently silly prices in hard cash, why are ordinary investors?

One reason is that the risk of such investment is much more diversely spread when it is in tradable equities. The sensible Internet investor will not be betting the shop on the web, but only what he can afford to lose. The other is the self evident reason that investor appetite for these stocks far outstrips supply. The free float in internet companies is often small and illiquid. Freeserve conforms to this pattern with less than 20 per cent of the stock sold to the public and the rest retained by Dixons.

As the industry grows and more companies come to the market, the problem of undersupply will eventually self correct. For the time being, however, valuations remain a crazy hype. On some criteria, Freeserve is one the most highly valued of the lot, so at least we seem to be beating the Americans at their own game on one level.

But from the industry's point of view, these valuations are obviously a good thing, since it reduces the cost of capital and encourages start- ups. Investors are in for a much rockier ride, for only some of these businesses can hope to succeed to the degree needed to justify such valuations. Many will fail utterly.

Even so, it could be that the London stock exchange is going to have to move further and more swiftly than it would like to accommodate the internet investment craze. Already it has had to lift the rule that requires companies to show a minimum three year trading record in order to allow Freeserve to float.

However, other listing requirements remain a severe deterrent to most business startups. The exchange needs urgently to examine how appropriate these rules are to the new investment and business environment.

The stock exchange should not, on the whole, be in the business of protecting the public against the natural risk of equity investment, and it is perhaps the case that in a fast changing world, ensuring adequate standards of disclosure and transparency should be the limit of the stock exchange's responsibility.

Many subscribers to Freeserve booked their profits and ran in first dealings yesterday, including some of those that had identified themselves to the sponsors as long term holders. But for every seller there was a buyer and it is clear that this type of high risk investment play is here to stay. The stock exchange ignores this demand at its peril.

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