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<nettime> How the Internet Bubble Broke Records, Rules, Bank Accounts

               [The Wall Street Journal Interactive Edition]
                               July 14, 2000

How the Internet Bubble Broke Records, Rules, Bank Accounts

By Wall Street Journal Reporters Greg Ip, Susan Pulliam, Scott Thurm, and
Ruth Simon

"The world has gone mad."

The thought flashed in the mind of Internet analyst Lise Buyer one morning
in November 1998, as she and colleagues at Credit Suisse First Boston
stared at a stock-quote machine. They were, Ms. Buyer recalls, agog at the
trajectory of the initial public offering of, a collection of
community Web sites. had puny revenues and heavy losses. CSFB
bankers didn't think the company was ready to go public. Yet's stock, offered at $9 a share, instantly soared to $97,
briefly giving the company a market value of nearly $1 billion. 

Crazy -- but there was a message to the madness. CSFB soon scrapped some
of the rules it had used to gauge whether a company was ready for the big
time, and took public no-profit Internet plays Audible Inc.,
Inc., CareerBuilder Inc. and others arguably just as slight as ever was. Today, Audible trades at 54% below its offering
price, Autoweb is down 69% and CareerBuilder is off 86%.
closed Thursday at $1.8125, or $3.625 before a split.
declines to comment on its IPO but asserts that the company is "committed
to achieving profitability."  Its underwriter, Bear Stearns & Co., very
much believed in at the time, a spokesman says, noting that
it traded above its offering price for months. 

The Great Internet Bubble may be starting to fade from many memories, but
the fallout blankets the landscape. This craze, after all, ranks among
history's biggest bubbles. Investment bankers, venture capitalists,
research analysts and investors big and small, through cynicism or
suspension of disbelief, financed and took public countless companies that
had barely a prayer of prospering. Rarely have so many people willingly
put prudence on hold to enter a game most were sure couldn't last. "We all
knew we were going to get a big kahuna correction at some point," says Jay
Tracey, former manager of the Oppenheimer Enterprise Fund. 

Murky Realms

While the Nasdaq Composite Index has clawed back half of its 37% plunge
between March 10 and May 23, Internet stocks as a group, valued at $1.4
trillion at their March peak, have lost 40% of that -- erasing almost as
much paper wealth as the 1987 crash. Even former stalwarts like
Inc. trade at a third of last winter's highs. Though investors are slowly
warming again to Internet IPOs, almost half of existing Internet companies
now trade below their IPO price. 

[Diary of a Bubble]

The question is: What brought on the mania? Some answers lie in the murky
realms of mob psychology, the human capacity for denial, the
get-rich-quick mentality -- factors in speculative frenzies since the days
of the tulip.  But to an unusual degree, the Internet bubble was a product
of basic avarice and tactics that smacked of the boiler room. From Wall
Street pro to fledgling day trader, all joined hands in a giddy game of
lowering standards, pushing out IPOs and trumpeting prospects, with little
regard for a company's true long-term -- that is to say, more than three
months' -- outlook. 

"People were throwing money at businesses that wouldn't pass simple
due-diligence screens five years ago," says venture capitalist Jim Breyer
of Accel Partners. "People overlooked almost all business fundamentals and
drove valuations into the stratosphere." 

Drenched in Warnings

Many investors have made good money, but many got clobbered. And the pros? 
They made billions, and most of them wound up winners even after the
bubble burst. 

People were certainly warned. Every IPO prospectus was drenched in
warnings and risk factors, but most investors breezed past them. When the
hype crossed the line into manipulation or other wrongdoing, the
Securities and Exchange Commission usually stepped in. But most of the
time, regulators could only stand by and warn investors about the risks of
playing a completely legal game. 

There is no denying the enormous business opportunity or the huge changes
represented by the Internet and information technology. Some of the
companies that emerged from the Internet upheaval will almost certainly
mature into enduring, valuable enterprises, as the rebound in a handful of
Internet leaders in recent weeks seems to bear out. Yet with the true
potential came some truly cynical actions driven by a willingness to see
what the market would bear and the investor buy -- i.e., a bubble. 

Here's how some of the pivotal players stoked one of the hottest
stock-market crazes in history. 

These have been heady times for investment bankers. Just since's IPO -- an event many cite as a line of demarcation between
raging bullishness and outright bubble -- Goldman Sachs Group Inc., Morgan
Stanley Dean Witter & Co. and Credit Suisse Group's Credit Suisse First
Boston each pocketed more than $500 million in IPO or secondary offering
underwriting fees, according to Thomson Financial Securities Data. It was
the most lucrative hot streak investment bankers have ever seen in a
single sector. 

It wouldn't have happened if bankers hadn't changed their rules. For
instance, way back at the beginning of 1999, CSFB had a rule of thumb that
a company needed at least $10 million in revenue in the 12 months before
its IPO. (Profits were no longer critical; Netscape Communications and, two early IPO meteors, had proved that.) 

Flying over Thailand on his way to meet a client in January 1999, CSFB
Internet analyst Bill Burnham piped into a regular Monday morning
teleconference during which a spirited debate had emerged over whether the
rule should be canned. The bank was losing clients -- and fees -- to
competitors. "Everyone realized the entire market was doing deals like
this," Mr. Burnham, now a venture capitalist, recalls. "Companies we had
relationships with but didn't have any intention of taking public anytime
soon announced, 'Hey, if can go public, we can.' " 

No formal decision on relaxing the guideline was taken at the time, but
soon CSFB's bankers concluded that if they really liked a company, they
could take it public with $10 million in annualized revenues -- in other
words, just $2.5 million in the previous quarter, regardless of revenue in
earlier periods. "It was emblematic to me of the competitive devaluation
of underwriting standards that went on and reached a crescendo in the
first quarter of this year," Mr. Burnham says. 

One company that wouldn't have fit CSFB's old standard was CareerBuilder,
an online recruitment firm. Before CareerBuilder's IPO in May 1999, its
prior 12 months' revenue was just $8.8 million. But revenue in its last
quarter was $2.8 million, or $11.2 million annualized. After CSFB took
CareerBuilder public at $13, it traded as high as $20 but has since fallen
to $4.0625. 

Bill Brady, CSFB's head of global corporate finance for technology, says
CareerBuilder remains a great company that is meeting expectations. He
says he doesn't regret any of the deals CSFB has done in the past 18
months.  Some, like Commerce One Inc., didn't fit the old standard either,
but were successes. Still, he acknowledges that he thought that the prices
many stocks hit after their IPOs were irrational, even as CSFB brought
similar companies to market. 

Other investment banks were priming the IPO machine, of course. Alan
Naumann, chief executive of Calico Commerce Inc., says that for nine
months before the business-to-business e-commerce software company went
public last October, he had 15 different investment banks courting him
with regular phone calls. 

"The pitch to Calico was, 'Other companies are going public with smaller
revenues and fewer customers -- we think you're ready. You've got $2
million in sales, go for it,' " he recalls. Calico held off and eventually
picked Goldman Sachs as its lead underwriter. It went public at $14, shot
above $62 on the first day, but have since slid back to $17.375 a share. 

Mike Yiu, a software developer in Los Angeles, paid an average of about
$58 a share for 1,100 shares of Calico between late October and early
January.  Mr. Yiu sold about 900 of his shares in April at about $19 a
share and the remaining 200 last month at about $16 a share, for a total
loss of more than $43,000. The timing of Calico's IPO was "perfect," Mr.
Yiu observes.  But "we got burned." 

The stock price notwithstanding, Mr. Naumann says Calico's business
remains on track. Its revenue grew 66% to $35.6 million in the fiscal year
ended March 31 -- but its loss widened by 82%, to $27.8 million. 

Goldman's Brad Koenig, head of the firm's technology investment banking,
says Goldman had good reason to believe early-stage companies could be
winners. He points to the debate preceding an early Internet IPO in April
1996. "There were a certain number of people who were highly skeptical of
this company named Yahoo! with its yellow-and-purple logos," he says. Even
with the recent 51% decline in its price from early January, Yahoo! Inc.
is up more than 100-fold since its IPO. 

The risks Goldman took on Yahoo went from being the exception to the norm. 
In 1997, of the 24 domestic companies Goldman took public for which data
are available, a third were losing money at the time. Of the 18 it took
public this year through mid-April, 80% lose money. A Goldman spokeswoman
says this trend reflects the growing number of IPOs of Internet companies,
which typically are unprofitable. 

Some were companies that its arch-competitor, Morgan Stanley Dean Witter
Inc., had decided were too speculative to underwrite. Mary Meeker,
Morgan's star Internet analyst, says the firm passed on taking the Inc., the Internet financial-news site, public because it
wasn't ready. (An official at says Goldman was its first
choice.) After Goldman took it public in May 1999 at $19 a share, shot above $70 on its first day, but has since slumped to

Goldman officials deny that their standards slipped, and contend that the
firm also passed on deals that rivals chose to underwrite. Mr. Koenig adds
that the criticism of underwriters is off-target. If an Internet start-up
with losses exceeding revenue "goes public and goes to a $22 billion
valuation, whose fault is that? It's a tough philosophical argument. ...
Is it an underwriter's responsibility to determine whether the market is
overvalued or undervalued? Investment bankers wouldn't be making a good
living if that was required." 

The bankers got help in feeding the furnace from a new breed of mostly
young securities analysts who presented themselves as pathfinders in the
uncharted terrain of the Internet. 

The best-known is Henry Blodget, famous for forecasting in December 1998
that would hit $400 a share. At the time, was
trading at $240; within four weeks it blew past $400 on its way to a high
of more than $600. Mr. Blodget was celebrated as a seer and left his job
at CIBC Oppenheimer for Merrill Lynch & Co. It closed at a
split-adjusted $35 Thursday, equivalent to $210 at the time of Mr.
Blodget's big call.

Mr. Blodget, 34, has regularly predicted that 75% or more of Internet
companies will fail, and he stands by his general belief that
and many of his other picks will be winners over the long haul. Mr.
Blodget adds, "If AOL, Yahoo, Amazon, eBay, a few others we recommend as
core holdings, go down 70% and stay there for four years, I will have been
wrong. No argument. But a 50% pullback is still in the line of how this
industry performs." 

Still, to critics, Mr. Blodget epitomizes the change in the analyst's role
during the overheated market in tech stocks: more cheerleader than
detached observer. And the buzz -- and career opportunities -- that Mr.
Blodget did draw may have encouraged other analysts to make similarly
adventurous forecasts, the critics add. 

Despite Mr. Blodget's 75% caveat, his recommendations on individual
stocks, like those of many Internet analysts, got more bullish even as
they led the Nasdaq Composite Index to ever-more-dizzying heights. Today,
he rates 12 of the 27 stocks that he follows as "buy" (the rest are
"accumulate"), compared with just one buy rating for the 10 stocks he
followed a year ago, says Bob Kim, a former Merrill Lynch supervisory
analyst whose Web site,, monitors Merrill technology research. 

Consider Inc., which Merrill took public at $11 in February. It
slid to $6.125 in a month, when Mr. Blodget initiated coverage with a
prediction that it would soar to $16 a share, or 160%, in 12 to 18 months. 
A major justification: Despite the pet-supply seller's continuing losses,
he noted that it was trading at five times this year's estimated revenue,
a discount to at eight times revenue. Since Mr. Blodget's
prediction, has been a dog, falling 70% to $1.8125. 

"Out of one side of his mouth, the message of caution," says Mr. Kim, "the
other side, buy the leaders." He describes the Blodget message as: "The
risk isn't losing 100% of your investment now, it's giving up 10-times
gains in the future." But, says Mr. Kim, "it seems that so far, little of
that has panned out except for the downside part." 

As lucrative as the bubble has been for investment bankers and analysts,
their profits pale compared with the money venture capitalists and other
early-stage investors have made. The journey of eToys Inc. shows why. 

The online retailer went public on May 20, 1999, at $20 a share, and
soared to $76.5625 on its first day of trading. On Oct. 11, it closed at a
high of $84.25 -- and has since plunged 93%, closing Thursday at $5.625 a

A disaster for eToys' early-stage investors such as idealab, an Internet
incubator that invests in and nurtures start-ups? Not exactly. Idealab
paid just half a cent a share -- a total of $100,000 -- for its eToys
stake in June 1997. In late 1999, idealab sold more than 3.8 million
shares at prices between $47.50 and $69.58, for a profit of $193 million.
It still holds a further 14.5 million shares, so idealab has seen its
paper profits dwindle. But even idealab's remaining stake in eToys is
still worth roughly 1,000 times what idealab paid for it, while anyone who
bought at the IPO price is down 72%. (Idealab, which itself is trying to
go public, declined to comment, citing its quiet period.) 

And plenty of investors fared worse than that. On Dec. 2, Daniel Sperling,
a 35-year-old technology consultant in the Detroit area, bought 200 shares
of eToys at $70. "Our goal was to ride the tidal wave of Christmas
shopping and get out," Mr. Sperling says. But in early December, it became
clear that big Internet sales weren't materializing, and eToys skidded.
Mr.  Sperling bought more: A hundred shares at $58.50 on Dec. 6. A hundred
more at $47.50 on Dec. 14. A hundred more at about $20 in January. Today,
his $26,600 investment in eToys is worth $2,800, a paper loss of $23,800. 

Some venture capitalists' profits were truly astounding. Benchmark
Capital's $5 million early stage investment in eBay Inc. grew to $4.2
billion by the time Benchmark distributed the shares to its investors late
last year and early this year. If Benchmark's partners kept a typical 25%
to 30% of the firm's investment profits, five of its partners would have
split more than $1 billion when cashing in eBay stock. 

Venture capitalists say they deserve big rewards because they take big
risks. Many investments go bust. During the early stages of the Internet
frenzy, however, it appeared that venture capitalists couldn't lose. They
threw more money in earlier stages at start-ups than ever before. Often,
they pushed the companies to go public as quickly as possible, to cash in
on their investments faster than ever. 

Even some who benefited from the feeding frenzy agree. "You could invest
in a company, take it public and cash out before you proved your business
model," says Michael Barach, a former venture capitalist who is now chief
executive of, an online health-products seller. received its first venture-capital investment in June
1998 and went public last December. 

The Internet craze set off an "Oklahoma land rush," says Roger McNamee,
general partner at Integral Capital Partners in Menlo Park, Calif., which
manages both private and public investments. "In a land rush, you suspend
rules because your perception is that time is of the essence." 

All told, venture capital invested in start-ups jumped to $36.5 billion
last year from $14.3 billion in 1998, according to San Francisco market
researcher VentureOne Corp. The number of deals increased to 2,969 from

Mr. Barach of attests to the craziness. Two investors
gave him $10 million apiece after hearing him give a speech at an
investment conference. Investment bankers told him they could take his
company public when it reached $750,000 a month -- an annualized $9
million -- in revenue, and they did. "No one ever mentioned or talked
about how much money we'd lose in 2000 to get to that revenue," he says.
The company, which Bear Stearns took public, reported a loss of $59
million last year on sales of $5.8 million. Its stock trades at 81.25
cents, down 94% from its IPO price of $13. 

IPOs can't soar without big buyers -- and mutual funds are among the

As tech stocks roared, mutual-fund managers faced powerful incentives to
ride the rocket, trying to boost their funds' returns -- which can mean
higher compensation for fund managers. Their voracious appetite for tech
shares expanded the bubble. 

Between Nov. 1, 1998, and last March 31, investors poured almost $72.5
billion into technology and small-cap-growth mutual funds, according to
Financial Research Corp., a Boston-based financial-consulting firm. It
says that about $11.4 billion of that total flowed into funds specializing
narrowly in the Internet. Six of the 14 Internet-only mutual funds tracked
by Lipper Inc. had gains of 100% or more last year. 

Sometimes the tactics driving the action in mutual funds have raised
questions. When business-to-business Internet player Ariba Inc. went
public at $23 (pre-split) share last June, it shot to a first-day high of
more than $90, thanks to people like Gary Tanaka, a founding partner of
Amerindo, a growth-oriented mutual-fund group. 

On most IPOs, Mr. Tanaka would get 50,000 to 70,000 shares. On Ariba, he
got 100,000, in part because he informed underwriter Morgan Stanley that
he would buy an additional 100,000 in the after-market once the company
went public. His agreement to buy shares in the after-market "probably
helped boost us to the top bracket for allocations," he says. Internet IPO
allocations helped juice returns of Amerindo funds; its Technology Fund,
for instance, posted a 249% gain in 1999. After-market orders also
contributed to a big first-day run-up in the stock price -- more than ever
the mark of a successful IPO. 

Some market experts say agreements to buy stock -- and thus support the
price-in the after-market raise regulatory questions depending on how
explicit the arrangement is. Mr. Tanaka says he believes his arrangements
are both appropriate and a natural result of his firm's role as "long term
investors. If we are buying one million shares, we feel we should get a
better allocation." Mark Hantho, managing director of equity capital
markets at Morgan Stanley, says the firm doesn't use after-market bids to
allocate IPOs, although "it's common to hear feedback as to how investors
value the company, ... and we listen carefully to that." 

Funds' appetite for IPOs also supercharged the market in another way. "On
a hot deal, everyone would put in for 10% and the bankers could tell how
hot a deal was by the number of guys who were circling 10% on the deal,"
Mr.  Tanaka says. None of the institutions really expected to receive a
full 10% allocation of a red-hot IPO, many of which involved only 10
million or so shares. But the idea was to get a bigger piece of the pie. 

The overstated "order book" from institutions, as it is called, was then
sent to research firms that rate IPOs based on their interest from
institutions. "Sure, that artificially inflates demand. But that's how you
rate a deal," says Vinnie Slaven, with Cantor Fitzgerald, whose job it is
to rate IPOs based on investor demand. So the process itself helped to
create an aura surrounding certain deals of vast enthusiasm among other
institutions. This in turn helped to whet the public's appetite for shares
of hot IPOs, often leading individuals to buys shares during an IPO's
giant first-day run-up. 

To catch the Web wave -- and keep up with peers' performance -- many fund
managers loaded up on Internet stocks even though many in their hearts
believed the shares to be overvalued. Twice last year, Mr. Tracey, until
recently manager of Oppenheimer Enterprise Fund, thought a mammoth
correction was coming and sold many Internet stocks. Both times he was
wrong. So, after the second time, he jumped at the chance a few weeks
later to buy into the IPO of an online industrial auctioneer called
FreeMarkets Inc. It was valued at $1.8 billion based on its IPO price,
despite 12-month sales of just $16 million and steep losses. But Mr.
Tracey figured that similar companies were trading at far richer levels,
and as to whether those valuations were ridiculous: "I said, 'I'm going to
suspend judgment for the moment.' " 

That proved profitable for Mr. Tracey, who watched FreeMarkets rocket from
its IPO price of $48 in December to $280 the first day of trading. He held
on as it roared to $370 in January, then dumped it in February at $215. It
now trades at $55.0625 a share. This strategy helped Mr. Tracey's fund
post a 105.8% return in 1999, though it's down 4.1% so far this year. Mr.
Tracey recently moved to Denver fund manager Berger LLC to become chief
investment officer. 

The tech bubble had one thing no past manias had: the push from online
brokers, who made speculating on stocks easier than ever and advertised
heavily to encourage people to chase riches. 

In September 1998, employees at online broker E*Trade Group Inc. hit TV
viewers with a barrage of commercials in an effort to add one million
customer accounts to its total of 500,000 in the coming year. Some ads
suggested that trading stocks over E*Trade was a better route to wealth
than waiting to win the lottery, others that it was better than waiting
for a rich relative to die. All promised a fast, cheap, powerful way to
play the stock market. 

As new accounts poured in, E*Trade kept upping its ad spending, says
Michael Sievert, chief marketing officer. E*Trade spent $321 million on
marketing in the fiscal year ended last Sept. 30, and surpassed its goal,
with 1.6 million accounts -- but with a loss of $54.7 million. It has
already spent an additional $307 million on marketing in the six months
through March 31, helping to boost the number of accounts to 2.6 million. 

The astonishing growth made online brokers a powerful force in the market,
as their customers drove the stocks of newly public and established
companies to unprecedented levels. By some estimates, individual investors
-- most of them trading online -- accounted at the peak for 65% of the
volume on Nasdaq. 

E*Trade's Mr. Sievert says the firm's ads tell investors they won't get
rich quick, and that they should take charge of their finances. He notes
one of E*Trade's commercials warned against getting carried away with a
profit that could quickly disappear. 

But critics say the Internet brokers did indeed encourage many
unsophisticated investors to trade aggressively in the belief they could
get wealthy and failed to adequately disclose the risk. "The marketing
campaigns by these Internet brokers encouraged novice investors, who had
no business trading securities, to short-term trade stocks, and they in
many instances ended up losing a major portion of their net worth,"
charges Douglas Schulz, a Westcliffe, Colo., securities-fraud expert who
advises investors with complaints against their brokers. 

Jay Kiessling, a physician living near Mobile, Ala., had been trading
through E*Trade for about 16 months when he heard about "I
wasn't quite sure if it was a good stock for the long run, but I was
almost sure it would have a terrific first day," he says. He put in an
order for 5,000 shares, expecting to get the stock at the IPO price of $9
a share. 

But because the stock rocketed at the opening, he ended up paying between
$84 to $88 ($42-$44 split-adjusted), more than $420,000 in total. He
finally dumped most of the stock a few days later at $42 a share, and had
to liquidate about two-thirds of his retirement investments to cover the

Dr. Kiessling and his wife filed an arbitration claim against E*Trade,
saying it allowed them to "buy an unsuitably over-concentrated position," 
according to his attorney, James Eccleston, and that E*Trade should have
alerted customers that the stock would open up so much higher. In a
statement of answer filed last year with the National Association of
Securities Dealers, E*Trade said that the Kiesslings "could and should
have minimized their risk" by immediately selling the shares and that the
couple is responsible for the loss. The case is pending. 

Mr. Kiessling hasn't made a single investment since But
though such stories are commonplace, it's hard to say whether the bubble
mentality is dead. Just Thursday, two new technology companies went
public.  Neither is a pure Internet play and one actually is making money.
Still, the prices of both more than doubled. 

-- Kara Scannell contributed to this article. 

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