Volatility of Web Stocks Parallels Biotech Frenzy
By GREG IP
Staff Reporter of THE WALL STREET JOURNAL
If you are waiting for Internet stocks to collapse in a brief, spectacular
fury, you may be waiting a long time.
Sudden collapses are the exception in sector crazes, not the rule. It took
more than two years for the mania for biotechnology stocks to unravel
earlier this decade. With the Internet craze far more entrenched, it will
likely take more than a few stomach-churning dives to scare investors off
for good.
Take last week. For no particular reason,
Internet stocks crumpled through the first few
days. At Wednesday's low, the 40-stock
Dow Jones Internet Index was off 39% from
its April 13 intraday peak. Internet initial public offerings, after months of
routinely doubling or tripling on the first day of trading, were rising only
modestly and some fell below their offering prices.
But by Friday, the bounce was in full swing. The index has rebounded
16% from that low, including a 5% climb Friday as the broad market rose
in quiet, pre-Memorial Day weekend trading. The Dow Jones Industrial
Average rose 92.81 points, or 0.9%, to close at 10559.74, still down
269.54 points on the week.
"In broad market moves, you rarely have someone just going over and
turning the light switch out," says Keith Mullins, head of emerging-growth
research at Salomon Smith Barney. Bringing Internet stocks back to earth
in particular "will be a big battle because it's been an extraordinary rally
and has attracted an enormous number of converts along the process."
Mr. Mullins, like most analysts, has no idea if April will ultimately prove to
be the sector's peak, although he says it has the markings of one. And if it
is, don't be surprised to see the stocks come roaring back from time to
time. "There are rallies in all bear markets. People look over their shoulder
and see what they've left off the table by getting out of these stocks, so
when the stocks break, there's a natural tendency to anticipate they'll
recover."
The most recent precedent for the current Internet craze was
biotechnology stocks from 1990 to 1992. At the time, investor enthusiasm
for dozens of potential blockbuster drugs prompted hundreds of small,
untested companies to go public. Hambrecht & Quist's biotechnology
index rose four-fold between the end of 1989 and January 1992.
Along the way, there were many incorrect predictions of its demise. One
particularly ugly sell-off in mid-November 1991, prompted a fund manager
to predict in The Wall Street Journal, "I think you'll see people selling these
stocks if they rally." But they rebounded to new highs. Amgen, the group
bellwether, plunged 5 1/2 to 52 that day (unadjusted for subsequent
splits), but by year's end had climbed 46% to 75 3/4.
Unfortunately, that marked the sector's peak. The stocks fell out of favor
as one darling after another failed to bring its drug to market. The most
memorable flameout was Centocor. It collapsed when regulators blocked
it from introducing its drug for septic infections, a leading cause of death in
hospital intensive-care units. It fell to 18 1/2 from 31 1/4 in one day in
April.
Internet investors should be wary of two things in particular that
undermined the biotech boom. First is failure of companies like Centocor
to deliver as promised (Amazon.com's announcement five weeks ago that
losses would be wider than expected might prove to be a parallel).
Second is the rising supply of new issues that eventually overwhelmed
demand. Even though biotech stocks peaked in the early weeks of 1992,
there were still 91 biotech initial public offerings that year, up from 72 in
1991, according to Thomson Financial Securities Data.
But neither failure deflated biotech overnight. "Even after an event like
Centocor's very public failure, investors still refused to run away and
continued to look for opportunities to be involved in the sector," says Mr.
Mullins.
Indeed, the group rallied 25% between June and November. But then they
slumped anew, and by November 1994 the average biotech stock had lost
two-thirds of its peak value. At its bottom, Centocor hit 5 1/2, and Amgen
31.
Both those stocks recovered, and biotech since then has performed well.
Amgen closed Friday at 63 1/4, or 253 unadjusted for splits.
The Internet boom is similar to biotech in the stunning price increases and
ease with which unprofitable companies raise money. But there are
reasons for and against a happier outcome for Internet stocks. One
negative is that valuations of Internet companies appear far more inflated.
No biotech stock back then equaled even a tenth of America Online's
market value of $122 billion today.
On the other hand, Internet companies may have better long-term
prospects. Roger McNamee, general partner at Integral Capital Partners,
a Menlo Park, Calif., investment firm, thinks Internet stocks are a bubble
waiting to burst. Yet he also thinks the companies have more going for
them than biotech did. "The biotech industry maybe produced four of five
legitimate pharmaceutical companies, none of which has really transformed
the industry. The Internet industry is already way ahead of that. It's already
transformed how personal computers are sold, the brokerage industry, in a
very fundamental way."
Also, Internet companies aren't losing as much money as biotechnology
companies did. "These [biotech] companies were burning incredible
amounts of cash," says Jay Kim, an analyst at Hambrecht & Quist. "When
the capital markets really dried up, a lot of these companies came into a
financial-survival problem."
True, Amazon.com needs to keep issuing new stocks and bonds to cover
operating losses. But AOL, eBay and Yahoo!, are already making money
and thus are less affected when investors turn a cold shoulder to new
issues, as they appear to be doing now.
One new, unpredictable element in the Internet mania which could prompt
a more violent shakeout than in biotech is the enormous role of individual
investors, who appear far less bothered by stratospheric valuations than
institutions. "We've left the valuations to amateurs," says Mr. Mullins.
Mr. McNamee jokes, "The pricing of Internet stocks is very simple. At
$50, Net stocks are cheap, at $150 they are fairly priced, but at $200
they're incredibly cheap again because they're about to split 4 for 1."
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