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Euphoria vs economics

R. Srinivasan

Never before has a concept had such a spectacular rise and an equally precipitous fall in a short space of time as the dotcoms did. Dotcom companies are ones which facilitate business operations through the Internet. The genesis of these companies were the path-breaking developments of the 1990s in the fields of communication and information technology and the growth of the Internet. Business through the Internet was acclaimed as the single most revolutionary development in recent times for doing business, either business-to-customer or business-to-business. The idea was great and the modus operandi was novel except that its potential was probably grossly over-estimated.

When the dotcoms first came on the scene, they were proclaimed to be a one-stop shop for doing direct buying and selling through the Internet or for deals through general auction sites and product exchanges on the Web. Business carried on through the Internet cut out several layers in the channels of distribution and protagonists of dotcoms claimed that the adoption of such a market-rationalisation model created the real value. No wonder that investors, fund managers and venture capitalists were very impressed with the idea and fell head over heels in funding these companies. And, whether they needed them or not, every Internet company went through the IPOs to raise funds in a hurry as if ``to get going when the going was good''.

In the early stages of its evolution, it was possible for the promoter of an Internet company to obtain finance for his venture from investment bankers, merchant bankers and venture capitalists with no great effort even if:

he was a first generation entrepreneur without any pedigree;

he had no infrastructure other than a business-to-customer Web site;

he had no credible management team;

the company was ``all about content''; and

he, or any of the management had no idea of whether the company would ever be profitable at all.

The phenomenal success of the communications and information technology companies in the stock market and the unbelievable growth in their profitability had lured investors into a false sense of security. The success of companies in the IT and telecom sectors had led them to believe that the dotcoms would be, at least, just as successful. Thus, the IPOs for such dotcom companies, which were predominantly in the US capital market, were substantially over-subscribed and the shares, when they were listed on the stock exchanges, commanded dizzy valuations, having no regard to their fundamentals.

For a while, everything went right with such stocks until April 14 last year, when the great crash of dotcom shares occurred on Wall Street. It was the day on which the dotcom era ended as wave after wave of selling sent dotcom stocks of every description crashing and more than one trillion dollars in market capitalisation was wiped out in a single day's trading. In the process, even stocks of such companies as Cisco systems, Microsoft and Sun Microsystems got caught in the selling spree, shedding billions of dollars in their market capitalisation. It was as if a huge tidal wave had swept everything away in its path of destruction. Only companies such as Yahoo, Amazon and AskJeeves having a broad spectrum of business models and, still retaining adequate cash reserves, could ride out this fiasco.

Even after such a crash, many of these dotcoms kept assuring analysts and investors that, irrespective of what had happened in the stock market, there was no damage to their fundamentals, although they knew this was not true. Notwithstanding these assurances, dotcom shares have continued to decline and are currently at around 90 per cent below the levels prevailing before the market crash. For instance, Yahoo shares, which were quoting at $245 before the crash, are now trading at $12. Apart from the fact that they were treading on unfamiliar terrain, they also faced the dual problem of meeting shareholders' expectations of profits and sustaining operations with periodic infusions of cash.

Ever since the euphoria for the dotcoms had vanished, sources of raising additional finances had also dried up. The bigger companies such as Yahoo and Amazon have still been able to stay afloat with the cash generated during their IPOs, but their business models are not generating enough revenues to stay profitable. In hindsight, however, it was good thinking on their part to have raised more then their requirements of funds through IPOs, even when they did not need them then, as ``the lesson is to raise money when you don't need it as it won't be available when you do'', says the founder of a dotcom.

Yahoo, for ever the Internet bellweather and, almost a household name now, has actually reported declining earnings in the third quarter of the current year -- a drop of 44 per cent from a year earlier. The company expects only to break even in the fourth quarter as a steep fall in revenue from advertising and related services will be severely impacting the company's ability to generate revenues.

Dotcoms have all along been too heavily dependent on revenues from online advertising and, with the drying up of this avenue and with no major plans for offering other premium services, such companies are on a typical do or die situation. Advertising on the Web is not generally considered effective because of the limited size of the audience it can reach.

Employees of dotcoms are the worst hit by their companies' stocks nosediving in the market. Stock options given to employees at a strike price set when the market was riding high are now literally worthless with the market prices having plunged below these strike prices. Companies are now finding it difficult to retain staff due to the drop in stock prices coupled with their inability to pay good cash salaries.

With share prices of these companies at ridiculously low levels, a degree of consolidation could take place in this sector as a takeover or a merger is more easily affordable now than it was before the dotcom crash when prices were at astronomical levels. Apart from this, for a long-term recovery of these companies to occur, they would have to re-define their objectives coupled with more realistic business models.

Recovery and sustainability of the dotcom companies would, also, depend on a substantial expansion in the country's band-width capacity that would, in turn, lead to an increase in the Internet-user base, especially in the light of the volumes of business-to-customer operations envisaged by them. The security aspects affecting settlements of Internet transactions through the medium of credit cards and bank account details will also have an important bearing on their sustainability.

Even as investors return to value investing by going back to the old economy stocks that they had once shunned, all is not yet lost for the new economy, especially now as the markets have been chastened by the pounding during the past eighteen months. The crash of April 14 marked a fork in the road of the new economy: the high road is the digital revolution; the low road is the dotcom. ``Digital technology has its underlying flexibility, fundamentals and the capacity for doubling of storage of bits every twelve months and of communications capacity for fibre optics every six months.''

This technology could change the hospitality business, the telephone business, the healthcare business or, for that matter, myriad other business categories in the blink of an eye. And, as for the dotcoms, the honeymoon is over and their existence will be governed only by the laws of supply and demand, operating with a vengeance. Unless they show sustained growth in profitability, it can safely be assumed that the dotcom crash of April 14 last year marked the beginning of the end of e-business as a separate viable entity.