System Crashing

Buying Wired magazine may align you with the digerati, but buying its stock might sink you into poverty

Wired Ventures may set the agenda for cyberculture, but its public offering could make it part of a pack that Louis Rossetto and Jane Metcalfe want no part of: the bellwether of a market crash.

"Many of these unproven companies have higher valuations than institutions you've been buying products from all your life," says Roger Smith, founder of Silicon Valley Bank, a well-known sugar daddy for high-tech start-ups. "When these young companies collapse, a lot of people will get screwed."

A record-breaking amount of money from institutional investors such as pension funds is flowing into venture capital firms. The VCs, in turn, hunt for companies to back. With the stock market booming, retail investors are looking to score as well. When they see the astronomical returns flowing from public offerings -- the "new products division" of the market -- scads of armchair Donald Trumps are throwing their money at the IPO flavor of the week. It's a case of too much money chasing too few deals, and many companies are going public as early as possible to reap the financial rewards. Through April of this year, 85 public offerings raised $4.3 billion. Last year, 203 venture-backed IPOs rang up $8.2 billion. That compares with 1990, when just 42 IPOs raised a paltry $1.2 billion.

"There's no doubt that we are in an explosion of Internet-related and data communication IPOs," says Jim Breyer of Accel Partners, a San Francisco venture capital firm. "By any historical measure, more companies are going public at an earlier stage than they ever have before."

Public offerings have always been chancy endeavors, but they are even riskier these days. An unwritten rule once held that a company needed a product, revenues, or -- believe it or not -- profits before testing the public waters. At the very least, a business needed to avoid losing large amounts of cash. Those days are gone. Netscape made its huge public offering, which pushed its value to $6.7 billion, based on $9.4 million in losses. Yahoo! racked up a $765 million valuation on no revenues at all. Although they are very different forms of financing, IPOs could be described as a kinder, gentler, '90s version of junk bonds. And just like junk bonds, IPOs could spur a stock market swoon similar to the nose dive that occurred in the '80s.

"They're not quite as bad as junk bonds, but the danger of all these high-tech IPOs is substantial," says Stanford's Connie Bagley. "My fear is that when a lot of these IPOs begin to fail -- and many will fail -- investors could lose confidence in the market as a whole and start saying, 'Oh my God, stocks are really, really risky; stocks are dangerous; let's dump stocks.' "

Optimists who blissfully ignore the inevitability of a high-tech dip simply haven't done their homework. "Historically, a lot of different emerging technologies have had periods of very rapid growth followed by a shakeout," says Josh Lerner, an assistant professor at the Harvard Business School. "It happened with the automobile industry in the 1910s right up through biotechnology in the 1980s."

At any other time, the failure of several companies in a single sector wouldn't be enough to put the entire market in a tailspin. But today's investors are especially skittish. They know the bull market can't last forever, and they're itching for a sign that it's over. A downturn in the high-tech sector could be perceived as an omen that the long-awaited correction in the market has arrived; Paul Revere announcing the bear market is coming.

"It's not far-fetched at all to expect that a significant downturn in a sector as broad as technology would pull the entire market with it," cautions Accel Partners' Breyer. "And there will be a shakeout in the technology sector. Nineteen ninety-five was an exceptional year, but there aren't going to be many more like it. These are the good old days."

Many stock prices of high-profile Internet companies that recently went public have already sunk below the jacked-up levels achieved in the buying frenzy surrounding their IPOs. Yahoo! has dropped by one-third in the last month alone. Netscape stock has sunk by 20 percent from its top price. Investors who got schooled on the altitude drops of those high fliers may have learned their lesson.

In that case, Wired's loss could be the public's gain.

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