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Some might ask why I’ve chosen this article, originally run in the November 1999 issue of International Speculator, to lead off a weekly column here on WorldNetDaily. The reason is simple: It gives you some perspective on the way I see things. And — in the case of the late, now much-lamented, dot-com boom — I was pretty much spot on.
Don’t, however, count on cosmic breakthroughs from my quarter every week.
Nobody, including myself, has a crystal ball. In fact, I’ll probably run mostly columns from the recent past. There’s a pretty good reason for that. Before you take anybody seriously (generally a foolhardy thing to do in the investment advisory business … but that’s another story entirely), you’ll do well to know not just what he’s saying now, but what he’s been saying.
Ergo, let’s go back to fall 1999:
Disinvest in the Net
It’s common knowledge the Internet is in process of changing the world in a profound and radical way. It’s as big an innovation as the printing press, the telephone, radio, or TV. It’s made scores of billionaires, at least on paper. And it’s in good measure responsible for the extraordinary degree of inflation of today’s stock market bubble. Many of the millions of new stock market players specialize in Internet stocks because they perceive (correctly) that they know as much, or more, about the technology as the analysts at brokerage houses. It looks like a level playing field, where 10-to-one and 100-to-one shots are dime-a-dozen.
Well, I guess I’m here to say that I love the Internet, and everything it stands for. And that it will change the world. But what has that got to do with the public making money? Absolutely nothing.
It did five years ago, before most people even had an e-mail account, but that was then, and this is now. What we’re seeing is a replay of so many manias that have happened before. The “Tulip Bubble.” The “South Sea Bubble.” The shoeshine boy market of 1929. I wasn’t around for those. But I remember the Go-Go market of the ’60s when “hot stocks” had “-onics” or “-ex” for a suffix on the corporate name (instead of dot-com), and it was identical to what’s going on today. People who didn’t know a stock from a schmock a few months before got involved up to their eyeballs. Nobody knew or cared about balance sheets or income statements, they just bought the exciting story. It was the final top of a long bull market (from the early ’50s to 1968), presaging the worst bear market (1968-71) since the Great Depression. At least until the 1973-74 bear market arrived.
It’s going to be much, much worse this time around. Vastly more people are in the market. The stock market has 20 times the market capitalization it did then. Stocks are two or three times more overpriced than they’ve ever been. And the economy. … But, hey, I’m a professional scaredy cat.
What really controls the market though, more than economics, is psychology. Psychology is the same across time, space and markets. Many readers remember the last several bull and bear cycles in the resource stocks. And what you’re seeing in the Internet stocks is the same euphoria, on a vastly greater scale. Almost every one of the Internet stocks is a burning match, just like almost all of the mining stocks. And they’ll meet the same fate — a 95-percent-plus meltdown among the survivors, with many disappearing totally.
Let’s look at a few of the big ones. This is a very brief and arbitrary selection, for illustration purposes. But I’m shorting, buying puts and selling naked calls on the lot of them.
Amazon.com (AMZN, $93): Its market cap of $25 billion is 20 times its projected year 2000 revenue, even though loss estimates for the year have soared from 29 cents a share to $1.26. They don’t even have a projection as to when they’ll be profitable; I think that’s because they won’t ever be. Regarding profit, founder Jeff Bezos (who may become the Ivar Krueger of this generation) says, “That’s not a significant part of our motivation.” The company is a lock-cinch for Chapter 11 bankruptcy, probably within two or three years. Why? Because they borrowed $1.25 billion in the bond market to finance their losses, and they’ll never even be able to service that debt, much less pay it off. They have about $1 billion in cash left, and it’s hemorrhaging away as they lose about $.30 for each of their billion dollars of sales. That’s bad enough, but they appear to be trying to make it up on volume. Meanwhile, this quintessential Net stock is building bricks and mortar warehouses for — gasp! — inventory. It won’t be a Chapter 7 only because the bondholders will probably convert into stock at a tiny fraction of today’s prices in hopes of salvaging something.
Ameritrade (AMTD, $23): This outfit, like its competitors E-Trade and National Discount Brokerage, is a beneficiary of the man-in-the-street’s involvement in the market and the rise of day trading. My guess is that its outlandish $4.2 billion market cap will start approaching zero in the next few years as the bear market basically wipes out most of its 450,000 largely unsophisticated customers (each of whom the market now values at about $14,000). Actually, when the ambulance chasers start filing suits to recover customer losses, each of those customers will be viewed as a potential liability.
AOL (AOL, $81): By far the largest Internet Service Provider. I have an account with them and have learned they’re arrogant SOBs, possibly a reflection of the character of one of their top execs, who I used to know years ago. Of course, he’s a billionaire now, but he won’t be for much longer unless he’s dumping his stock by the truckload. AOL is looking to actually make money next year, but I wouldn’t plan my life around it: 75 percent of their income is from $20 per month subscriber fees, and that’s going to start disappearing as outfits like NetZero (NZRO, $24, another great short) provide ISP services for free. The remainder of their income is mostly from ads, sales of which will collapse as profitless advertisers run out of cash. AOL has $1.4 billion of cash, which is pretty trivial relative to its $120 billion market cap (which is about 50 percent larger than the GDP of Israel, or twice that of New Zealand, for what that’s worth) and the over 12,000 employees on its payroll. It’s selling for over 200 times projected earnings in 2000. A lot of techies think AOL is a dead duck when people start hooking up to cable, which can deliver access about a zillion times faster than a telephone wire and a modem.
drkoop.com (KOOP, $13): The avuncular, conventional ex-surgeon general’s stock came out at $12.62, and is back where it started, showing a market cap of $485 million. Annual revenues might run $10 million this year, about a quarter of what they’ll spend to get them. KOOP has about 500,000 registered users (which are basically the company’s only asset, other than its website and cash). Each of them is apparently worth $970. But a registered user is not a customer, just someone who signs up to use the free service; just a name, in other words. KOOP’s hope is to peddle the names, and banner advertising, to people selling health products. My friend, Bill Bonner, who publishes International Speculator, is quite familiar with this business template. He, too, might invest in buying circulation in hopes of making money that way, on the back end. But if he did that for long, he wouldn’t be my publisher, because he’ll quickly go bust. He finds names of subscribers — and here we’re talking about serious people that pay several hundred dollars for a product, not just tire kickers — aren’t worth $50. Maybe they’re worth $20 each, or $2, or maybe nothing. KOOP is one of hundreds of health sites, and by no means the best one.
MP3.com (MPPP, $44): This is where you go to get free music from completely unknown bands — the kind, it’s been said, that might play a gig at your kid’s birthday party, or a grunge club, if they’re lucky. MP3.com has a market cap of $2.9 billion, about that of EMI Group (EMIPY), which has annual music sales of $4 billion. MP3 showed $1.2 million in revenue last year, almost all from advertising, because almost none of its music is worth buying, except for other people’s conventional CDs it sells for mail delivery. This outfit will likely survive, however because it managed to peddle 12.2 million shares this summer at $28 each, raising $344 million. Still, as competitive as the business is, and as unlikely as they are to show operating profits in the lifetime of even their youngest customers, this outfit could wind up selling for whatever cash it has left in a few years. Which is true of most e-stocks.
Priceline.com (PCLN, $64): These folks auction empty airline seats, mostly to budget travelers on red-eye flights. In some ways this is the goofiest of all these stocks, the one people will recount generations from now as the most expensive tulip bulb lookalike ever, because it has a market cap about equal to that of the entire airline industry whose marginal products it tries to sell. It’s anybody’s guess how this promotion got so out of control; perhaps it was the William Shatner ads. My guess is that since only about 35 percent of bids that are even accepted as “reasonable” by the company ever get filled, the public will lose interest rapidly, and better known competitors (like Amazon) will scavenge what business they have. The price is way off from the high, but I wouldn’t let that bother me; it’s like shorting Bre-X at the same place in the power curve.
Back to the future
Check your calendars; we’re back in 2001. Amazon has fallen to $14.62, Ameritrade to $9.21, AOL to $48.70, drkoop.com to $0.34, MP3 to $4.34 and Priceline to $2.68. That’s an average gain of 77 percent — if you went short. And the bear market in stocks has really just begun.
Still, let’s not get ahead of ourselves. Returning to 1999:
How do Net companies make money?
Asking how Net companies make money is something of a trick question. The answer, of course, is that very, very few of them do. The money is made by owners of their stock. And that’s not because the business really has prospects; it’s because we’re in a stock market bubble of historic proportions, and Internet issues are the flavor of the day. Nonetheless, I thought about what one does to generate revenue on the Web, and there are basically two approaches: Sell “stuff,” and sell advertising — which presumably helps other people sell their stuff.
Stuff: Selling “stuff” on the Web is necessarily a very low margin business. Everyone is trying to build name recognition and market share, so they sell things with minimal margin, or even at an intentional loss, to gain eyeballs. In the brick-and-mortar world that kind of thing happens from time to time, but never for very long, if only because of constraints of geography. In the simplest alternative, after a while only the most efficient local provider can stay in business, because they all have similar property, labor, material and tax costs in a given area. But on the Net a competitor can be anywhere; so prices will start falling to the lowest levels possible not just in a given community, or a given country, but in the world.
I’ve made the point in the past that the price of material goods — “stuff,” if you will — is fated to continue falling and falling, continuing a trend that’s been in motion for several thousand years. The trend of falling prices has vastly accelerated throughout the Industrial Revolution, and when we enter the nanotechnic era in a couple of decades, the cost of most stuff will fall to the level of the royalties payable on the software used to create it. The price of “stuff” is going to approach zero in the future; the Internet just ensures that the profit in selling stuff today approaches zero — or less. In any event, how can a company that’s got to pay pricey executives, lawyers and supernumeraries of every description compete with a kid working out of his parents’ basement? Because a lot of products lend themselves to exactly that kind of competition, and there will be ever more of it. In any event, the companies that make “stuff” are going to sell it on the Web themselves. Why does Simon & Shuster need an Amazon website to sell their books? They don’t. Or soon won’t. And, as I’ve argued before, why will most authors even need Simon & Shuster, when they can effectively self-publish on the Web? Amazon not only loses money, but it does it to no purpose; it’s already on the wrong side of the power curve.
One advantage an e-store selling stuff has is that they get paid up front, and deliver later, whereas a brick-and-mortar retailer has to hold inventory then get paid. So they get better cashflow, and it’s harder for them to get stuck with the wrong inventory, since they don’t have to carry much. But it’s an academic point if there’s no money in the basic business.
E-tailing won’t eliminate the mall, the corner store, or the superstore, but it’s going to change them in ways that may be impossible to predict. My guess is that the entertainment economy will start crowding out the information economy just as most people were only getting used to the disappearance of the industrial economy. With cheap Net prices, infinite inventory, and next-day delivery, why go out to a store and have the hassle of moving your physical body, plus paying more, unless there’s a real incentive? The salvation of brick-and-mortar stores will probably be in the form of entertainment; that’s why you might buy a book from your local Borders instead of Amazon. You want the coffee and croissant while you browse. After all, when you have all the stuff you can use, and more information than you can even comprehend (much less use) in 10 lifetimes, entertainment is all there is.
The bottom line is that more and more stuff will be sold on the Net, but for less and less profit. And it’s a notoriously dumb idea to try to “make it up on volume” when you’re running at a loss.
Advertising: The other revenue source of Web companies is the ads they sell to each other. Entirely apart from the fact that fewer and fewer will be able to afford the ads, there’s evidence that ads are about the least effective way to drive people to a specific site. The Web lends itself like nothing else before it to “viral marketing,” where word of a good thing is passed on from one user to another voluntarily. Not only is it the best possible type of ad, but it’s totally free.
An example of that is offered by the success of Hotmail, a free Internet e-mail service. They were trying to figure out how to promote it, and determined just to append “Get your free e-mail at Hotmail” at the bottom of every e-mail going out to everyone that signs up. Largely due to that simple coup, Hotmail then signed up 11 million users in 18 months. Sabeer Bhatia, the company’s founder, went to school in India; he sent one e-mail there. Three weeks later, he had 100,000 registered Hotmail users in India. Those users have value, otherwise Microsoft wouldn’t have bought his company for something like $400 million. But how many websites both provide a useful service and are free? Certainly Microsoft is no dummy, but how much money can you really generate with ads on an e-mail service that itself never had to buy ads to grow?
I suspect there will be a scandal at some point concerning the revenues from advertising many Web companies are booking. It appears to be a shell game. I’ll sell you a banner on my site for $1 million, if you sell me a banner for $1 million. Arbitrary numbers. But big ones look better than small ones. It’s a lot like the joke about the two would-be property magnates who sell a $1,000 lot back and forth between each other, at higher and higher prices, until they’re both billionaires based on the last sale, the one because he owns the property, the other because he owns the paper secured by it.
Who could have imagined the Net stocks would have run as high and as long as they’ve gone? Certainly nobody who believes in Graham-Dodd analysis, fundamental value, contrarianism, or similar time-tried (most today would say outmoded) methods of figuring out where a stock’s price is headed.
Basic value indicators — dividend yield, price/book value, and price/earnings, among others — can tell you when a bull market or a bear market “should” start. But if the market always did what it should, then everybody would be wealthy. In reality, it’s very tough figuring when the tide has turned, towards either the bulls or the bears. My feeling is that the real peak in the market came in the summer of ’98. Since then, although major indices and big caps have held up pretty well, the “average” stock has been doing badly. The two indicators in this regard are the ratios of new highs to new lows, and the ratio of advances to declines. In both cases, on the average day, the declines and new lows have predominated by about two-to-one for close to 18 months now.
Between the commissions, the various fees, the absence of dividends and the steady decline of most stocks, my guess is that the average guy is losing money. The market is pretty much like that of 1972, when there were “one decision” stocks and the “nifty fifty,” which held up to outrageously high levels (although cheap by today’s standards), while the rest of the market got sliced away like a gyros in a Greek deli. Pretty much what’s happening today. The nifty fifty were the last to go, but when they collapsed they lost 80-90 percent of their value by the end of 1974. And unlike today’s Net stocks, they (Xerox, Clorox, Kodak, International Flavors, etc.) were real businesses, with real earnings and assets.
This market is resting on nothing but perceptions, enthusiasm and confidence. Unfortunately, those things can, and eventually will, blow away like a pile of feathers in a hurricane.