Re: [Fleckenstein] The Story of Bubblenomics

Adam Rifkin -4K (
Sun, 19 Dec 1999 00:27:54 -0800 (PST)

Rohit forwarded from Fleck:
> Everyone has his favorite story of extremes these days. For instance,
> the six biggest tech stocks (Microsoft, Intel, IBM, Cisco, Lucent and
> Dell) are now valued at $1.65 trillion or 20 percent of GDP.
> Microsoft alone is valued at $500 billion, making it larger than the
> entire junk-bond market!

Current market caps of thirteen well-known companies:
Microsoft -- $596 billion
General Electric -- $498 billion
Cisco -- $341 billion
Wal-Mart -- $290 billion
Exxon Mobil -- $285 billion
Intel -- $274 billion
Lucent -- $247 billion
IBM -- $198 billion
Nokia -- $194 billion
AOL -- $190 billion
AT&T -- $171 billion
Dell -- $117 billion
Yahoo! -- $92 billion

Total: $3.5 trillion.

By comparison, the total value of the entire U.S. stock market in
mid 1997 was $10 trillion. Now 13 companies have 1/3 that value.

> My personal favorite anecdote illuminating today's hysteria is
> Internet Capital Group. It is an Internet venture capital fund valued
> at approximately $12 billion (that has only one public holding worth
> about $400 million).

Fleck wrote this piece on October 1. It is now December 18.
Internet Capital Group is now worth $31 billion.
Its public holdings have swelled to $2 billion.
Its PE of 1405 seems reasonable compared with Yahoo's 1364 PE,
and cheap compared with eBay's 7400 PE or Amazon's lack of PE.

> In a recent interview, a big-time Wall Street
> analyst justified the current valuation by explaining that recent
> venture capital returns have been 30-fold. If all of ICGE investments
> and the cash received from the IPO were valued at 30 times, he said,
> the stock would be worth about what it was selling for, but that
> meant you would be getting management for free! Consequently, he
> liked it. It has rallied over 30 percent since the interview.

In the Bizarro World, faulty logic is rewarded. Shares in
business-2-business companies are up an average of 598% year-to-date:

So let's step back and look at one of the hot b2b sectors, procurement
companies. One week after it came public, FreeMarkets has a market cap
of $11 billion, which makes it truly a peer of CommerceOne ($10 billion)
and Ariba ($12 billion). Then, earlier this week, Ariba purchased Tradex
Technologies for $1.9 billion in stock. With the acquisition, Tradex
adds 18 customers. Since Ariba has some 100 customers, a
back-of-the-envelope calculation would suggest that Ariba gave Tradex
roughly what the public markets were valuing each of its own customers.

So what does this mean to Internet Capital Group? A lot. They own a
fully diluted stake of 8 percent in Tradex, so upon completion of the
deal, ICG's stake would be worth $150 million, up from a cost to them of
$5 million. Creating additional value for ICG has been the
well-received public offerings of VerticalNet and Breakaway Solutions.
ICG's cost base for VerticalNet and Breakaway was $14 million and $17
million, respectively, according to Merrill Lynch. Those holdings are
now valued at $1.5 billion and $380 million.

"The outlook for B2B remains excellent," said Merrill Lynch Net analyst
Henry Blodget. In the Bizarro World, faulty logic is rewarded.

> Former Fed Chairman Paul Volcker recently summed up the situation
> quite succinctly when he said, "The fate of the world economy is now
> totally dependent on the stock market, whose growth is dependent on
> about 50 stocks, half of which have never reported any earnings." I
> urge you to think about that statement. It is the reason why any
> responsible person should be aware of these facts.

Volcker exaggerates, but his point is well-taken. There are not 50 but
several hundred companies making a real difference in the world economy.
"Half of which have never reported any earnings" is also an exaggeration.

> "Two new and sinister elements emerged: a vast increase in margin
> trading [online/day trading] and a rash of hastily cobbled-together
> investment trusts [Internet stocks]. By 1929 some stocks were selling
> at fifty times earnings. [How about well in excess of 50 times
> revenues today?] As one expert put it, the market was 'discounting
> not merely the future but the hereafter.' A market boom based on
> capital gains is merely a form of pyramid selling.

To make the pyramid worse, we have derivatives, tracking stocks,
spinoffs, merger/acquisition goodwill, and companies' ability to float
loans with ease.

Who came up with the idea of the tracking stock, anyway? It's nuts.
Example: Sprint creates a "tracking stock" for its PCS divison and foists
all the unfavorable accounting (for example, the highly leveraged
infrastructure costs, the huge debt, the lack of revenues, etc) on the
tracking stock. And institutions eat it up. Check out the chart of PCS:

Excuse me, a 52-week range of 14 to 114? A market cap of $50 billion?!
Earnings per share of MINUS $5.35???

Then again, Qualcomm's spinoff of Leap Wireless reeks of the same:

A 52-week range of 5 to 94, and earnings per share of MINUS $9.19??
Don't even ask what the debt-to-equity ratios of these bad boys are.

> The new investment trusts, which by the end of 1928 were emerging at
> the rate of one a day [several internet IPOs per day now], were
> archetypal inverted pyramids. They were supposed to enable the
> 'little man' to 'get a piece of the action.'

Just check out the NAMES of some companies that filed to go public in 1999:

AltaVista. America's Shopping Mall. Avanex. Chordiant. DigitalThink. Diversa. Divine Interventures.
FairMarket. ImproveNet. Inforte.
Iteris. Krispy Kreme. LendingTree. MatrixOne. Net2000.
Palm. Selectica. Universal Access.
Urban Cool Network. Versata. WorldQuest Networks.

I couldn't make this stuff up if I tried.

> "It is astonishing that, once margin trading and investment trusting
> took over, the Federal bankers failed to raise interest rates and
> persisted in cheap money.

On the other hand, in 1999 Greenspan raised interest rates three times
and it looks like he's going for another 3-5 interest rate hikes in 2000
as well. [Never mind the fact that he's growing the money supply for
Y2K despite raising interest rates -- ignore that man behind the curtain!]

> "The 1929 crash exposed in addition the naivete and ignorance of
> bankers, businessmen, Wall Street experts and academic economists
> high and low; it showed they did not understand the system they had
> been so confidently manipulating. They had tried to substitute their
> own well-meaning policies for what Adam Smith called 'the invisible
> hand' of the market, and they had wrought disaster.

Unfortunately The Hand *is* Invisible, so we cannot see when it's
flipping us the bird.

> "An alluring corollary of this principle was that making money in the
> stock market was now the easiest thing in the world. It was only
> necessary to buy "good" stocks, regardless of price, and then to let
> nature take her upward course..." [How many times have you heard
> something like this repeated in the last month?]

Too often.

> Nevertheless the majority of the issues had been
> drifting down for a long time...In a real sense there has been under
> way during most of this year a sort of creeping bear market.'
> [Exactly, today's market action.]

People have been selling non-tech stocks throughout the 1990s to buy
technology stocks. This has escalated recently. But can we blame
them? People aren't being irrational. They're being TOO rational in
chasing the stocks that are going up, which in turn exaggerates the
movements, which in turn makes more people interested in them.

> In 1995, almost all analysts and investors believed that widespread
> semiconductor shortages and surging prices were a sign of huge
> Windows 95-related pent-up demand for computer products and
> peripherals. Unfortunately, Windows 95 was a disappointment relative
> to expectations leading to a sizeable tech stock decline that lasted
> until the middle of 1996. In fact, 1995's worldwide semiconductor
> sales of $150 billion is a peak that has yet to be surpassed.

People talk about the cyclical nature of the semiconductor industry, and
how 1999 represents the start of a new upswing. I guess we're going to
find out if this is really true.

> More illuminating still is the fact that there's been no revenue
> growth worldwide in the PC industry in the last 2 1/2 years.

The reason being the Asia crisis. The question being, now that Asia has
pulled out of its crisis, will PC demand pick up after Y2K passes.
Again, I guess we're going to find out soon enough.

> hope springs eternal as every year for four years running Wall Street
> has believed that the year's first-half PC debacle has had no
> relation to the one the year before.

PC stocks have not been doing well this year at all. Compaq is down,
Dell has gone sideways, and Hewlett Packard and IBM are only up because
of perception of their non-PC divisions. Intel and Microsoft have
pretty much gone sideways this year and are only now starting to move
again. So Fleck's reasoning in the first part of the article seems
sound, but the second half of the article goes downhill for me. Why
pick on the PC stocks? They're not the ones moving. Pick on the
wireless stocks, the fibre channel stocks, the fiber optics stocks, the
networking stocks, the Internet stocks, the software stocks, the
semiconductor stocks, the b2b stocks, the Linux stocks -- those are the
ones that have been going crazy this year.

These are truly unique times. And this kind of stock appreciation
cannot go on forever. But I wouldn't be so foolish as to think I could
call a top on it or an end to it. Since EVERYONE from the media to the
financial institutions to the government to the vulture capitalists to
the small fry investors has a vested interest in keeping it going as
long as possible, for all I know it's going to keep going for another
3-5 years.


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