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Hi, The following is an excellent article on the potential of a "financial bubble" in the making. This purpose of this forum is for an open discussion whether you agree or disagree with the thesis and your reasons thereon. pcyhuang huangcapital.com ---- June 22, 1999 SmartMoney: Unconventional Wisdom: Trouble In Paradise: We Hate To Burst Your Internet Bubble, But . . . This story appears in the July issue of SmartMoney magazine. By Roger Lowenstein Before you buy your next Internet stock, take a few hours to read Edward Chancellor's engaging new history of investment bubbles, Devil Take the Hindmost: A History of Financial Speculation (Farrar, Straus and Giroux). Okay, so you already know that Internet valuations don't make sense.Anyway, you're going to get out before the bubble bursts, right? Here's what you don't know: The people who went in for every other bubble had the same idea. Sir Isaac Newton, Winston Churchill and multitudes in every age were seduced into speculating in stocks and schemes that they knew were ridiculously overpriced. Guess what happened to them. Indeed, reading these pages of greed, human credulity and popular contagion, one can only believe that the best chapter has yet to be written. The mania for Internet stocks exhibits all the classic signs -- notably, the desire to engage in fantasy and the ability to rationalize away unpleasant facts -- of bubbles past, from Dutch tulips to Japanese land. Such warnings have become a commonplace(indeed, my kids hear them at breakfast). But that will not diminish the pain and shock once the bubble bursts. It was William King, Archbishop of Dublin and no naif, who wrote of the South Sea Company in 1720, "Most that go into the matter are well aware it will not [succeed], but hope to sell before the price falls." One such investor was Isaac Newton, who frankly confessed, "I can calculate the motions of the heavenly bodies, but not the madness of the people." South Sea -- organized to buy up the British government's debt -- had revenue guaranteed by the Crown, on the basis of which its value was estimated at GBP 150 per share. As enthusiasm turned to mania, talk in England was of nothing else, and the shares soared to GBP 1,050. Nor was the public ignorant of South Sea.com's true worth. According to a pamphleteer: "The fictitious value must be at loss to some persons or other, first or last. The only way to prevent it to oneself must be to sell out betimes, and so let the Devil take the hindmost." A few months later, the shares collapsed by 80 percent. A member of Parliament despaired, "I said, indeed, that ruin must soon come upon us, but I own it came two months sooner than I expected." Alexander Pope, another investor, sounded offended not to have been given advance notice of the crash: "No man consider'd it would come like a Thief in the night."When South Sea tumbled, so did everything else. Of 190 other "bubble" companies organized in 1720, only four survived. It is easy to poke fun at the most outlandish schemes. One exceptionally far-sighted promoter floated shares to colonize "Terra stralis"-about half a century before James Cook discovered Australia. Another (forerunner of eBay?) was to trade in human hair; still another proposed "A Wheel for Perpetual Motion." TheStreet.com may be worth a lot or, as I would argue, not a lot, but at least its business is real. Still, 1720 contains the kernel of an enduring speculative verity. The most famous bubble company -- "for carrying on an undertaking of great advantage but no one to know what it is" -- may have been a joke, but it resonates today. The more specific a company's plans, the more its stock is grounded in fundamentals. For the purpose of whipping up excitement, the vaguer the better. Thus no sooner did Amazon.com's market cap eclipse the total of all competing book chains than its defenders hurried to proclaim that books alone did not begin to define its future possibilities. From the 1800s on, bubbles showed a marked tendency to congeal around real and, indeed, revolutionary inventions. Mining companies (perpetual traps for suckers) were soon replaced by canal stocks and railroad shares. As with the Internet today, promoters emphasized not just the economic boon but the transformation of society. "Railway time," it was said, had changed the meaning of distance. That it had, but English rail stocks (of which far too many were floated) went bust anyway and touched off the Depression of 1847. In the 20th century, radio transformed the world, but RCA crashed (during the Great Depression) from $114 to $2.50. Indeed, given the sorry fate of early personal computer makers and the sea of red ink spilled by airlines, the generalization holds that radical inventions are bound not to sustain the speculative dreams they inevitably spawn. To hazard a guess, modernization tends to lower costs and level barriers; neither is auspicious for making money. And the Internet is the greatest cost- cutter and barrier-leveler yet. Although Chancellor does not discuss it, the bubble that the Internet most resembles is the mania for the "go-go" electronics stocks of the 1960s, when institutions, rather than sneer at dicey issues, jumped in whole hog. It's the same sorry case today. As Salomon Smith Barney analyst Keith Mullins wrote in a sizzling report, "Tears.com," Internet stocks, once a pastime of day traders, are attracting "a considerable number of serious institutional investors." Serious except that these monkey see, monkey do portfolio managers do not believe in the values of the stocks they own, according to Mullins, who talked to dozens of them. So it was in 1720; so it is today. It is easy to understand why. Priceline.com was recently valued at nearly $25 billion, fully diluted-roughly equal to American, United and Delta's valuations combined. The latter three make money; Priceline doesn't. What Priceline does is sell (at a loss to itself) surplus tickets that the airlines choose not to sell. This is not a new business; only the medium (the Internet) is new. Most likely, airlines themselves will increasingly sell tickets online. When I asked Samuel Buttrick, an airline analyst at PaineWebber, to cobble together some very rough numbers, he figured that consolidators might sell $5 billion of tickets on and off the Net. Give Priceline a healthy 25 percent of that market and a 5 percent net profit margin, and it might someday make $60 million or so, meaning its multiple on potential and quite distant earnings would be in the hundreds. Naturally, disciples such as Jonathan Cohen, of Wit Capital, see Priceline as anything but bound to the airline business. It is,rather, a multi-industry experiment in selling mortgages and whatever else, "a platform provider for conducting transactions." Another analyst, Henry Blodget of Merrill Lynch, rationalizes the stock by arguing that Priceline could, eventually, "grow into" its valuation. This is not analysis but fancy. When rationalization fails, distortion may do the trick. So it was in bubbles past, Chancellor reports, and so today, as Internet companies disguise true earnings by excluding all sorts of charges from the "earnings" they report in press releases. At the final stage, numbers don't matter-faith is all you need. The recent prospectus of NetObjects, a "leading provider" of software for the Web (yearly revenue: $15 million), might be a marker. Among 12 pages of risk factors, this money-loser admitted, "Our auditors have substantial doubt about our viability as a business." In normal times, such a disclosure would stop an offering cold; today it fetches a market cap of several hundred million. Such faith has seeped into the general investing culture, notably when The Wall Street Journal's Bernard Wysocki offered that the very idea that businesses need to make profits might be a quaint notion of the past. Here is another quaint idea: The line between Internet and other companies is blurring every day. Amazon is in a price war with Barnes & Noble; CVS, which just bought a foothold in cyberspace, will show that selling drugs online is far more effective if you have real stores to go with it. Internet firms vying with brick-and-mortar rivals will not long escape competing valuations. Investors may dream of the heavens, but stocks come back to earth. --- Roger Lowenstein is the author of Buffett: The Making of an American Capitalist and a director of the Sequoia Fund. | ||||||||||||
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