Net Nuggets - Focus on First Sierra Financial

"Our new Internet bank will allow us to offer additional high margin e-commerce products to our rapidly growing number of business customers. We believe that our focus on the business customer has the potential to drive higher margins than the more commoditized Internet consumer bank model.'' -- Michael Sabel, Exec.V.P., 4/14/99

(New: see below):
. . . First Sierra will provide ecommerce channel for accounts receivable financing
. . . Will establish the first Internet-based business-to-business bank
. . . Changes ticker symbol to "BTOB" ("business-to-business")

Background and History of First Sierra

Founded in 1994 by Tom Depping, former president of SunAmerica Financial Resources, and originally financed by Redstone Group, First Sierra is a specialized finance company based in Houston that concentrates on originating, servicing and securitizing equipment and software leases. The equipment includes computers and peripherals, office, hotel security, automotive servicing, food services, and specialty vehicles. First Sierra also originates lease financing for commercial software products, "private labelling" custom tailored lease programs for software vendors and web site developers. Their SoftLease Progam extends the benefits of their leasing products to their customers own marketing efforts.

In its first year, First Sierra sold a portfolio of its leases through a structured finance transaction, beginning a securitization strategy that it continued using to access capital for originating more leases. Each year, it sold to a special purpose vehicle (SPV) a bundle of leases which are held in separate "static pools," producing revenue streams for the purchaser SPV. The SPV obtains capital by selling bonds to investors, which are backed by the receivables in the pool bought by the SPV. First Sierra retains the right to service all of the leases sold, creating an additional revenue stream for it. In late 1998, it changed its policy to one of retaining the receivables on its balance sheet, rather than recognizing gain on the sale to an off-balance sheet entity.

Acquisitions of Leasing and Marketing Companies

In 1996, First Sierra acquired two companies and closed the year with $1.2 million in net income. An IPO in May, 1997 raised over $16 million capital, which helped it to acquire eight additional companies and increase its net income to $7.7 million for 1997. A secondary offering in February 1998 raised another $39.7 million. First Sierra continued acquiring companies, including three in the United Kingdom, and reports continued interest in those that specialize in the high-yield leases arranged directly with vendors. They report that their customized, paperless system lets them increase efficiency by switching acquired companies to First Sierra's own system, leaving them to concentrate on originating new leases.

First Sierra doubled its sales force in June, 1998 with the for-stock acquisition of The Republic Group, Inc. of Anaheim, California, a specialist in small business-direct telemarketing, sales recruiting and training. First Sierra's acquisition of three U.K. leasing companies with about $35 million in 1997 volume opens the European Union to the company.

Tools for Marketing Partners

One of the ways First Sierra attempts to simplify life for its customers and trading partners is through tools on its "First Link" website. First Sierra puts its lease and financing applications online and encourages its "Marketing Partners" and potential customers to apply online to a customized, paperless system. Their online extranet system lets marketing partners use 24/7 online tools for submitting lease applications, getting application status reporting, generating documents and other functions.

New Product: Web Site Leasing

At First Sierra Software Finance, a division of FSFH based in Prescott, Arizona, online information details the entire application process for obtaining financing through the "SoftLease Program." Their entry into financing of web sites was written up in a July 22, 1998 article in Investor's Business Daily that is online at First Sierra's site. Quoting from IBD's article:

"First Sierra started its Web-leasing program in January when clients like Adtrax started demanding it. 'Many companies don’t have the cash in the bank — $10,000 to $50,000 — or they have it, and they just don’t want to spend it,' said Hal Hayden, vice president of First Sierra."

"For First Sierra, the biggest challenge facing its Web-leasing program is finding reputable site developers to sign up as partners. It has six so far. Web-site creators that suddenly go out of business could pose big problems to customers, Hayden says. 'We are looking for companies that have been in business for a while and are stable,' he added. 'We are not going to work with two guys running a company in a garage.'"

Recent Financial Results:

The following are a few figures from First Sierra's report in February of its earnings for the last full year and the previous period. They show the results of changes it made during third quarter of 1998 to the way it handles its financing portfolio, and the effects of substantial growth and acquisitions in 1998.

(millions x per share figures - USDollars)	Full Year 12/97	Full Year 12/98
Total Revenue	51.6	61.1
Total Expenses	35.9	69.7
Net Earnings After-tax	10.5	(5.9)*
Diluted Earnings per share	1.03	(0.43)*
Diluted Earnings before special charges including charged-off R&D and acquisition expenses	1.03	0.16

*Toward the end of the third quarter, First Sierra changed its business strategy to keep future securitizations on its balance sheet and recognize interest income over the life of the lease. As a result, income will be deferred until later lease periods, rather than recognized earlier in the form of gain on sale of the receivables. This decision may have the effect of reducing the volatility of future earnings results and dependence upon the pricing effects of the resale market, while reducing reported earnings in earlier periods.

Future Prospects and Market Response:

First Sierra's decision to switch to retaining leasing receivables on its balance sheet, combined with its acquisitions, significantly reduces its reported earnings in current reporting periods. The announcement during third quarter of 1998 came just at a time when the stock market was severely marking down valuations on stocks of all types, including First Sierra. The shift may ensure more stable earnings flows over the coming years, regardless of the resale market for debt in those future years. A number of commentators attributed subsequent softness in its share price to this accounting decision.

Yet, following the company's announcement, a group including the Bass family affiliate Thomas Taylor revealed its acquisition during late 1998 of 1.436 million shares of First Sierra, according to filings with the SEC.

In February, 1999, First Sierra announced the formation of "B2B Solutions," a strategic services group focusing on providing business with online technology solutions and online financing products for their commercial customers. B2B Solutions will develop functional ECommerce web sites for business-to-business (B2B) applications and provide maintenance and training. This initiative grew out of First Sierra's 1998 acquisitions of Solutions will use the talents of Nexsoft and Integrated Lease Management (ILM). Nexsoft develops paperless commercial lease financing transaction software. ILM manages captive finance programs for companies including Netscape, Silicon Graphics, and others.

In April, First Sierra made several announcements of new services. First, it will offer accounts receivable financing to its customers via e-commerce channels. Later, announced it will open an Internet-based business-to-business bank, to be operational by the end of 1999. Additional capital will be needed to met regulatory requirements. First Sierra's CEO:

"Now, in addition to providing the financing services most banks no longer offer to small businesses, we're moving fully into the market niche they no longer occupy. By establishing an Internet-based bank, we can diversify our funding sources, lower our all-in cost of funds, and further the e-commerce strategy that is central to First Sierra's continued success.''

The company reported hiring E*Offering Corp., an investment-banking partner of E*Trade, to develop joint ventures and strategic relationships for the company's e-commerce initiatives. Reflecting its focus on business-to-business applications, the company changed its Nasdaq ticker symbol to "BTOB."

Financial results for the quarter ending 3/31/99:

(millions x per share figures - USDollars)	Quarter 3/98	Quarter 3/99
Total Revenue	14.7	19.4
Total Expenses	10.4	19.1
Net Earnings After-tax	2.8	0.03
Diluted Earnings per share	0.21	0.00
Diluted Earnings before "non-cash goodwill expense"	0.21	0.04
Total Assets	428	641

First Sierra is the subject of a message thread on Silicon Investor, and another message thread at Yahoo! Finance. Check there for breaking news and views. See the right side gutter for links.

Do your own research before buying any security.

The Net offers tremendous opportunities for those who can appreciate the "increasing returns" economics of networks, the power of community, and its opportunity to eliminate the costs of intermediaries and manual hand-offs in the distribution chain. Many have pointed to financial services as especially suitable for enhancement using the Net.

This article will be archived at nnarc-btob.html and may be edited in the future. Check in with Net Nuggets from time to time. The information contained herein is believed to come from reliable sources, but no warranty of accuracy is expressed or implied. The author may own shares of the company profiled that were purchased on the open market and has never received or been offered any compensation from the company profiled or its employees, agents or affiliates. This article is for informational purposes only, is neither an offer to buy or sell a security and is not intended to constitute financial advice.

If you have verifiable information about this company, its business plan or competitors, you are invited to share it via email with me.

doug.simpson@snet.net

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