Investors have been falling over themselves to get a slice of dotcom action. But it seems the dotcom bubble is about to burst
Love it or loathe it the internet will transform people’s lives. It is already having a seismic effect on the global economy, and the rise of “new economy” stocks has pulled a rug from under the share prices of many their “old economy” brethren, even though these old-timers have healthier revenue streams.
Last week, however, investors and e-entrepreneurs were starting to see sense. The internet bandwagon, which has enabled many dotcom start-ups to command vastly inflated market values, is showing distinct signs of slowing down.
As internet stocks saturate the market, and with the cost of borrowing likely to go up, there are concerns that the bubble is starting to deflate or will burst.
Even though most European share indices rallied last Friday as technology, media and telecommunications stocks re-discovered some of their winning ways, the failure of last week’s two internet flotations to rise much above their original offer prices reinforced the impression that times are changing.
Shares in Lastminute.com, Martha Lane-Fox’s glorified travel agent which does not anticipate making a profit earlier than 2004, closed only marginally above their issue price last Tuesday.
World Online, a Dutch internet service provider which floated last Friday, did not fare much better. It is valued at £7.5 billion, fractionally above its issue level. Until last week, the norm for internet flotations was triple-digit first-day gains.
There may be parallels with Asian crash of 1997-98, which rocked stock prices around the world. If nothing else there are signs that, in the wake of warnings from Howard Davies, chairman of the Financial Services Authority, stock markets are being talked down to Earth and rediscovering a form of sanity.
Speaking to a House of Commons inquiry, Davies said: “I am not saying there is a systemic crisis but the risk profile of some of these companies must be higher because there isn’t the same information about successful trading.” It is thought he wanted to take the froth out of some of the shares through a “re-rating”.
Investors seem to have started taking heed. They are certainly getting more twitchy about some of the more extreme valuations put on some dotcom firms.
David Rough, head of investment at Legal & General said that, within five years, 90% of the dotcom stocks coming to the market will have gone bust.
By the same token, investors are starting to recognise the intrinsic value of more profitable old-economy businesses. Last Tuesday, a survey by Merrill Lynch showed most fund managers will cut their exposure to the telecoms, media and technology (TMT) sector over the next 12 months.
But the slide may be more of a short-term “correction” than a fundamental shift in investment flows, and there’s a chance TMT stocks could still reward patient investors.
Some venture capitalists are becoming tired of seeing so many vacuous business ideas, many of which are based on smoke and mirrors.
Calum Paterson, managing director of Glasgow-based investors Scottish Equity Partners, said: “We are seeing two or three business-to-consumer dotcom proposals each day and at least 95% of these, in our view, do not have any legs.”
However, Scottish Equity Partners has backed all-hotels.com and britsport.com largely on the back of distinctive concepts and strong management.
Paterson added: “There are clear analogies with the Gold Rush. The people who made the money were the people supplying the picks, the shovels and the jeans.”
This, he says, is why SEP has a preference for infrastructure and business-to-business internet companies, including Quadstone and IndigoVision.
“Internet service providers are definitely yesterday’s market,” said one technology banker. “I’m more interested in looking at software related to the internet and hubs for business-to-business trading.”
There is no doubt, however, that it makes sense for a credible dotcom firm to cash in their chips with a stock market flotation while the going remains good. For example, if a dotcom company manages to float while the current window of stock market enthusiasm remains ajar, it might be in a position acquire large, undervalued, old economy businesses, paying with highly-rated paper. It could follow the model set by AOL’s “clicks and mortar” acquisition of traditional media group Time Warner.
Some pundits argue that many dotcom stocks have a lot in common with pyramid-selling schemes. The money made is the money of investors who follow, and is not being made by the dotcoms themselves. “Eventually all pyramids collapse when the number of lemmings entering is not enough to sustain the illusion,” said one commentator on the Motley Fool bulletin board.
While the “lemmings” certainly exist — especially among private investors who lack the propensity to scrutinise a company’s future earnings potential of their institutional investing peers — there may still money to be made.
Bert Siebrand, an analyst at SNS Securities, said: “The whole atmosphere around ISPs has really soured since last week and a lot of people now see the basic ones as dead meat.”
Yet despite these market weakness, Europe’s ISPs are still valued at a premium to their US counterparts and are still only beginning to join the stock market.
Copyright SMG Sunday Newspapers Ltd. 2000
This article was published in the Sunday Herald on 26 March 2000