The Making of a Market Bubble. Ah, to pen the first draft of history.
"IVillage Becomes a Metropolis on First Trading Day," roared a headline
in The Los Angeles Times on March 20, 1999, describing the tripling in
the stock price of iVillage, the online community for women. When
Miningco.com went public a few days later, The Wall Street Journal
called that Web forum "the latest Internet stock to strike gold." And a
few days after that, Priceline.com ended its first trading session at four
times its offering price, prompting USA Today to call it "a hot ticket."
Awful puns aside, those were
heady days. The seven
Internet companies that sold
shares that month were in the
vanguard of the legions that
made their debuts in 1999
before a public hungry for
nothing but Net. Stock prices
exploded out of the gate.
Entrepreneurs became
billionaires overnight. And in
the months that followed,
investors only clamored for
more as the hysteria for
anything dot-com reached
fever pitch, helping push the
Nasdaq market index to its
all-time high on March 10,
2000.
Now for the rewrite.
The Nasdaq market's recent
rout, even with last week's
rebound, helped bring the
highfliers back to earth. Four
of the seven companies that
went public in March 1999
now are trading below their
offering prices:
Manhattan-based iVillage,
down 49 percent;
OneMain.com, a collection of
Internet service providers,
down 72 percent;
Autobytel.com, which refers
car buyers to dealerships over
the Internet, down 74 percent;
and Ziff-Davis-ZDNet, which
operates technology Web
sites, down 34 percent.
The remaining three --
About.com (the Web portal
that began life as
Miningco.com), Priceline.com
and Multex.com, which
distributes financial information
-- are trading at least 60
percent off their record highs.
(Priceline.com has performed
most admirably, up 324
percent from its offering
price.)
Market pundits say Internet
stocks were due for a
correction. Anyone who read
a prospectus knew that the
dizzying sums that investors
were paying for unseasoned
companies defied their
fundamental worth. The
breezy days of last spring
were bound, logic said, to turn
unwelcoming and cold.
But how was it that the investing world suspended disbelief in the first
place, letting the most irrationally exuberant investors assign values to
these companies?
Put simply, it was in the interest of everyone involved to take advantage
of a frenzied market that, in more measured times, would have seemed
absurd. Entrepreneurs rushed to get money -- and lots of it. Venture
capitalists were eager to cash out. Investment banks were happy to
oblige. And, of course, rapacious investors -- big institutions and the man
and woman on the street -- clamored for their shares of the new
economy.
It is too soon to close the book on the Class of March 1999; the Internet
story is far from over. No expert worth the title can predict the
permanence of the damage caused by the market's recent shakeout. And
investors are only beginning to decide which companies they think have
the most promising future.
Even so, these companies are a microcosm for an Internet marketplace
where the fortunes of companies have been made -- and lost -- virtually
overnight. And their experiences shed light on the roles that financiers,
entrepreneurs and investors played in inflating the Internet bubble until it
almost burst.
"Try to think about it as Charles Darwin meeting Adam Smith," said Gary
Rieschel, a partner at Softbank Technology Partners in Mountain View,
Calif. As in nature, he explained, "the checks and balances have to get
out of whack for them to get back in order."
The Natural Order of Things
Steve Smith, a founder of OneMain.com, knows about the natural order
firsthand. His company, an Internet service provider (like America
Online), went public on March 25, 1999.
Even then, Smith recalled, he was worried that the offering price for his
company -- $22 a share -- was too high, even though bankers had
discounted the value of his subscriber base to the clientele of more
established peers.
But who was he to bicker over his good fortune? "I wasn't going to argue
with the market at that time," he said.
This, after all, was a market that had just bid up iVillage -- a company
that had struggled for several years to go public -- from an offering price
of $24 to a first-day close of $80.13. And those numbers did not fully
express the demand for dot-com shares; iVillage's investment bankers at
Goldman Sachs had originally planned to price the stock at $12 to $14.
So iVillage became the standard against which other companies
measured first-day success. Watching the excitement about iVillage
mount, executives at Miningco.com decided to put off their public
offering so its shares, too, could command more than the $12 to $14 a
share that executives first expected, recalled Dan Veru, an early investor
in the company. It was a smart move; bankers at Bear, Stearns priced
Miningco.com at $25 a share.
How could a rational market
push the share prices of these
nascent companies to such
heights? As he conducted the
road show for OneMain.com,
pitching the business to
professional money managers,
Smith recalled, he was surprised
that they did not ask many
in-depth financial questions. Of
his 72 one-on-one meetings with
institutional investors, he said,
few lasted more than 20 minutes.
"I found people were only
interested in the story," he said.
"They hadn't read anything at all."
Smith's stock hit a high of
$39.5625 the day it began
trading, an 80 percent increase
over the offering price.
Colleagues at Morgan Stanley
Dean Witter, where he had been
a banker for nine years,
swooned.
Soon, though, the stock price of OneMain.com began to slide -- by
June, the shares were trading in the mid-teens -- despite Smith's
contention that he was delivering on everything he had promised
investors, including his subscriber projections. He said, however, that
bankers at what is now Deutsche Bank Alex Brown had failed to deliver
on two of their promises: The analyst he had expected to cover his
company left the bank, Smith said, and its sales and trading desk did not
support a higher price. And that, he added bitterly, was despite
OneMain.com's having paid fees of more than $7 million. Deutsche Bank
Alex Brown declined to comment.
And so Smith, a 40-year-old Californian, found himself across the table
from investors for 40 days last year, struggling to pump up his stock
price. He was briefly successful -- OneMain.com hit $33.125 last July,
during a two-week road trip that took him from San Diego to Boston.
But the shares have since drifted downward, falling 87 percent since their
peak to close at $6.25 on Thursday, even though he said the company
has met the earnings and revenue targets it set for itself.
For Smith, who owns 8 percent of the company, that decline has erased
tens of millions of dollars in his net worth.
Other executives in the March '99 class said that at least some investors
inquired deeply into their companies and business models, but the
executives agreed that most professional money managers had ignored
fundamentals and just bet on stocks that seemed to have momentum.
"There is a herd mentality around Internet stocks," said Daniel L.
Rosensweig, chief executive of ZDNet.
Even those who professed to be long-term fundamental investors turned
out to be short-term traders, he said. "You go on the road show, and all
these people say they will hold forever. Then you get the first list of
shareholders and find out they flipped the stock right away. The best you
can hope for is that they will buy your stock back on the dip."
Yet once a stock falls out of favor, even good news will not necessarily
restore its luster. A month ago, iVillage announced a $200 million venture
with Unilever, the consumer products giant. And while financial analysts
lauded the news, investors ignored it.
"I announce highly strategic deals, and there is no movement in the
stock," said Candice Carpenter, the company's chief executive. "Poor
Pavlov's dog is confused. It doesn't know what to do."
Of Risky Businesses
Like most of her peers, Carpenter attributes her company's stock
performance to an investing environment that now favors the
business-to-business Internet sector and companies promising a quicker
path to quarterly profits.
In an earlier era, that would have sounded like an odd complaint;
companies generally did not even go public until they stood a good
chance of delivering profits. So if the market is again demanding earnings,
it is only reverting to form.
But when iVillage and the others had their coming-out parties, Carpenter
rightly notes, Internet companies and their bankers certainly made no
secret of the hurdles that stood between them and earnings. Specifically,
she said investors in iVillage were told that it could take the company 7
to 10 years to become profitable.
In fact, some companies devoted 20 pages or more of their prospectuses
to such warnings. So much so, some analysts suggest they have little
meaning.
"The risk factors have become so common they are almost irrelevant,"
said Scott Siprelle, a cofounder of Midtown Research Group, a
Manhattan investment boutique.
Because Internet companies were so young, he said, investment banks
relaxed their insistence on a management team that had long worked
together and on years of profitability before taking a company public.
"A good investment bank has to constantly balance the franchise versus
the revenue," Siprelle said. "But the opportunity has been so large it has
been hard to be disciplined."
Since Jan. 1, 1998, investment banks have earned an estimated $2.18
billion in underwriting fees for taking Internet companies public,
according to Commscan, a research company based in Manhattan.
One of the most prosperous investment banks in the technology world is
Goldman, Sachs; since 1995, it has helped take 54 Internet companies
public. If Brad Koenig, Goldman's co-head of technology investment
banking, sounded frayed last week, it was because the criticism leveled
at bankers for stocks trading below their offering prices was wearing a
little thin.
"First of all, you have to remember that investment banks and
underwriters were getting criticism for underpricing IPO's not too long
ago," Koenig said. He is right: banks took a drubbing all last year for
pricing offerings too low, supposedly to make the stock price soar in
first-day trading.
Now, with e-commerce stocks suffering, Koenig suggests that it is unfair
to blame the same bankers for having set offering prices too high.
"It's not like you wake up one morning and price the I.P.O.," he said. He
explained that pricing was a three- to four-month process of comparing
companies against their peers. Considerable time is spent examining
fundamentals.
And even established companies, like Yahoo, traded lower than their
offering prices in the early days. Besides, it isn't as though bankers don't
exercise discretion: Goldman is one of the most selective, he said, and
turns away 15 companies for every one it takes public.
"I don't think we should be held accountable or responsible if a sector
falls out of favor," Koenig said.
Even in a momentum-driven environment, some financiers like venture
capitalists certainly play their part in the making of fads.
When Isaak Karaev and James Tousignant founded Multex Systems
seven years ago, they wanted to help brokerage firms send electronic
research to institutional clients.
"Then the Internet happened," said Karaev, the company's chief
executive. "And all our investors said, 'This is an Internet play.' We took
the opportunity to change ourselves."
Multex created a Web site that lets individuals read Wall Street research
for a fee. But the venture capitalists were not satisfied. "The consumer
was the big play, so everyone wanted us to jettison everything else and
give it all away free," Karaev recalled. The founders agreed to change the
company's name to Multex.com, but insisted on keeping the institutional
investor service, which accounted for two-thirds of revenue.
Their venture backers should be grateful they did; now,
business-to-business Internet companies are hot, while those catering to
consumers are not. These days, Karaev said, the company calls itself a
"financial e-marketplace," to play to the latest frenzy.
"Our strategy hasn't changed," he said. "The challenge is which
component to highlight."
Robert Greene, who invested in Multex at Chase Capital, and is now a
partner in Flatiron Partners, concedes that venture money has long
followed trends. In 13 years as an investor, he said, "I spent all my time
going from one hot area to the next."
Still, the Internet era has been a remarkable time. It used to be that a
return of 300 percent was "an awesome home run." Now, with the public
markets so accommodating, venture capitalists can make 1,000 percent
to 2,000 percent on shares they hold for just two years.
And that means early investors are barely splattered when a bubble
bursts. Chase Capital, for example, has paid an average of just over $3 a
share for its 3 million Multex.com shares, he said -- putting it hardly in the
same boat as investors who bought at $60 a share and saw the stock fall
as low as $13.
"Even if these values fall to half of where they peaked, in the context of
our industry, they are great returns," Greene said.
The recent decline, however, has sobered things up, he said. "Two
months ago, you would look at a business plan and the investment banks
would say, 'We can take that company public in four months for $500
million.' So you would say, 'Why not?"' Now, Greene said, "We don't
say 'Why not?' We say 'Why?"'
Not to Mention Day Traders
If any one group played the most public role in fueling the Web frenzy, it
was day traders and other online investors, many of them congregating in
Internet chat rooms like Silicon Investor and Raging Bull. They could
sometimes inflate and burst bubbles in a single day.
A little after midnight on March 26, 1999, someone posted a message on
Silicon Investor wanting to know if Autobytel.com shares would begin
trading later that day. They would -- offered at $23 a share -- and by
noon, posters were speculating about how high the price would soar.
"All indications are it will open between 40 and 50," wrote "Scott H."
"They wouldn't start over lunch would they?" added "William Griffin."
"Looking 60-65 opening in next 10-20 mins," wrote "SteveG" at 12:50
p.m.
"WOW," Scott H. responded. "Steve, do you think it will take off after
the open?"
In a word, yes. Autobytel.com opened at $52.75 a share, hit a high of
$58 and then closed for the day at $40.25.
"nnnnnnnnnooooooooooooooo wwwwaaaaayyyyyyyyyy!! Close around
39-40!! OOUUCCHHH!!!!!!!!!!" wrote "Opey."
"Got to feel the pain for the buyers at $58," replied "Panita." "They will
not sleep well tonight."
Since then, the stock has plummeted, closing Thursday at $6.03, down
90 percent from its high.
And in the chat rooms? "IS THIS ONE GOING ANYWHERE?" read
one message posted last month.
Chief executives of the Class of March '99 say they find these investors
to be distasteful. Ms. Carpenter said iVillage now has a corporate policy
of not answering questions from day traders and people in chat rooms.
Still, when shares in iVillage and About.com were enjoying positive
momentum last fall, both companies rushed to raise more cash in
secondary offerings.
Were they taking advantage of the moment? Ms. Carpenter said iVillage
recognized that the business-to-consumer Internet story "was going out
of favor."
"We always wanted to have cash on hand for a nice long time," she said
-- enough cash, she hopes, to last through what may be a long summer of
investor discontent |
