A Nation of Greater Fools?

The heart of The Internet Bubble is located in the charts that illustrate Appendix A.

The first chart shows how Internet stocks (indexed by the authors) have done in contrast with the S&P 500. The annual return of the Internet index is 400%; the S&P annual return is 18%.

The second chart shows the kind of growth these Internet companies will have to achieve in order to justify their fantastic market capitalizations: “the average Internet company in our set of 133 will need to generate revenue growth of approximately 80 percent every year for the next five years…”

The third chart brings down the hammer. According to Anthony Perkins and Michael Perkins, who are the founder and editor in chief of the booming Red Herring magazine, the overvaluation of Internet stocks can be fixed between $130 billion and $230 billion.

So, like Alan Greenspan and Bill Gates, the Perkins brothers think we are witnessing “irrational exuberance” in the marketplace; at least, that is, the Internet sector. Greenspan’s famous phrase refers to the definition of rationality within the Efficient Market Hypothesis, to which he is a subscriber. The markets, in other words, are self-regulating, with price shifts determined by information ultimately extraneous to the price levels themselves. Greenspan’s remark underlined the fear that prices in the market place had begun to represent only their positions in the marketplace – in other words, that their prices were dependent on the “greater fool” willing to buy them.

When the latter condition is satisfied for a great number of stocks, and actually begins to generate business start-ups, we are in a classic bubble.

The Perkins address this situation by showing how venture capitalists and investment bankers have assiduously assisted in blowing up the bubble. By encouraging earlier IPOs, these investors cut their investment risks by assuring themselves of the benefits of the inevitable initial spike in stock price. So beware of IPOs – the descent in price, over the six months succeeding the IPO, is almost as inevitable as the price explosion at the beginning. IPOs are still insider games.

To put the Internet bubble in perspective, the authors review other recent bubbles, especially the PC frenzy and the biotech bubble of the 80s and 90s. The lessons from the biotech debacle seem especially relevant, since only 20 percent of biotech companies were profitable at the time of their IPOS. The Darwinian sorting out of biotech companies has been rough, and even the best of them are still much smaller than the pharmaceutical giants. The book reports that an equal investment in every biotech IPO would (so far) return just 1 percent a year.

Well, so what, the speculator might well ask. The rough and tumble of the market is not designed to make everybody rich. And that response is fair enough. The Perkins are concerned as much with how the bubble is destabilizing the business models of viable Internet companies, which is real-world damage. Here, however, the attentive reader can detect some underlying tension between the honorable journalistic goal of reporting on the fallout from the self-interest of VCs and the deference customarily accorded Silicon Valley warlords like the partners at the venture capital firm, Kleiner Perkins Caufield & Byers.

A Kleiner Perkins partner, William Randolph Hearst, III, ran @Home, a company that wants to bring the Net to the next level of speed, merging it with cable. This mean upgrading cable, which runs into billion-dollar costs. As the authors gently suggest, @Home is going to have to perform twice as well as Microsoft to justify its market valuation. When in January 1999, Excite was merged with @Home, the deal put a $6.7 billion valuation on Excite, which is rather dear for a company that lost $37.6 million on $155.4 million in revenue. The authors suggest this deal was seen as a way to keep @Home afloat, which is the kind of temporary expedient that might just spread collateral damage from @Home to Excite. When VCs start organizing life-saving operations, one has to ask whose interest it serves—their own, or the interest of the “rescuing” company.

Since the book was written, fallout has occurred in the Internet sector, especially among e-commerce companies. For the investor who scurries to put money in every new IPO, there are some rocky times up ahead. For market voyeurs, we are getting that old familiar tingly feeling, which signals that the best part of the show is coming up: the extensive bloodletting. Believe me, this is better than boxing.

Note to reader: The BookReviewGlobe team of grammatical mavens argued long and hard about how to deal with Perkins in the possessive and plural. Was it “the Perkinses are concerned…” or “the Perkins’ are concerned…” or what? In the end, everything came out sounding like Homer Simpson when he talks about his neighbors, the Flanderses. So we just went with “Perkins” and are willing to endure the poison arrows of junior grammarians everywhere.

Roger Gathman has written for Salon, the Austin Chronicle and Publishers Weekly. He lives in Texas.