The Irresistible Appeal of Dot-Com Reality

Some people love the thrill of roller coasters and keep getting back in line for more, but others can hardly take a single stomach-churning ride. When the torture is finally over, they stagger toward the nearest bench and breathe deeply, savoring the simple pleasures of life on solid ground. For dot-com investors who have been yearning to stay connected with earth’s gravity, the rough ride may be nearing its end.

Until very recently, out-of-this-world market valuations for Internet companies were so commonplace, it seemed as though the financial world had been turned upside down and inside out. Like Alice in Wonderland, investors explored a strange new country — blissfully unaware of the diabolical grin of a barely visible Cheshire cat.

Out of a Hat

There was no way to determine realistic market values for Internet stocks — no history, no precedents. So revenues were crowned king, but hype actually ruled. Anyone who had achieved some measure of success in the technology domain quickly ascended to the C-level and drew investor confidence measured in the millions (US$). So did anyone who had a good idea — especially if it was the genius stroke of adding “dot.com” to a company’s name.

The headlines told the news. Dot-com IPOs were “taking off,” “flying,” “soaring,” “going through the roof,” and “rocketing” — presumably into the vast reaches of a financial universe with no known boundaries.

Pricing shares for an initial offering was neither science nor art — it was a game played without rules. “Here we go again,” wrote an E-Commerce Times reporter in March of 1999. “Online travel agent Priceline.com (Nasdaq: PCLN) has become the latest Internet company to raise the price of its initial public offering in a dramatic way. Priceline announced Friday that the new pricing range is $12-$14, up from $7-$9. Just to put this in perspective, a rise from $9 to $14 is more than a 50 percent gain.”

The next day, there was more Priceline IPO news. “Shares of online travel agent Priceline.com started trading today after the company priced its initial public offering at $16 a share Monday. The pricing of 10,000,000 shares came just one day after the company announced that it had raised its IPO price to $12-$14 from $7-$9. This, of course, means that the IPO price was actually raised twice, and shares of the IPO are being sold at about twice their original price.”

This has become rather typical for Internet IPOs,” the reporter wrote. “Priceline’s shares are soaring in trading today.”

Priceline soared to 108 before making a change in trajectory that brought the company’s shares down to a low of 32.375. Priceline stock is currently trading around the $40 mark. But according to Goldman Sachs analyst Anthony Noto, Priceline is one of a handful of major Internet companies with “a proven business model.” The company is on track to reach breakeven in this year’s fourth quarter, Noto said.

Down and Out

Nevertheless, most of the e-commerce ventures that experienced the heady rise and dizzying fall of their stock values have been marked for endangerment — if not extinction — rather than near-term profitability.

Following their stunning IPOs, some dot-coms burned through their cash so fast, they were forced to make repeated pilgrimages to the venture capital holy land, looking for new investors or trying to stir up interest in possible mergers. As confidence waned, new rounds of financing were required, causing stock prices to fall. Even the highest flyers were forced into lower earth orbits.

The roll call of failures began. A raft of little-known companies faded into oblivion, and some big players — like Peapod, Homegrocer, Boo.com and CDNow — were bought out at bargain prices.

But as the shakeout began in earnest, many analysts assumed a calmer tone in sizing up the effects on e-commerce than they had used in making their doom-and-gloom predictions. “Consolidation” became the new buzzword, and most observers soothingly described the process as a necessary step that would leave the industry healthier in the end.

Revenues Irrelevant?

In the brief history of the Internet, it seems clear that analysts have been feeling their way just as blindly as investors and entrepreneurs. But now there is enough data to provide a measure of assurance in making predictions about the future of e-commerce. Many of the latest conclusions and prognostications are based on the performances of a few emerging bellwethers.

Barron’s reported in March that startups and smaller e-commerce entities were not the only companies that were cash poor. According to the report, 60 Internet companies, including Amazon, were expected to run out of cash within the next year. Amazon would be tapped out in 10.08 months, the report claimed.

Whether Amazon would finally make a profit or die a sudden death became an issue with implications ranging far beyond the concerns of a single — albeit huge — dot-com. Internet historians are now watching companies like Amazon for signs that the new economy is moving past infancy into adolescence, and they are theorizing that when maturity is reached, the old economy rules will once again come into play.

The Amazon Tale

In early June, Goldman Sachs’ Noto called Amazon — along with Priceline — one of the Internet’s “pioneers with proven business models,” and said the company would not need to look to capital markets for funding. Yet a few weeks later, Lehman Brothers analyst Ravi Suria wrote in a report that Amazon’s recognizable brand name was not doing enough to stem a string of steady losses.

“We believe that the combination of negative cash flow, poor working capital management and high debt load will put the company under extremely high risk,” Suria wrote. The report sent Amazon’s shares sliding to their lowest level since December, 1998.

But last week, Amazon rebounded mightily from its slump, just in time to celebrate its fifth birthday. A favorable report from Salomon Smith Barney analyst Tim Albright triggered the upswing. “We expect the company to finish Q1 2001 with approximately $667 million in cash and Q1 2002 with $757 million in cash,” Albright said. Albright also said the third and fourth quarters would be good for Amazon.

The conflicting forecasts are less indicative of analyst confusion than of the favorable circumstances that now allow industry experts to base their predictions on something other than a hunch. There is data to be processed. There are trends to be uncovered and understood. If not yet 100 percent reliable, methods of evaluating a company’s health have nevertheless arrived.

Old Rules

The welcome news for investors who have felt lost at sea over the past couple of years is that a good old-fashioned analysis of how well a business model is working may once again be a strong indicator of a company’s likelihood for success. And some of the companies who are on the right track are currently selling their shares at bargain basement prices.

The reality is that some of them may not weather the storm — but to anyone who has ever dipped a toe into the stock market’s turbulent waters, that should be a given. The reality is also that those who do survive will probably never soar the way they soared before — but to those who prefer moderate hikes to extreme roller coaster rides, that should be a relief.