Internet industry - an analysis of bubble, the crash and the recovery

Abstract

The Netscape IPO The beginning of the Internet Age was marked by the completion of the Netscape Communications’ IPO on 9th August 1995. The stock, which had been priced at $28 a share, zoomed as high as $75 that day and closed at $58. The real significance of the Netscape IPO was that a decrepit outfit of young engineers had touched the lives of millions of people -- and had reshaped the competitive environment. More than any other company, it set the technological, social, and financial tone of the Internet age. In the four years before the Netscape IPO, GDP grew at an annual rate of 3%. In the four years after the IPO, GDP grew at an annual rate of 4.3%. This Netscape effect, i.e. the rise in the value of the Netscape stock defined the underlying logic of the Internet boom. It demonstrated the role of the financial markets as a driver of change. That is, the stock market didn't go up because technology moved so fast -- technology moved so fast because the stock market was prepared to go up. The Netscape IPO was followed by the public offering of Yahoo in April 1996. The main investor here was Softbank and many other investors were jumping in as well. This was followed by a spate of IPOs in the latter half of the 1990s, with hundreds of startups coming up. There was proliferation of dotcom startups, and this period saw a rise in the valuation of 100s of startups. These cash-strapped startups, brimming with ideas met the venture capitalists who were looking out for lucrative avenues for investing their capital. The explosive growth of venture capital created an opportunity for technology startups with big ideas to materialize their dreams. The ability and the willingness of the equity markets to embrace those ideas through IPOs injected even more money into the process. Thus, the smartest people in the economy were persuaded to join the startup game. Asmore and more startups took shape, big, established companies had no choice but to respond to the threat by spending more money on technology. That spending created an even more attractive climate for startups. The result was perceived dramatic gains in productivity and low inflation. “Buy, buy, buy” was the order of the day. Billions of dollars flowed into this industry and the American stock market saw its largest ever Bull Run. There was now talk of the ‘New Economy”. The old fashioned brick and mortar businesses were "anachronisms" and were almost history. The stocks of these internet companies sky-rocketed with the ‘new economy’ becoming the in-thing. It was not perceived at this time, that the Bull Run may have beenmerely due to gross over-valuation; rather the explanation for this stock market bubble was sought in the ‘Paradigm Shift’, another term for the New Economy. Some of the prominent IPOs of the 1990s are shown in Exhibit 1, and are indicative of the valuations these companies’ stocks reached. The dot com era was marked by the extremes that existed then. From 1996 to 2000, the NASDAQ went from 600 to 5,000. In the two-year period from early 1998 through February 2000, the internet sector learned over 1000 percent returns on its public equity. In fact, by this date, the internet sector equaled 6 percent of the market capitalization of all U.S. public companies and 20 percent of all publicly traded equity volume. While certain companies ended up surviving, many others fell, and billions of dollars were wiped out. But what was common was that almost all the internet firms experienced a sharp rise in their stock valuations, as exemplified below: • Amazon.com: The largest bookseller on the net. In December 1999, the company's stock was over $100 and in September 2001 it was around $5.50 • Excite@Home, which in its six years of life profitlessly spent over $10 billion • Priceline.com, which went from a market capitalization worth more than the entire American airline industry to one worth less than two Boeing 747s. • Globe.com's offering, which saw its share price soar to $97 from $9, a record breaking increase of 866 percent on the first day of trading. A money losing start-up had been transformed overnight into a company with a market capitalization of almost a billion dollars. The Globe.comclosed on July 13 at $1.8125, or $3.625 after a split • Webvan Group Inc., the online pioneer that aimed to revolutionize the grocery industry but ended up losing $830 million, ceased operations Monday and said it would file for Chapter 11 bankruptcy protection.