Watch out! Here's why Internet frenzy is poised for a free fall
Back in the old days -- say 1996 -- young companies sold stock to the public
only after reaching a certain level of success. Today, the same is true for
Internet startups: They go public after the founders successfully dial up the
investment bankers.
Many loony things happened in the business world last year, but none of them
rivals the historic nuttiness surrounding the Internet. Can it last? Well, in
the time it took you to read this far, shares in online auctioneer eBay rose
$22 per share.
Just kidding. They only rose $10. As we usher in 1999, Internet bookseller
Amazon.com is worth more than the entire book industry. Yahoo!, an Internet
portal, is worth nearly $24 billion. That's more than the Walt Disney Corp.
paid for ABC and the ESPN cable channels in 1996.
Now, I hear that a Web grocery store, Netgrocer.com, hopes to raise $38
million in an initial public stock offering. Netgrocer.com had sales of
$300,000 last year. Its plan is to use the money to build a business.
Isn't that doing it backward? Heck, maybe next I'll take this column public.
VirtualView.com has no sales, no earnings and one moody employee. But page
views are growing! That ought to be worth at least $20 million.
It can't go on. The bubble will burst. The resulting mess will be uglier than
a Jerry Springer retrospective.
Why? Because the current run is fueled largely by two factors: enormous hype
about Christmas sales numbers and a shortage of stock available for trading.
The stock shortage issue first. There simply aren't enough shares of Internet
companies for everyone to own some.
The smart Internet company issues less than 4 million shares at its IPO.
Online auctioneer eBay sold 3.5 million shares at its IPO. Copycat uBid sold
1.6 million shares. Broadcast.com sold 2.5 million shares.
This small float makes it hard to buy stock and nearly impossible to borrow
it. By taking shortsellers out of the game -- they borrow stock and sell it
when they think the price is about to drop -- the Internet companies lay the
foundation for a nice run.
Next comes the daily churn of press releases. Trust me on that.
A frenzy begins
Soon the public is in a stir. Want to buy 5,000 shares of Whoopeedoo.com? Your
trade may send the stock price up $3. During Christmas week, stock in
theglobe.com, the Web site controlled by Fort Lauderdale mogul Michael Egan,
rose $10.56 one day as 1.25 million shares changed hands. The next day, shares
fell $7 as fewer than 500,000 changed hands.
Theglobe, of course, only issued 3.1 million shares at its IPO. The value of
this company is in the scarcity of its stock.
In 1999, however, many money-losing Internet companies will have to sell more
stock to stay afloat and tons of crummy new offerings will emerge. Plus,
executives who haven't been able to sell their personal stock will be free to
do so as the first anniversaries of their initial stock offerings pass.
You think insiders at eBay, a site where people sell their knickknacks, aren't
dying to sell shares after watching them rise from $18 to as much as $300 over
the past three months? The stock closed Thursday at $241.25. This company has
76 employees and a stock market value of nearly $10 billion.
Same thing at theglobe. The stock market values the business at $340 million,
while third quarter sales were $1.6 million. Only a fool wouldn't sell at that
price.
Insider selling starts
What happens when stock scarcity ends? SportsLine USA, which runs the sports
site cbs.sportsline.com, saw its stock race from $8 to $37 within months of
the IPO in 1997. The company did a secondary offering, which raised money but
also increased the float. Insiders sold a couple million shares. Today, it's a
$16 stock.
As for Christmas hype, heaven knows how this got so out of hand. Even the New
York Times ran a breathless front-page piece last week on soaring Internet
sales.
They're soaring all right. Forrester Research believes total online retail
sales for 1998 reached $7.8 billion, up from virtually nothing two years ago.
Rule one of retailing, however, is that it's easy to post good sales
comparisons when you start with no sales. Retailers focus on the huge
percentage gains in online sales; press them, however, and they admit the
Internet accounts for less than 1 percent of total sales.
Forrester says Internet retail sales will make up 6 percent of total U.S.
retail sales by 2003, or $108 billion. That's impressive growth. It is also
less than Wal-Mart's 1997 sales of $117 billion.
Many will go bust
Even as Internet sales grow -- they will double or triple again in 1999, make
no mistake -- I believe many of the jokier Internet companies will go bust.
Remember how K-Tel soared after it announced it would flog its disco albums
online? And how it tanked after the company revealed it had no money and was
being delisted from the Nasdaq market?
That's going to happen again and again, because investors have not
distinguished between companies with good products and prospects and
Loser.com.
Investors are going to learn a hard lesson: just because you're on the Web
doesn't mean you've got the key to riches.
For years, I was a bulk buyer of Securities and Exchange Commission filings.
My employer would pay a service $30 to copy the annual 10-K report businesses
must file and $15 more to have it shipped to me overnight.
Now, I view the same document for free on a Web site the day it is filed. I
can get news contained in the document into the next day's paper.
Pretty slick. But where's the profit? The consumer saved $45. The shipper and
the document service lost revenue. The Web site perhaps generated a couple of
bucks selling ads, but it didn't get $45, or $25, or even $5.
The Internet, I would argue, is wonderful for consumers. It will save us all
time and money. It is not so good for the document retrieval service or many
other old-fashioned businesses, probably including newspapers and TV stations.
Like the casino craze
But it's not clear that the Internet creates a new super-rich online document
service to replace the old one. If Amazon.com has proven anything, it is that
you can sell a lot of books if you are willing to lose money on every sale.
But do you bid a money-losing stock up 10 times because it makes life rough on
book stores?
So much bodes ill for Internet companies. Their growth rates -- while very
high -- don't even approach the growth rates for their stocks. Profitability,
with rare exception, is nil. New players are flooding the marketplace. Soon,
new shares of stock will wipe out today's scarcity.
The pundit James Cramer recently likened the Internet stock boom to the craze
for casinos a few years ago. As gambling expanded across the country, every
company that opened a new riverboat in Backwater, Miss., saw its stock soar. I
interviewed ''experts'' who felt Florida's tourism economy would be ruined if
the state did not legalize casinos.
Of course, in the end, too many riverboats in too many locations cheapened the
value of them all. Viva Las Vegas.
Right now, everyone is cheering as new riverboats open up on the Internet. But
history tells us that they won't all make money, even if they do all reap
millions from IPOs. Only the best ones, the ones offering excellent products
and services, will survive.
Just like in real life.
Virtual View is an occasional column. Herald Business Writer David Poppe can
be reached via e-ma |
