TCS Daily

The Dot.Con Con Game

By James K. Glassman - April 5, 2002 12:00 AM

Almost since it went public nearly five years ago, the online retailer has been a poster child for Internet skeptics. How, they groused, could a new company selling books over the World Wide Web be worth more than Sears, Federated Department Stores, Saks, and Nordstrom combined? To the critics, Amazon was an absurd manifestation of the high-technology bubble.

In some ways, it was. Amazon sold its first public shares in May 1997 at $18 apiece. Two and a half years later, the stock had split three times, and the price had soared to $113. An investment of $1,800 became $135,600. Then within another two years, the share price had crashed to $5.50. The $1,800 nut was then worth a less stratospheric $6,600.

Amidst this roller coaster ride, however, Amazon had strong fundamentals. It was built on a great idea, had excellent management, and good finances. Amazon's founder, Jeff Bezos, spent billions to develop a strong brand and excellent customer service. Now that strategy seems to be working. On January 22, Amazon announced it had just completed its first quarter in which revenues exceeded expenses.

Amazon's official earnings, after taxes and interest, were $5 million for the three months ending in December 2001. It lost $526 million for the year, but that compared with a $1.1 billion loss in 2000. The company finished 2001 with a cushion of $996 million in cash and marketable securities. With this news, Amazon stock jumped to about $14, indicating the market valued the company at $5 billion.

The triumph of Amazon comes at a time when Internet naysayers are crowing over what they see as the popping of the Internet bubble. New books like Dot.Con, by John Cassidy of The New Yorker, contend that the technology boom was a put-up job by stock promoters. That's nonsense. Technology tends to be overestimated when it is brand new and underestimated after the early excitement fades. Certainly, there was too much enthusiasm a few years ago, but there is too little today.

Look at eBay, the online auction house. When it went public in September 1998, two years after its founding, it was already profitable. In 2001, a recession year, sales rose 74 percent to $748 million, and profits roughly doubled to $90 million. Dell Computer, which sells computer hardware over the Internet at exceptionally low costs, is now making $2 billion in annual profits on $30 billion in sales.

Yahoo!, the Internet portal, makes most of its money selling advertising-a difficult endeavor in 2001. Yahoo!'s profits fell last year to $41 million, from $291 million-but it was the company's fifth profitable year in a row, and sales, at $717 million, were still impressive. Like eBay, Yahoo! has mountains of cash and no debt.

But investors did overestimate Yahoo!'s value: At one point in 2000 they bid its share price up to $250. Less than two years later, it had fallen to $8. Still, an investor who put $10,000 into Yahoo! when it went public in April 1996 had shares worth $66,145 on March 5, 2002.

It's the nature of start-up companies to die by the thousands. Only the fittest thrive. The risks are enormous, but so are the rewards. An investor who put $10,000 into Dell in 1991, three years after its IPO, had $1 million in stock a decade later. Was it really so crazy to take a chance on Amazon, in the process valuing it higher than Sears? Few expect Sears to increase profits more than about 5 percent a year, but Amazon, having invented a new way to sell things, could, in a relatively short time, earn $1 billion annually on $20 billion in revenues.

In an important speech last year, Stanford economist Robert Hall stated that "The pricing of new technology companies tries to avoid the error of Microsoft-a dollar invested in Microsoft stock in 1990 resulted in a claim of $1.38 in after-tax earnings in 2000 alone. Obviously, the market in 1990 guessed absurdly low about Microsoft's cash-flow growth."

In other words, with early-stage technology firms, pricing is not easy. Hence, the market's volatility. Dot.Con author Cassidy claims that the tech bubble was the result of marketing, some of it crooked. Certainly, there was overselling-that always happens on Wall Street. But there was underselling, too, as in the cases of AOL, Microsoft, and Dell.

Sometimes investors get the prices right, and sometimes they get them wrong. But the tech boom was hardly just a scam. Denigrating technology can only hurt the U.S. economy.

This article first appeared in the magazine The American Enterprise.

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