Shares of business-to-business (B2B) online trading communities operator VerticalNet(Nasdaq: VERT) went parabolic this morning for a more than 20% gain on news that the company has formed a strategic alliance with software giant Microsoft (Nasdaq: MSFT). Based on a quick glance of the press release, the agreement seems fairly tame. Microsoft has agreed to market and support VerticalNet's B2B communities through its MSN network and Microsoft bCentral small business portal. In return, VerticalNet will use Microsoft's Windows 2000 Professional Edition operating system, SQL servers, and future e-commerce technologies.
What's so exciting about that? Not very much, except that Microsoft has also agreed to make a $100 million equity investment in VerticalNet. That's a significant amount of dough for VerticalNet, which will presumably use the money to add more B2B communities and build the corporate critical mass it needs to turn its business model into a profitable business model.
VerticalNet has more or less used up all of the money from its stock market initial public offering last February through acquisitions, investments, and capital expenditures. Given that the majority of the proceeds from a September $100 million private placement of convertible subordinated debentures are still sitting in its bank account, the new Microsoft money gives the company an added degree of financial flexibility. VerticalNet now has plenty of breathing room to keep growing its business and fund continued future operating losses, at least for a little while.
At some point in time, however, investors will demand that VerticalNet and B2B pure-play companies like it start turning profits instead of more tired yarns about how their business models will shake up the world. This is already happening with many of the former high-flying "Internet stocks" that have thus far failed to build the necessary scale that seems to be a prerequisite to sustained profits on the Web. The result? Their share prices have fallen faster than Bill Clinton's jaw at a bikini contest.
Despite the arguments that traditional valuation principles are bunk in the Internet age, future cash flows still play a large part in determining how much a company is worth, whether that company is a B2B hotshot or not. With that in mind, it's not surprising to see VerticalNet jump on the news of its Microsoft alliance. Sure, having Microsoft in its corner is an important validation of VerticalNet's business model and game plan. But more importantly, VerticalNet president and CEO Mark Walsh told Reuters that the deal should "guarantee" the company some $200 million in revenues over the next three years. That's the relevant point that investors should focus on.
Considering VerticalNet only booked $10.7 million in revenues over the nine month period ending this past September, the Microsoft revenue boost will go a long way in advancing the company further along down the road toward eventual profitability. At this point in the game, investors seem more concerned with VerticalNet's day-to-day stock price momentum than its ability to profit from its business niche. The investing currents will not always be so forgiving, however. In that light, today's Microsoft deal better positions VerticalNet to weather any potential B2B business model shakeout storms in the future.
