Warning: Dot-Com Companies Are Burning Up

Blockbuster IPOs, internet mania and fraud. How the Dot-Com bubble unfolded.

New York, November 13, 1998

A small internet startup founded by two Cornell dropouts is about to go public at $9 per share. It’s 9.30am, the market opens, but the ticker for theGlobe.com doesn’t show a price. Millions of retail investors are frantically punching “Buy at Market” into their computers. The initial 3.1 million shares offered are swamped by an avalanche of buy orders, overwhelming market-makers who are trying to price the stock. Every few minutes, the estimated opening quote is adjusted. “Indications at $30!” shouts a trader. Thirty minutes later: “Indications at $50!” Traders are sweating, shouting into their phones, working furiously to find the equilibrium point where supply finally meets demand.

The clock ticks to 11am, and TGLO opens at $87. A collective gasp echoes across trading floors. For the next five hours, the stock’s price oscillates violently. By the closing bell, theGlobe.com settles at $63 and is one of the most heavily traded stocks on the Nasdaq. It’s a shocking, almost surreal, result for a company that just a day earlier was about to run out of cash, and whose business barely generated any revenues. But for as surprising as it may be, this story is not unique. Earlier that year the same script played out again and again: Inktomi, Broadcast.com, and eBay, to name a few.

The mania started three years earlier when Netscape, the maker of the most popular web browser, listed on the Nasdaq. It was still in its infancy and never made a profit, but quickly reached a $3 billion valuation as investors poured money into the dazzling wonders of the internet. And it was, by any measure, a genuine revolution. All of a sudden, ordinary people could read the news from other countries in real time, or look up a fact without going to a library, and many more things that previously required time, money and often also a middleman. But it was not what the internet could already do that captured people’s imagination. It was what it could do, and soon.

The wave of IPOs that followed was met by a new breed of hungry, greedy investors. With the arrival of online trading, anyone could open an account with E*Trade or Ameritrade and buy and sell newly issued stocks from home. Ordinary people and institutional real money accounts were glued to their screens watching their investments go up in value. CNBC just introduced a live all-day reporting from the New York Stock Exchange, and many retail investors started avidly following it from home. It became a self-fulfilling loop: as a stock rose, the channel reported on it, which in turn created even more demand. Companies which added dot-com to their title soared as speculators rushed to buy. And every rising company sent a signal to banks, analysts and venture capital that the market was hungry for more.

David Simons, a junior equity analyst at a mid-sized investment bank on Park Avenue, spent weeks valuing Value America. The company sold everything from electronics to furniture online, but had no meaningful revenue and no idea how to scale its business. David used different valuation methods, but none of them produced a number that would justify the company’s $2.4 billion valuation. So he walked into the office of his managing director, Greg Feller, laying in front of him a pile of papers with his calculations.

“The company is a pile of rubbish. I can’t issue a positive investment recommendation”, said David. Feller looked at the calculations for a moment, then slowly leaned back in his chair. He brought up Henry Blodget, the star analyst who put a $400 price target on Amazon when it was trading at $240. Three weeks later, the stock hit the target and Merril Lynch hired him for a $12 million pay check. When David tried to protest that Amazon’s lack of profits didn’t justify its share price, Feller abruptly cut him off. “This department runs on the fees investment banking generates” he said, adding that a negative recommendation meant fewer IPO mandates and less revenue for their bank.

He stood up and waited for David to reach the door before continuing, “Write the note, David. Say that it’s a buy, and find a price target that works”. David did as he was told, joining the many other analysts who found themselves in the same position.

In this environment, by March 2000 the Nasdaq had risen nearly sevenfold in five years. But the music was about to stop.

On the morning of March 20^th, traders returned to their desks after the weekend, fired up their screens, and read through the news. A market maker at a large bank picked up the latest issue of Barron’s, whose cover read: ‘Burning Up; Warning: Internet companies are running out of cash—fast.’ He glanced over it, casually at first, then his eyes stopped at a company he had in his book. Cash remaining: 4 months. He choked, coughing hot coffee onto his crisp white shirt. More people read through the magazine, and suddenly all came to the same realization: the equity market was a house of cards waiting to crumble. A silent, icy panic rippled through the financial system.

The next day, the Fed raised rates for the fifth time in nine months, while a federal judge found Microsoft guilty of operating an illegal monopoly. Any remaining optimism evaporated instantly, and the Nasdaq tumbled 35% in three weeks. Many investors, including a prominent hedge fund in Connecticut, bought more at the lows, convinced the market had overreacted. And why wouldn’t they? For half a decade, every market dip had been bought, sending stocks to new highs. This time, though, there was no bounce. A brutal wave of liquidations hit the market, dragging into the ground companies like Pets.com just nine months after its IPO.

Retail traders at home watched their portfolios fall back through the level at which they had started. But they didn’t sell. The CNBC presenters were still describing the losses as temporary, still bringing on fund managers who talked about long-term value and the fundamentals of the internet revolution, which remained, they said, intact. Many ordinary people as well as professional fund managers held on through the 2001 recession, and through 9/11.

Then, on December 2, 2001 trust in the American financial system collapsed. In Houston, Texas, the headquarters of the world’s most powerful energy trader looked like a crime scene. Security guards stood by the lobby as federal investigators carried boxes full of documents and traders were escorted out of the premises. On Wall Street, news quickly spread that Enron filed for bankruptcy after manipulating its financial statements. Traders, investors and regulators, all stared at their screens in disbelief. If Enron’s books were all a lie, whose books could they trust?

An institutional fund manager slammed his fists onto the keyboard, shattering it. Then he rang Citi’s equity trader: “Sell, sell all our positions at market”, he said in a resigned tone. In complete and utter disbelief, the same investors that had endured the pain of watching their investments bleed month after month began to surrender.

Across the country, ordinary people logged into their online brokerage accounts, and stared at ruined retirements, canceled college funds, and erased life savings. On the screens, the Nasdaq sliced through all support levels, like a hot knife through butter. By October 2002, the Nasdaq bottomed out 80% lower from its peak. The magnitude was such that it would take the index almost 16 years to reach its previous highs.

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