What is fueling the Internet stocks' bubble?
By James Brookfield
World Socialist Web Site ( wsws.org )
12 January, 1999
The 1999 opening week on Wall Street saw skyrocketing share prices for
a number of Internet-related companies. While to a certain extent this jump
continued the late-1998 trend and mirrored the rise in the market as a
whole following the autumn interest rate cuts, it has taken on a phenomenal
character.
Last week share prices rose 10, 20, even up to 50 percent in a single day
for a number of companies. It is not unusual to find Internet firms--Yahoo,
the popular search Web site; and Amazon, the bookseller, for
example--whose stock prices have quadrupled since September. The
overall market capitalization figures have correspondingly gone through the
roof. America Online, the popular online service, for example, has seen its
price more than triple during this time, giving it a larger capitalization than
General Motors.
Why are the prices of the Internet stocks soaring? To find out, I examined
one of last week's heavily traded companies, broadcast.com, which bills
itself as the "leading aggregator and broadcaster of streaming media
programming on the Web." Broadcast.com held its initial public offering on
the NASDAQ exchange last July. In September its stock fell from the
mid-60s to the low-30s, only to skyrocket to 100 at the end of the year.
Last Friday it rose from 132 to 197, a jump of 50 percent. Panicked
NASDAQ officials stopped trading and tried to get an explanation from
the company, which could offer none. On Monday, after the company
announced a two-for-one stock split, its price climbed to 278, a 40
percent gain.
Broadcast.com is little more than a name, a company in search of a
business. Its web site is limited, almost amateurish. It produces nothing
itself (it relies on "content providers" in Internet lingo). It simply plays
("streams" to use the jargon again) low-quality audio and video generated
by other companies (radio stations, CSPAN, etc). The most recent of its
"Current Events" is a speech given by Sandy Berger, the US National
Security Advisor, on December 23, i.e., more than two and a half weeks
ago. Even with a high-speed modem the picture is choppy, hardly a
surprise given the still limited technology of Internet video.
The company's most recent filing with the Securities and Exchange
Commission is a revealing document. "The Company has incurred
significant losses since its inception and, as of September 30, 1998, had an
accumulated deficit of approximately $20.2 million." In the first nine months
of 1998 it had revenues of $11.4 million, a figure that, within the
framework of US capitalism, puts it in the category of small- to
medium-size businesses, a group encompassing tens of thousands of
generally struggling firms. The company spent $23.1 million in the same
period, a figure twice the size of its revenues. Nevertheless, Monday's
closing price gives the company a market capitalization ($4.873 billion)
larger than Wendy's ($2.831 billion), which has annual earnings of $100
million and 47,000 employees, and more than half that of Delta Airlines
($8.282 billion) which has annual earnings of nearly $1 billion and 70,000
employees.
Broadcast.com's losses, even the company admits, will continue. It's SEC
filing states: "The Company expects to incur substantial operating losses for
the foreseeable future." Are there plans to cut back? "The Company
expanded from fewer than 10 employees on September 20, 1995, to 225
employees on October 31, 1998, and the Company expects to increase its
personnel significantly in the near future." It goes on: "The Company
currently intends to increase substantially its operating expenses in order to,
among other things, (i) expand its distribution network capacity, (ii) fund
increased sales and marketing activities, (iii) acquire additional content, (iv)
develop and upgrade technology and (v) purchase equipment for its
operations."
The long-term outlook is also highly questionable. "There can be no
assurance that the company will ever achieve profitability or, if profitability
is achieved, that it can be sustained." The SEC filing adds that the
company's agreements with its program providers are nonexclusive, i.e.,
broadcast.com can be underbid. Most of the company's revenue is from
short-term advertising on its web site and radio and TV. There is no
guarantee that their site will ever be widely used. "It is not known whether
businesses and other organizations will utilize the Internet to any significant
degree as a means of broadcasting business and other events."
And finally there are the internal problems, including: that nearly all the
senior management just joined the company, that nearly all of its equipment
is in a single location with no backups maintained, that it may not be able to
handle a large increase in user traffic, that it has no guarantee against being
hit by the year 2000 problem, and that it carries no insurance to protect it
from copyright lawsuits or the loss of key employees.
In other words, the company is a young, small startup facing immense risks
and uncertainties. Its underlying fundamentals are shaky. It has few ideas
and no real product. Not only its future earnings, but even the company's
future existence, are dubious. The skyrocketing share price is entirely
speculative.
Broadcast.com has become a magnet for drawing together vast aggregates
of capital, which it does not employ for any real constructive purpose. It
exemplifies the growing detachment of capital from the social productive
process. Money is poured into the market, driving prices up, increasingly
without regard to the underlying productive capabilities. The company's
dividend from earnings plays an increasingly negligible role in the return on
investment in light of the inflated prices. Prior to the 1990s bull market a
price-to-earnings ratio (PE ratio) of 20:1 was considered to be at the
upper end of a safe investment. In 1999, however, PE ratios of 100 to 200
are increasingly common and ratios of 400 are not unheard of. For some
stocks, like broadcast.com, the PE ratio cannot even be calculated as the
company has never earned money.
The snapshot of broadcast.com gives some idea of the feeding frenzy that
is presently under way in the US stock market. The Dow Jones Industrial
Average, and other indices, have become quasi-religious national
obsessions, displayed and cited ubiquitously. The spirit of the lottery and
the unhealthy ambition for easy money have swept over a substantial layer
of US society. This has coincided with the entry of wider sections of the
middle class, and even a strata of the working class, into the stock market.
Their mesmerization by share prices will continue until the inevitable
puncturing of the present bubble.
If history teaches anything, the runaway valuations will end in a flood of
tears. The rupture of the bubble--the fall in prices--will leave substantial
numbers of people hard-hit. Many have allowed themselves to accumulate
personal debt that they view as offset by the increasing paper values of
their portfolios. The resulting decline in consumer spending will also have a
dramatic international impact since the US has absorbed a large fraction of
the exports from the Asian countries still reeling from the 1997 meltdown. |
