http://www.herring.com/mag/issue35/bubble.html
On July 11, a speculative bubble burst and a score of improbably
overvalued public companies with scant profits, little cash, modest
revenues, and unproven business models found themselves worth very
little. By July 16, Excite, which had been trading at 20 a share, was
worth 6 1/8, and Lycos, which at one time was worth 21 15/16, was
trading at 7 5/8; Open Market was down 62 percent, OpenText 61 percent,
InfoSeek 60 percent, and NetCom 55 percent.
What happened? Whose fault was it? Did it really make any difference?
And what were the costs?
The immediate circumstances of the euphoria were a surplus of cash
entering small-capitalization mutual funds; but the mass delusion that
the companies involved could ever regain their valuations occurred
because of an uncritical fascination with the Internet. Internet
companies were valued at a premium relative to other companies in the
same market because investors and financiers both hoped and feared the
Internet would replace the existing Wintel ecology. As George Bell, the
CEO of Excite, says in explanation of his own company's $177 million
valuation, investment banks could ask so much only because of "the
romance of the story that says companies can break out of a traditional
business paradigm."
In A Short History of Financial Euphoria, John Kenneth Galbraith writes,
"In every speculative episode, some artifact or some development --
tulips in Holland, gold in Louisiana -- captures the financial mind or
perhaps, more accurately, what so passes." Enchanted by the novelty of
the Internet, the financial mind was willing, according to CNet's Halsey
Minor, to treat every Internet IPO like the first flotation of MTV's
stock, even though every company could not in fact be MTV. The public
markets were, in effect, engaged in venture capital investment.
To take just one example, EarthLink, an undistinguished California
Internet service provider founded last year by a 24-year-old
Scientologist, hoped to offer 3.6 million shares of common stock at $10
to $12 a share, potentially raising $43 million. But EarthLink had lost
$4.9 million in its recent March quarter on revenues of $3.4 million and
had a mere $290,000 in cash. Worse, EarthLink had no networking
technology of its own; its only plan was to resell UUnet to consumers.
In the end, EarthLink was thwarted in its public offering only by the
bursting of the bubble.
To contrast EarthLink with another IPO, when Electronic Data Systems
went public last June, 34 years after its founding by Ross Perot, the
company had a declared revenue of $12.4 billion for 1995. Its net profit
was $938.9 million, up 14.2 percent from 1994.
The speculation ended for no reason better than that such episodes
always end: They must. As always, there were immediate causes for
investors' sudden nervousness (in this case, poor macroeconomic
indicators, surprisingly bad results from Hewlett-Packard and Motorola,
and an IPO from Wired Ventures that even the most dizzy Internet
enthusiast could not swallow).
Ironically, nearly everyone involved behaved rationally. Investment
banks were only obeying their clients' instructions. Venture
capitalists were looking for a return on their investments. Mutual fund
managers wanted enviable portfolios. Companies were looking for capital
and validation. The retail investor, as the least rational agent, paid
the most. Thinking of the private investor who purchased the stock of
Internet companies in good faith, some pundits were angry. "It's my
privilege to say they're behaving criminally," Bob Metcalfe, the founder
of 3Com and an InfoWorld columnist, said of investment banks and venture
capitalists just before the crash.
Panglossians like Twenty-First Century Internet Venture Partners' J.
Neil Weintraut were quick to say that the market had experienced a minor
correction and that stocks would recover. But although the market as a
whole did spring back, the companies that recouped their stock value or
went public after all were quite different from the IPOs of the first
half of the year. Large-capitalization transactions were all right;
small-cap Internet IPOs were not. The main consequence of the 1996 IPO
bubble was a new, wised-up demand for quality from investors. The market
accepted Etrade's IPO on August 19, but Internet companies with unproven
businesses like BigBook will have to show years of profits before the
public market will welcome them.
By going public at such exaggerated valuations, the companies overpriced
any stock options they might offer new recruits. They created
extravagant expectations on Wall Street that, when disappointed, will
punish the companies. Deserving companies that had hoped to go public
have been hurt by the recklessness of those that did: Since July, 31
planned stock offerings at an estimated value of $1.8 billion have been
either withdrawn of postponed. And, at least for the immediate future,
the investment banks and venture capitalists have hurt their reputations
for financial probity.
----
adam@cs.caltech.edu
The truth hurts, doesn't it Hapsburg? Oh, sure maybe not as much as
jumping on a bike with the seat missing...
-- Naked Gun 2 1/2