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  • pg 1
  Review and Outlook

  David S. Carr
  Contemporary Topics in Finance
  MBA –8439
  Prof. W. Delva
  April 25, 2001


The last several years will go down as one of the most volatile periods to invest in stocks.

Nowhere is that volatility more prevalent than in the technology-laden Nasdaq Stock

Market. This index has seen stock prices rise to stratospheric levels in the late 1990’s

and early 2000, driven mainly by the vast potential of the internet and technologies

developed to exploit its use. But, as many investors have learned, potential does not

equate to earnings, and sooner or later a lack of earnings equates to failure.         This

document will examine the Internet bubble and subsequent technology fallout that

occurred from the late 1990’s to today. It will attempt to explain the causes that led to an

abundance of e-commerce initial public offerings, ease in accessing capital, and inflated

stock prices. Predictions from e-commerce executives, fund managers, and Wall street

analysts during the bubble will also be provided. Furthermore, reasons why the bubble

“popped” will be explored.      Finally, a historical perspective draws parallels to other

“revolutionary” times in American History, which will offer support why the internet and

the technology sector, are by no means dead, and are poised to provide the long term

economic growth engine for the world.

How did it all Start?

Arguably, it all began with Netscape in 1995. The IPO was extremely successful as the

stock price rose from $28 to $71 on the first day, and ultimately cleared the way for

hundreds more net companies to do IPO’s far earlier than ever before. A firm with $3

million in losses was suddenly worth $2 billion. Jim Clark, Netscape’s co-founder had

been advised strongly against going public, but went ahead anyway because he had to

make payment on a mega-yacht he was having built. If he missed the payment, the

builder would give his slot to someone else, and he wouldn’t get his yacht for years.

From such motives, among others, grew one of history’s great stock manias and a new

model for venture funding.

E-Commerce Examples

E-Toys is a great example of a dot-com start-up with an innovative idea, great promise,

and huge Wall Street backing that ultimately felt the pinch when customer demand dried

up. On its first day of trading in May 1999, shares of E-Toys opened at $20, catapulted

to $120, before closing at $76. Immediately it boasted a market capitalization of $7.6

billion, bigger that bricks and mortar giant Toys R Us. Chris Vroom, Internet analyst for

Thomas Weisel partners initiated a strong buy on the stock, predicting that the company

is likely worth $10 billion, and will continue to dominate online toy sales.

In June 2000, with losses mounting, cash dwindling and the stock price near $6, the

company received another $100 million infusion from three private institutional

investors. The sale was from preferred convertible stock over three years. E-Toys CFO

indicates that the cash should carry the company until the fall of 2001, and that the

company expects to be profitable by early 2002 at the latest.

In January 2001, the once-darling of e-commerce companies slashed its staff by 70

percent, and indicated that it will continue to search for a buyer. It also shut down all

European operations. The news was no surprise as holiday sales came in at roughly half

of the company’s projections. E-Toys attributes its decline to a “generally harsh retail

climate and the continued disfavor of internet retailing.” At this time it’s stock traded

around 16 cents.     In February 2001, E-Toys was de-listed from the Nasdaq stock

exchange, officially closed its doors and announced its intent to file for bankruptcy.

Another great e-commerce example is online grocer, Webvan. At the time of its IPO in

November 1999, its promise was compelling, however its operational record was suspect.

Yet at one point during its first day of trading the shares reached $34 giving it a market

capitalization of $15 billion. Overall, the company raised more than $1 billion over its

short lifetime. It has a star-studded list of venture capital backers and hired George

Shaheen, former head of Anderson Consulting (now “Accenture”). For the year-ended

1999, the company reported $13 million in revenues and $144 million in losses (See

CHART 1 below). But unlike many other e-companies, Webvan can lay claim to a

substantive core that other e-retailers cannot. In groceries, it is offering something that

every single household purchases at great trouble (2.6 visits per week), and on a grand

national scale ($450 billion annually) than far dwarfs the book business that brought e-

commerce into view.

                 CHART 1 – Webvan Income Statement Data

            Webvan Income Statement         In Thousands      In Thousands
                                            2000              1999

            Net Sales                       $178,456            $13,305
            Gross Profit                      $47,217            $2,016
            Net Loss                        $(453,289)        $(144,569)

It now appears, however that its business model is also severely flawed. The costs of

picking, packing and delivering most orders are likely the main cause of its sub-par

financial performance. Furthermore, the company is a scale business with significant

fixed costs that can only be covered with a certain amount of customers. Needless to say,

they haven’t come close. Their problem, along with many other e-commerce companies

also lies in the fact that they are expecting a dramatic change in consumer behavior.

Instead of shopping at supermarkets, customers must opt for a more expensive, plan-

ahead method of shopping for groceries. That hasn’t happened.

WebVan now has roughly $200 million in cash and at its current run rate will burn

through the cash in two quarters. Furthermore, its stock price now at 13 cents, and faces

imminent de-listing from the Nasdaq Stock Exchange. It’s dismal stock performance is

charted below (CHART 2).

                  CHART 2 – WEBVAN Stock Performance

The E-Toy and Webvan stories are commonplace nowadays as more than 130 dot-coms

closed their doors in 2000 and approximately one per day is shutting down this year.

Nowadays the fun is gone, as executives and employees are on a grim march towards

profitability, hoping to reach that elusive goal before running out of cash.

So what did the E-Commerce companies do wrong? Mostly everything, but looking

back, these issues can be pointed to that contributed to their ultimate demise.

They did stupid things.      Million dollar Super Bowls were run by many of these

companies that ultimately produced little to the bottom line. Many dot-commers wanted

branding, but “they don’t know what branding means,” says Rena Kilgannon, co founder

and principal of the Ad Incubator, an Atlanta marketing firm that works closely with

start-up tech companies. “Bright people run these companies but they’re clueless about

low cost ways to market, the kinds of strategies start-ups should be implementing.”

They underestimated the importance of real-world know-how. Significant vertical

know-how is needed to succeed in retailing and “e-tailing” is no different. Expertise is

needed at sourcing and pricing products, something many dot com companies never

developed. To outperform the established bricks and mortar players without this acumen

turned out to be devastating for most e-commerce companies.

They overestimated consumer demand. Consumers were much slower to adapt to new

technologies than most entrepreneurs had thought. Many of these companies incurred

exorbitant expenses simply trying to persuade customers to shop online. A bricks and

mortar start-up doesn’t have to spend one dime explaining to consumers how to shop at a

local mall. But online it’s different where most consumers still haven’t made purchases.

And these companies never made a strong enough case for consumers to switch from

bricks and mortar store to online buying.

They never factored in customer acquisition costs in their business models. They

also were not getting repeat business. Many companies eked out some sales by offering

free shipping or significant discounts, but it never amounted to any kind of customer

loyalty. Customers would simply move on to the next site offering the lowest price.

Furthermore, when many did make sales, they failed miserably when it came to order

fulfillment. Shipments were late, wrong or not made at all. That’ll hurt customer loyalty

for sure.

They lacked fiscal controls. Many of these companies had no fiscal discipline. Dot-

coms spend wildly on everything from office space to freebies for workers such as free

massages and free yoga, and many more “non-traditional” expenditures.

They settled for unimpressive management. There was a real lack of talented top-level

management during the internet boom.           During the tough times, management

inexperience and inadequacies became glaringly obvious.

They didn’t execute. Perhaps due partly from poor management, many start-ups were

built on good ideas, but companies never executed those ideas. This seems to be true of

virtually every failed dot-com.

Given these weaknesses it’s no wonder that most of these companies fell by the wayside.

So who is to blame? The executives, investors, Venture Capital firms? The answer is -

“D” - all of the above. While it is certainly true that executives of many of these

companies drove their companies into the ground, Venture Capital investors should share

much of the blame. These supposedly shrewd investors took wild plunges with these

companies without doing their due diligence. There was a herd mentality and they

invested irrationally.

The rest of the Technology Sector (2000 and 2001)

As the e-commerce shake-out began to take hold in late 1999 and early 2000, many

professional investors and analysts were still extremely bullish on the Nasdaq a nd most

technology companies. “This time it’s different” was the mantra heard throughout Wall

Street   as    B2B       companies,   PC    makers,    semi-conductor      manufacturers,

telecommunications and wireless players, and biotech firms were cruising along, boasting

stratospheric stock prices and phenomenal actual and expected growth rates.           The

fundamentals were less important as ludicrous P/E ratios were somehow being supported

by equally optimistic anticipated growth rates. At their peak, the average P/E on the

Nasdsaq (excluding stocks with no earnings) approached 120, as compared to the S&P

historical average of 14. At that time, the Nasdaq P/E’s traded at approximately 2.2 times

the P/E on the S&P 500 (See CHART 3 below). Also at that time, technology stocks

represented over 35% of the S&P 500, the highest weighting ever for any industry group

(See CHART 4 below).

                   TO S&P 500

         Jan- Jan- Jan- Jan- Jan- Jan- Jan- Jan- Jan- Jan- Jan- Jan- Jan- Jan- Jan-
          87 88 89 90 91 92 93 94 95 96 97 98 99 00 01

                    S&P 500









         1991   1992   1993   1994   1995   1996   1997   1998   1999   2000   2001

Beginning in March 2000, that all started to change. As many e-commerce companies

were no longer in the landscape, other technology companies that relied heavily on these

big spending dot-coms to purchase their equipment, started to feel the pinch.         PC

companies experienced slower demand as there was no real compelling new technology

to drive new PC purchases. The dot com fallout coupled with the PC slowdown also

caused inventory issues and slower growth for the chip makers and server producers.

The trickle down theory took effect as optical networking companies experienced slow

downs as their primary customers, the telecommunication companies, were experiencing

their own inventory glut. Virtually every technology sector experienced the slowdown in

2000. All of a sudden, even the mightiest of high-flying technology companies (Cisco,

Sun Microsystems, Microsoft, Dell, Oracle, and countless others) started experiencing the

slowdown. Investors started questioning the growth rates, P/E’s and yes, stock prices.

The Nasdaq continued its decline, losing 39% in fiscal 2000 (See CHART 5 below).


To exacerbate the matter, the Federal Reserve continued in its fight against inflation and

raised interest rates several times in 2000 and even held its “tightening bias” through

November 2000. Not until December 2000 did the Federal Reserve “loosen” its bias and

then ultimately began reducing the Fed Funds rate on January 3, 2001 and continued to

reduce rates through its most recent meeting in March 2001. But it may have been too

little too late, as the hiked rates in 2000, and December earnings warnings dampened the

climate, squelched additional corporate borrowing and placed downward pressures on

stock prices.

The interest rate declines in 2001 gave investors hope that the now economic slowdown

would rebound in the second half of 2001. As a result, the Nasdaq was up more than 10%

in January alone. But as profit warnings came flowing in at an alarming rate, fears of a

hard landing were rampant, bleak earnings visibility, and technology spending estimates

dropping through the floor, the Nasdaq plunged to a 2 ½ year low of                 1619,

approximately 68% off it’s all time high in March 2000. The Merrill Lynch Tech Index

P/E still stands at roughly 1.5 time the P/E on the S&P 500 (See CHART 3 above). As

of April 6, 2001, the Nasdaq stood at 1,719, and technology stocks now represent

approximately 18% of the S&P, down from 35% in March 2000 (See CHART 4 above).

Initial Public Offerings

Initial Public Offerings saw a similar pattern whereby they skyrocketed in the late 1990’s

(in quantity and value) as companies thinly floated their shares to achieve instant market

capitalization. In March 2000, 65 companies went public, mostly on the Nasdaq. The

average first day returns of those stocks was 78% and 18 of the 65 jumped more than

100% in one day. Today, 62 of those 65 stocks remain publicly traded (the other three

have been bought out.)   The 62 stocks stand, on average, at nearly 70% below their IPO


Consider the following chart (CHART 6) of the highest ever one day gains from IPO’s

and look and the sharp decline in stock price today.


Company               Public Date      Offer Price     Day 1 Close      4/5/01 Price
VA Linux Systems      12/1999          $30             $ 239.25         $ 1.94
Theglobe.com          11/1998          $9              $ 63.50          $ 0.19
Foundry Networks      09/1999          $12.50          $ 78.13          $ 7.19
Webmethods, Inc.      02/2000          $35             $ 212.63         $19.00
Freemarkets, Inc.     12/1999          $48             $ 280.00         $ 8.69
MarketWatch.com       01/1999          $17             $ 97.50          $ 3.88
Akamai Technol.       10/1999          $26             $ 145.19         $ 7.50
CacheFlow Inc.        11/1999          $24             $ 126.38         $ 4.00
Crayfish Co.          03/2000          $240            $1,126.00        $ 6.50

Over the past year, IPO activity has dropped drastically. After the mid-April Nasdaq

correction, investors had to look cautiously for quality giving a green light only to

companies with actual profitability, strong business prospects and an established

customer base. Prior to this period, only an interesting idea was needed. Activity dried

up so much that in the first quarter of 2001, only 21 IPO’s came to the market, compared

with 135 in the first quarter of 2000. CHART 7, below highlights the declines in IPO’s

underwritten by some of the major Wall St. Investment Banking firms.

       CHART 7 – Investment Banking Firms IPO’s Underwritten

Firm                             IPO’s -   Amt Raised       IPO’s            -    Amt
                                      March 2001           Raised           March 2000
Morgan Stanley Dean Witter       4      -   $5.8 billion 22             -    $ 8.0 billion
Goldman Sachs                    3      -   $0.4 billion 19             -    $12.8 billion
Merrill Lynch                    4      -   $1.4 billion 9              -    $ 3.3 billion
Lehman Brothers                  2      -   $0.2 billion 7              -    $ 2.1 billion
Deutsche Bank Alex Brown         1      -   $0.1 billion 10             -    $ 6.4 billion

This decline has led to dramatic drop in underwriting revenues and has forced many top

Wall Street firms to announce significant layoffs. Long gone are the days of picking their

deals and raking in the cash. Now its back to fierce competition for a few deals, and hope

the window opens again.

Venture Capital Market

The venture capital (VC) developments tell a similar story. The burst of the internet

bubble, the high-tech bust, the IPO market gone dry, and the slowing economy have

resulted in a serous decline in VC deals, and a major dent in VC portfolios. A little more

than one year ago, VC firms could do no wrong. Anything they invested in, especially if

it had “dot-com” in its name would take flight as soon as it hit the market. These days,

instead of doing deals venture capitalists are licking their wounds and trying to shore up

the companies they already invested in.

Last year, VC firms financed an estimated $100 billion worth of start-up companies and

entrepreneurs.   This year, the bewildered stock market and shaky economy have

prompted industry experts to project only $25-$30 billion in financing deals in 2001. Just

as the case with IPO’s. VC firms are only backing firms that can produce a sound

business plan and can generate profits virtually immediately. Blueprint Ventures, a San

Francisco VC firm lists its worst pitches for start-up companies approaching VC firms:

      “Contact me as soon as possible so that I can start this profitable venture in a few
      “Financial performance doesn’t really matter for our company prospects.”
      “The market we are targeting has yet to be defined.”

These quotes weren’t so laughable just one year ago.

Predictions during the inflating bubble:

Throughout this tumultuous period, investors, fund managers, Wall Street analysts,

company executives and anyone else who could get on the air or on the internet, posted

their opinions about the seemingly endless rise in internet and technology stocks

throughout the late 1990’s and into 2000. The predictions are extremely varied. Some are

way off, and some seem to have hit nail right on the head. Below is a sample of these

quotes and predictions.

The Skeptics

   In December 1999, Burton Malkiel, Author of “A Random Walk Down Wall Street,”

    indicated that the Internet was “clearly a speculative bubble – dangerously close to

    the boom in biotechnology stocks of a decade ago, the Nifty Fifty boom of the early

    1970’s, and the bubble in Japanese stocks that ended in 1990. I think it’s going to

    come to a very bad end.”

   On March 10, 2000, the day of the Nasdaq peak, Jeremy Siegel, a professor at the

    Wharton school, and a long time bull on Wall Street, appeared on the TV show

    Moneyline and indicated that the bluest blue chip tech stocks were dangerously

    overvalued. He claimed that it had become “too much of a good thing.”

   Anthony and Michael Perkins, Author of the widely popular 1999 book, “Internet

    Bubble” said, “Sell Now.” They were referring to 133 publicly traded internet

    companies with market capitalization of more than $100 million.

   In February 2000, after many of the e-commerce “B2C” companies were

    experiencing major declines in their stock prices, and Business to Business (B2B)

    internet companies were the next hot thing, Youssef Squali, analyst at ING Barings

    indicated, “It’s only a matter of time before investors lose interest in “B2B” stocks.”

   Towards the end of 1999, JP Morgan investment strategist Douglas Cliggot, began

    telling investors to trim their tech holdings. He indicated that “an aggressive tech

    exposure is making an enormous leap of faith.” He also downgraded the then hot

    telecom sector in April 2000 based on U.S factory orders of U.S. communications

    equipment which showed slowing order growth.           Unlike many others, he was

    focusing on fundamentals.

The Optimists

   James Glassman and Kevin Hasset, authors of “Dow 36,000,” when discussing the

    abnormally high P/E ratios in existence as of early 1999 says, “Could it be that the

    model that Wall Street has been using to assess whether stocks are overvalued - a

    model based largely on historic price to earnings ratios is deeply flawed?----We think


   On March 10, 2000, the day of the Nasdaq peak, Ralph Acampora, Prudential chief

    technical analyst forecast that the Nasdaq could hit 6000 in the next 12 to 18 months.

   In July 1999, Mary Meeker, an analyst and managing director with Morgan Stanley

    Dean Witter discussed the markets and the requirements for going public. “The old

    rule of the 80’s was that a company needed three quarters of profitability and to show

    a rising trend before trying a public offering. Now, companies should act rationally

    reckless to use capital markets as a tool and proceed as if they have nothing – and yet

    everything- to lose.” When asked if we were in an internet bubble, she responded,

    “No. The next trend – businesses selling internet based services to other businesses

    will dwarf the revenues of the past four years.

   In March of 2000, now Merrill Lynch mutual fund manager James McCall stated,

    “We don’t get too hung up on valuations. Even if it’s a gazillion times earnings,

    that’s not my part of the decision.” Two funds he manages opened in March 2000 are

    both down more than 65% since inception.

   In April of 2000, Thomas Bock, SG Cowen analyst, who has never even taken an

    economics course indicated, “We’re not focusing on earnings or even revenues.

    We’re looking at the size of the market and a company’s defensible position in it.”

Examples of excesses:

Consider the following mind-boggling statistics of some of these once high-flying

internet/technology stocks.

   There are 4,321 companies on the Nasdaq composite. More than 450 are down 90%
    from their highs. These names include E-Toys, Webvan, Teligent, Scient, Drkoop,
    AskJeeves, CMGI, NetZero, Internet Capital Group, Theglobe.com, NBCi,
    iVilliage,Akamai, VA Linux, Inktomi, Chinadotcom, Realnetworks, RedHat,
    Broadvision, and Peapod. And hundreds more.

   Priceline.com’s market value last year exceeded the total valuation of Continental,
    Delta, Northwest Airlines and United Airlines - $13.8 billion versus $12.3 billion.
    Despite its dismal financial performance, ($1.1 billion in losses on $482 million in
    revenues), investors perceived the online ticket auction firm to be worth more than
    the big airlines flying his customers. Priceline’s current market capitalization is near
    $500 million.

   Sycamore Networks is in the optical networking field. In March 2000, Sycamore’s
    outstanding stock was worth $40.1 billion, while nine of the Dow Jones Industrial
    giants including Alcoa, Boeing, Caterpillar, and United Technologies. The smallest
    of these Dow firms had revenues of $14.1 billion. Sycamore’s revenues were near
    $60 million. Sycamore’s market cap is now at $2.4 billion.

   The companies that comprise Nasdaq have lost more than $4 trillion in market
    capitalization. Consider the following analogies:

              The GNP of France in 1999 was $1.4 trillion.
              The GDP of the entire manufacturing sector in 1999 was $1.5 trillion.
              The value of all U.S municipal securities is $1.5 trillion.
              President Bush’s tax cut over the next 10 years in $1.6 trillion.
              The combined value of all 401k plans is $1.5 trillion.

   In one year, Cisco, Microsoft, Intel, Lucent and Oracle lost over $1 trillion in market
    capitalization. That’s more than what the entire market was worth in 1980.

What caused the bubble?

The Nasdaq chart above (CHART 1) is a constant reminder to everyone that we did in

fact experience a bubble. As the markets continued their rise throughout 1998 and 1999,

individual investors, day traders, and even institutions were enamored with technology

stocks.   Although many e-commerce stocks began their decline in 1999, investors

continued to dump cash into high flying larger cap issues such as Cisco, Microsoft, Sun

Microsystems, Oracle, Dell, Intel and a host of other high cap, high technology names.

Several factors contributed to this technology frenzy. They are highlighted below:

   A Fundamental Economic Revolution. The internet has opened up so many

    opportunities by changing the way consumers shop and the way companies do

    business. E-commerce and technology companies are attempting to exploit its

    vast potential by being the first. But as the historical perspective discussed later

    will indicate, first is usually not best.

   Greed and Hope. These human traits together are strong enough to overcome

    minor inconveniences such as common sense and logic. The herd mentality was

    at work here as stories of glamour and riches intoxicated everyone down to the

    smallest investor.

   Day traders. While many studies indicate that more than 75% of them lose

    money, the lure of easy money was so powerful that more kept joining in. For

    such traders, fundamentals ceased to matter, and it was only the day’s hype that


   The relatively small floating stock. This brings us back to basic economics of

    supply and demand.         Technology company executives would float a small

    percentage of the company to 1) inflate prices given the small supply of shares,

    and 2) to retain a larger part of the company and ultimately reap the rewards their

    own pockets are filled as share prices rise.

      For the more professional players, there was the lure of the internet-based “new

       economy” of perpetual low inflation, increasing productivity, and banishment of

       business cycles. In their minds this justified extraordinary stock prices and Price

       to Earnings (P/E) ratios.

      Role of Venture Capitalists. They added to the feeding frenzy, with investments

       in technology companies increasing from $3-$5 billion per year in the mid-1990’s

       to $25 billion in 1999 and near $100 billion in 2000. Having invested at high

       stock prices, their hopes of making profits were tied to a continuation of the trend.

What caused the bubble to pop?

Unlike other market bubbles, there was no one event that led to the precipitous fall in

internet and technology stocks. Certainly there were some warning signs of a bubble,

such as increases in domestic debt, corporate debt, as well as personal and corporate

bankruptcies during the boom. But the real causes of the bubble popping is a complex

issue with many forces at hand. The following factors were significant factors in the

Nasdaq slide.

The Federal Reserve raising interest rates. The degree to which the Fed’s interest rate

hikes affected the technology stock bubble is a widely debated topic. Some (including

Mr. Greenspan) indicate that it was necessary to stem fears of rising inflation. However

others believe that inflation was non-existent, and was a major cause in the technology

sector’s decline in 2000. Eric Guftason, Managing Partner of a prominent fund portfolio

indicated in a February 2001 interview on CNBC that “…..the cause of the technology

stock decline rests solely at the feet of Alan Greenspan and the Federal Reserve Board.”

One thing we know, the rate hikes certainly didn’t help the fate of technology stocks.

Secondary Offerings.      Many companies are very dependent on IPO’s to generate

excitement and attract capital. After these companies burned through the cash generated

on the IPO, investors started asking those questions like, “What did you spend the money

on last time?” and “Why should we give you more money now?” This thought process

snowballed. This was emphasized in a March 2000 article in Barrons, which indicated

that many internet companies are running out of cash at an alarming rate.

Furthermore, a large number of those secondary offerings in late 1999 and early 2000

involve insiders unloading their shares on the public. This hurt companies because

instead of the cash raised going into company coffers, it was going straight into the

pockets of the selling executive/shareholders. So the general public was left holding the

bag, and was burdened with the massive subsequent declines in values.

Competition. There was no fundamental scarcity of new business models for dot-coms

and technology companies. The result was an intensely competitive environment, where

it has been extremely difficult to make money.        There was, ultimately an inherent

contradiction in the Internet hype of 1999 and 2000. The internet was supposed to

remove all barriers to entry, encourage competition, and create a frictionless market with

unlimited access to free content. But at the same time, it was supposed to offer hugely

profitable investment opportunities. You can’t have both at the same time.

Historical Perspective & Outlook

Has such a boom and bust ever happened before? The answer is a definitive – yes –

many times. The truth is that cutting edge technologies take many unforeseen twists that

often obsolete the early industry leaders. New markets emerge out of nowhere dominated

by new companies that dwarf or knock out current industry leaders. Markets grow at an

enormous clip for which investors pay huge multiples, and then ultimately slow down.

For each industry, there are dozens of “me-too” companies that have mediocre business

plans and have little hope of long-term survival. Generally, few companies emerge from

the crash’s rubble, and market leaders frequently take advantage of the inroads made by

their predecessors (in many cases, which died in the crash).

In the 1870’s there was a 20-year railroad bubble. Tens of billions of dollars flowed in

from overseas to savvy promoters of the U.S. railroad system. But most investors lost

their shirt to these unscrupulous promoters who viewed the investors as sheep lining up to

be fleeced. But the railroads really did launch America into the industrial age, powering

the rise of steel and coal industries and the birth of factory farming. Investors were right

that some fundamental shift was happening, but it wasn’t until the hectic growth phase

was over that railroad investing became safe again.

The automobile industry had more than 500 public companies at the beginning of the 20 th

century and ultimately shook out to a mere handful. Even the most visionary people

could not have foreseen the way the automobile dramatically changed people’s lives.

In the 1920’s, radio emerged from military control after the First World War, and nobody

really knew what to do with the technology. It was initially perceived as a point-to-point

medium and thus a competitor to the telegraph. It took quite some time before people

figured out that it was best employed as a broadcast (few-to-many) medium. This led to

a scramble to build receivers and transmit content, which would permit people to

purchase them. But for a time, the only people who made money were the manufacturers

of receivers.   Nobody could work out how to profit from broadcasting itself, and

hundreds of companies “went under” in search for a viable business model that could

harness the potential of this new technology. In the end the problem was cracked and

audio broadcasting became a profitable business, which shaped the evolution of mass

culture based on national advertising. But it took a long time and there were many

casualties along the way.

The 1980’s was the advent of the PC revolution. Scores of PC companies went public,

prices soared in a great bubble that ended with the technology crash of 1983-84.

Although PC unit growth continued at more than 25%, for almost two decades, only one

participant in the original PC boom – Apple Computer survives today. Dell and Compaq

both developed after the PC bubble burst. And Microsoft, which dominates PC software,

only went public near the end of the original boom

While the entry barrier for internet companies appears to have been far lower than it was

for the PC or automobile industries, the internet bubble has similar characteristics to

bubbles of other generations. Few have yet to figure out how to make serious money

from it. The key for investors to realize is not to confuse revolutionary technology with

enormous profits.

Outlook for technology stocks

The long term for technology is bright. Given the dramatic developments in the internet

and technology, there will be more innovations and breakthroughs that no one would ever

imagine. But the short-term outlook is very questionable. The following factors continue

to weigh heavily on technology stocks:

      P/E’s are coming down, but not entirely. While reverting back to the historical

       S&P level of 15 may not be necessary, a Nasdaq P/E of roughly 35 still looks

       high, as the true winners and losers have not yet been shaken out.

      Higher Compensation Costs. Given that many of these technology stocks issued

       enormous stock options to employees that are basically underwater, companies

       will be forced to pay more in cash to retain top talent. This will ultimately be a

       drain on the already battered earnings estimates.

      Accounting Rules. Those stock options granted to employees are not considered

       compensation expense according to the Financial Accounting Standards Board.

       Thus, earnings of high tech companies (where options are most prevalent) may

       actually be inflated due to this phenomenon. It therefore lowers a stocks P/E


      Technology Spending slowdown. This can only hurt technology companies. As

       corporations “take a breather” and find ways to cut costs in a wobbly economic


      The economy. Taking a top-down approach to stocks, if indeed the country is

       headed into (or is already in) a recession, that dampens consumer confidence, and

       places consumers and business in a wait-and-see mode.

After many investors got burned with their internet and technology stocks over the past

year and a half, everyone seems to be taking a big breath and assessing the landscape

before committing. For investors it’s committing to buying technology stocks. For U.S.

corporations it’s committing to additional technology spending.             The internet

infrastructure is being built. The next phase is the figure out how to profit from its


Long term prospects for technology are quite promising. The next great surge in the

market will likely be propelled by streaming audio and video. It is likely that everything

we call radio and television will migrate to the Web’s digital platform, because it offers

far richer capabilities and far more choice. Streaming audio and video will require

broadband connections to the Web, something that roughly 6 million users have now.

But as it grows in popularity, and that number approaches 20 million, then the real fun

begins. The industry will sell more hardware, software and services in the next ten years

than what was sold in the past 20 – that means more microprocessors, audio cards, chips,

disk drives, digital radios, broadband hardware, storage software systems and fiber optic


To say that the Internet and the technology sector was a big bust is extreme. Surely, the

plummeting stock market was disconcerting, but the web continues to redesign the way

business is done. The web has impacted even the least internet dependent corporations

by flattening hierarchies and customizing products.      Their skill requirements have

changed as muscle work declined and mind work increased. Alliances and complex

supply webs have reduced vertical integration, and more market niches have been

created. Companies have been forced to innovate and operate at a faster pace than ever

before. Consider the “Old Economy” company, Federal Express. The company has

totally re-designed its business around the web. Customers can track packages 24 hours a

day to pinpoint there whereabouts. In 1998, the company declared that its physical

distribution system of trucks and airplanes was less valuable than its information

resources. This is an example of how smart companies are using the web to achieve

goals they have been striving towards for years: focusing on core competencies, reducing

transaction costs, innovating more effectively and gaining new ways to achieve customer


There are more than three million digital switches for every human being on the planet.

There are half a billion PC’s - one for every 13 human beings. They are not going away

any time soon. The internet is spreading at high speed throughout the world is also not

going away. The revolution is real, and the recent upheaval in the stock markets will be

looked back upon as a minor spike in the road of the new economy. While picking the

individual winners will be a challenge, and there may be some more short-term dust-

settling, the technology sector as a whole should be a profitable place to be for the long


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                              Bibliography (cont.)

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                             Bibliography (cont.)

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