WRONG! REAR ECHELON REVELATIONS State of the Web: How the Dot-Com Mania Began -- and How It Could All End By James J. Cramer
Almost a year ago the dot-com craziness began when theglobe.com (TGLO:Nasdaq) came public. Before theglobe.com's offering, the idea of a company without a powerful brand or revenue getting public money just seemed far-fetched.
The capital markets, regardless of their temporary moments of insanity, usually serve as an alternative to the debt markets or to bank loans. They each have a discipline of their own. The banks and the debt markets want to know that they can get repaid. The stock market wants to know, or at least initially wanted to know, whether there would be a dividend streak, or at least the possibility of profitability down the road.
The equity markets are supposed to be willing to wait longer for profitability than the banks or the debtholders, who tend to be more cautious and conservative.
The equity markets were never believers in fantasy. Concepts, yes. Restaurants with rainforests in them, biotech companies with one potential product, even dubious black-box roll-ups, where acquiring mom-and-pop outfits with equity was the mantra, could get the occasional funding. But usually there was some rigor to the process.
A couple of trends worth discerning here, however, make the inevitability of the craziness that much more likely when you think about it.
Nothing is more powerful to anyone -- venture capitalists, mutual fund managers, individuals, investment clubs, whatever -- than to be the next Microsoft (MSFT:Nasdaq). Bill Gates has made more money for his partners than anybody who has ever lived. The storybook rise of that stock, against many doubters -- and there have been doubters at every point in the road -- changed people's minds about the risks and rewards of equities. The idea that you could have one great stock, Microsoft, that could make up for all of the dogs in a portfolio changed the equation dramatically. A big winner was all that mattered.
If there had been only one Microsoft, the drive to find the next one would be chimerical. It turns out, though, that there have been dozens of them, from Cisco (CSCO:Nasdaq) to Sun (SUNW:Nasdaq) to Gateway (GTW:NYSE). We all have our winners.
Now, Microsoft took the time it takes for an oak tree to grow strong to make you millions of dollars. What nobody counted on was that you could take time-lapse photography and make that money much faster in three stocks: Amazon (AMZN:Nasdaq), Yahoo! (YHOO:Nasdaq) and America Online (AOL:NYSE) (the Big Three).
When we look back at this era, we are going to note that these three companies destroyed the equity market's discipline. Greenspan really goofed the other day when he talked about risk premium in front of a bunch of faceless, uninventive bank examiners. They are just as risk averse as ever. He should have been speaking to some sort of equity group, like an All-Tech convention, or maybe one of those daytrading seminars by Harvey Houtkin. Or maybe to a conference of Janus and Alger managers or other growth funds. That would have made more sense. It's not the bankers that are causing the trouble. They aren't funding inflation. It's the seekers of the next Big Three that are.
The Hunt for Pay Dirt
One Big Three can make up for a whole lot of mayhem. That's what the equity market discovered when theglobe.com came public. This deal was supposed to fail. But it succeeded spectacularly within the matrix of what makes for a win in equities: how much the stock pops when it goes public. People wanted in. And when the stock opened up huge, people wanted the next one, and the next one, and the next one, and so on.
Of course, not all stocks have the potential of the Big Three. But a couple of acquisitions along the way, notably Hotmail by Microsoft and GeoCities by Yahoo!, made it so that even if you did not hit pay dirt with your initial play, you might later on.
Let's look at both of those. Because AOL seemed to have such a lead on Microsoft, and because Gates is an extremely competitive guy, he was willing to pay anything to get some email business. He reasoned, correctly, that email is how people start their online fascination. So Microsoft paid $400 million for Hotmail. Until Hotmail got a bid, I had no idea how it would be able to stay in business. It had no way of monetizing those names. Here, and this is the key takeaway point, YOU COULD NOT TAKE THAT LIST OF NAMES TO THE BANK AND GET A LOAN ON THEM. The bank would laugh you out of the room the way Potter laughed George Bailey out of his office in It's a Wonderful Life.
But the good people from Hotmail could sell out to someone who needed that list. Some outfit that had to compete with AOL. As long as the bull market continues, Microsoft's currency is, in many ways, better than the one you get from the ATM machine. You do nothing; it goes up!
Same with GeoCities. Man, was I skeptical about that stock, even though my good friend and business partner Jerry Colonna, from Flatiron Partners, was on the board. I remember reading in Barron's about how some tech guru money man was going to short GeoCities until the cows come home. Who was I, a generalist, to disagree?
But the good people from GeoCities could sell out to someone who needed that community. And another home run got hit.
Falling From the Nest
So now, let's look again at theglobe.com, which came public and immediately skyrocketed to some astronomical level before crashing back to earth. Maybe TGLO could be like Hotmail. Theglobe.com looked a lot like GeoCities. Why not invest in it?
I am picking on theglobe.com because, in retrospect, maybe it should not even have been public yet. It was far from making a profit -- usually there has to be some visibility about such things as profit -- and it didn't have exploding revenue yet. It simply had a plan for exploding revenue.
But the venture capitalists, who are as greedy as the next guys, realized that they could come to the public equity markets ahead of schedule with their next dot-coms after theglobe.com's ensuing progeny worked as well as it did.
Throughout the big venture capital firms, a thought began to take hold: The public markets aren't as rigorous as they used to be. Let's talk about birds. A venture capitalist is like a mother robin with babies in the nest. The mother doesn't want to have them hanging around any longer than they have to. The nurturing thing is a huge drag. It is time-consuming and taxing. The moment those babies should be able to fly -- whether they can or not -- they get the push. The ones that don't make it -- well, that's tough.
TGLO and its spawn made the venture capitalists change the nurturing cycle. It was as if all of the robins discovered that you could kick the baby birds out much earlier and they would be able to live off the public markets even before they learned how to fly. Suddenly there were baby birds falling out of nests everywhere you could look.
Because of the curious nature of the dot-com world, companies that should not have been able to make it at all on their own, in the real world, companies that were awfully hungry for cash, to belabor the metaphor, suddenly found themselves flush with more food than they needed. That allowed them to brand. If done correctly, that gave them more of an ability to be valuable to some dot-com that wanted to acquire more brands than they had. As long as the capital markets continued to believe in the dot-coms, no one minded taking dot-com stock for dot-com stock. They still don't.
So what's the matter with this process? Ah hah, what happened to theglobe.com this week? It preannounced that it could not make the revenue projections it had set for itself. Less than a year after it came public, it had to lower expectations.
Now, think back. The public market was willing to invest in the rapid revenue thesis in lieu of the profit thesis. But the public market doesn't like the nonrapid revenue thesis. That's what TGLO just became. Lately, also the public markets don't like those companies that don't have a handle on expenses. Either rapid revenues and okay expenses, or good revenues and terrific tightness on the expense side, can justify some of these pricings. But you have to have one of those combinations. If you don't, the market will lose interest.
In other words, the public market is beginning to wise up. And it couldn't happen at a worst time for all of those fledglings on the ground still eating from the public trough. Many of these companies didn't raise a lot of money when they came public. For example, I was looking at one of TheStreet.com's (TSCM:Nasdaq) competitors the other day and I marveled how it had burned through a huge pile of cash in a very short time. That's what tends to happen, by the way, when you are branding without a revenue stream. The cash does run out.
The Fed Steps In
When the existing dot-coms run out of money, they will be no more bankable to the debt markets or the banks than they were when they came public. They won't have the venture markets to turn back to. They, in fact, will have no one to turn to. They will have to sell themselves. And you don't make much money selling when you are out of money, as the acquirers know how to read balance sheets, too.
Compounding the potential nightmare that is developing in the dot-com world is that the Fed, which initially just viewed this process as a lottery experience, has now chosen to get vigilant about the stock market. What a shame this is. If Greenspan wanted to stop the inflation of the market, he would do much better to go in and sell a massive number of DOT calls! That would be more effective. He needs to knock down that index. He needs to create a run on Munder NetNet. He needs to take down bushels full of Net stocks and then blast out of them sloppily and badly.
I would have hoped he would let the market run their course. The action in TGLO this week tells me that the disappointments are about to begin. When they occur, the spigot will shut quickly and Greenspan's job will be done for him. Instead he is hastening it. I guess he is just impatient and can't wait any longer.
Ironically, for me personally, I am grateful as a shareholder of TheStreet.com even as I am downcast as a shareholder of Cramer Berkowitz. If the door was closing to the public markets anyway because companies are going to begin to disappoint en masse, we don't need Greenspan out there with a nail gun slamming it shut. If TSCM is to win, it doesn't need any deep-pocketed competitors launching now in its space. But as someone who has been good at evaluating these dot-coms from the hedge fund side, I say the more the merrier.
Let's see if TGLO is the exception, or the rule. If it is the exception, I may be wrong. But I am not betting that way.
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James J. Cramer is manager of a hedge fund and co-founder of TheStreet.com. At time of publication, his fund was long America Online, Gateway, Sun Microsystems, Microsoft and Yahoo!, and Cramer was long TheStreet.com. His fund often buys and sells securities that are the subject of his columns, both before and after the columns are published, and the positions that his fund takes may change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Cramer's writings provide insights into the dynamics of money management and are not a solicitation for transactions.