If Joe Smith saw a stock like Lycos profiled on CNBC, he could jump online and place an order for Lycos stock within minutes. There was no longer any middleman to talk him out of it. And if Mr. Smith wanted to spend his days discussing the relative merits and future prospects of Lycos, he could do so on message boards at sites like Yahoo Finance that had many thousands of forums devoted to discussing individual stocks. Often, the readership of these boards would break down between bulls and bears, or longs and shorts. Today, we are all familiar with the Roman Colosseum–like combat that goes on in the comments section of an average blog post, or the pages of a site like Reddit, but it was in the late nineties that average Americans became familiar with Internet conventions—such as flame wars and trolls—thanks to the bull versus bear debates on stock market–focused pages of a site like the Motley Fool.
■
IN DECEMBER 1998, a thirty-three-year-old stock market analyst by the name of Henry Blodget was working for the investment bank CIBC Oppenheimer.10 Oppenheimer was not a particularly prominent player on Wall Street, and Blodget was not a particularly important analyst; he had basically lucked into the job less than three years previously, because banks were desperate to find someone “young” who understood this new Internet thing. Two months earlier, Blodget had published his first analyst report on Amazon.com. He had recommended buying the stock, setting a one-year price target of $150 a share. It was a good call. At the time of Blodget’s first recommendation, Amazon was trading at $80 a share; it had subsequently exploded to $240. The Oppenheimer sales team wanted a fresh recommendation to take to their clients for the new year. At their behest, Blodget dutifully calculated that a 70% rise over the course of the next year might make sense, based on Amazon’s recent sales growth. He put a new price target on the stock: $400 a share, writing, “Amazon’s valuation is clearly more art than science, and we believe that the stock will continue to be driven higher in large part by the company’s astounding revenue momentum.”11
A far more experienced analyst covering Amazon at the time was Jonathan Cohen. Cohen worked at a more prominent firm, Merrill Lynch, and unlike Blodget, Cohen’s analysis was widely followed. A few months previously, Cohen had actually downgraded his recommendation of Amazon to “reduce,” saying the stock was too expensive. More precisely, Cohen would later, famously, call Amazon “probably the single most expensive piece of equity ever, not just for Internet stocks but for any stock in the history of modern equity markets.”12 Cohen’s price target for Amazon was $50. So, Henry Blodget was going out on a limb by making such a wildly divergent call from the more experienced Cohen’s. When Blodget circulated his numbers internally, “One of my bosses stopped by my office and sort of raised his eyebrows—‘$400 a share?’ ” Blodget would remember later. The next day, when the call went public, “My phone lit up like a Christmas tree. I thought, ‘Oh, no, I blew it.’ ”13
Far from blowing it, the Amazon call made Blodget’s career. Blodget made his famous forecast of Amazon’s $400 a share on December 16, 1998. The stock closed up 20% that day alone, in no small part thanks to news of Blodget’s recommendation. By January 6, not even a month later, Amazon’s stock blew past Blodget’s $400 target. Almost overnight, Blodget became a regular on CNBC. He began to be routinely quoted and profiled in almost every newspaper and financial magazine in the country. A month later, when Jonathan Cohen left Merrill Lynch, Blodget took over Cohen’s analyst chair at the more prestigious firm. By 2001, Blodget would be paid a rumored $12 million a year for his stock analysis.14
The experience of Jonathan Cohen was not unique on Wall Street. Hedge fund managers, mutual fund managers, stock analysts, even financial reporters learned and internalized a sharp lesson in the late nineties: People didn’t want to hear negativity. For everyone involved, it was far more helpful to your career if you joined the hosanna chorus talking up the prospects of the soaring market. Fund managers who did not fill their holdings with technology stocks saw their returns trail those of their peers and even the market indexes. “You either participate in this mania, or you go out of business,” Roger McNamee, one of the most famous technology investors of the era, told Fortune in June of 1999. “It’s a matter of self-preservation.”15 One by one, bearish stock market analysts who for years had been saying the bull market was too good to last threw in the towel and got with the program.16 Now one of the most famous technology stock boosters, Blodget joined a pantheon of Wall Street soothsayers who were almost ubiquitous in the late 1990s, analysts like Ralph Acampora, Jack Grubman, and especially Mary Meeker and Abby Joseph Cohen. Their slightest utterance could move markets, and they were all fully committed bulls, staking their reputations on the growth prospects of Internet companies.
Economists of all stripes were looking for a justification, a rationale, anything that could explain the boom times that they felt certain they were living in. Most just instinctively credited information technology. After all, everything was getting connected! The world was shrinking! Computers were everywhere! Surely that meant that things were functioning better, more efficiently, more profitably. The only problem was, none of this seemed to show up in any of the official numbers. Economic output is easy to measure when you can count widgets coming off an assembly line. But when your “economic revolution” is built around thoughts and ideas, and the speedy new ways you’re connecting them all together, how do you quantify the value of those innovations? ATMs might mean fewer bank tellers had jobs; but think of the time saved by millions of consumers! How did one measure that? “More and more, value is produced not by real assets like factories and capital, but rather by people thinking and working together,” Fortune opined in 1999. And yet, “while it seems obvious that computers have to have boosted productivity, proving that they have has been impossible.”17
Many people came to believe that the proof might just be the soaring stock market. According to this line of thinking, stocks (and tech stocks especially) were rising because investors were rationally pricing in the vast improvements and profits that technology was making possible. Stock markets are a forward-leaning indicator of economic trends, and so perhaps the market itself was revealing the profits and efficiencies that would show up in official figures sometime down the road.
This rationale went all the way to the top. When Chairman of the Federal Reserve Alan Greenspan couldn’t find the increases in productivity that he felt must be behind the run-up in stock prices, he commissioned Fed researchers to dig deeper into their statistical data in order to prove that productivity was, in fact, growing faster than government numbers showed. “Greenspan condoned the bubble—and then concocted a theory as for why it was rational,” quips Maggie Mahar.18
Greenspan had begun the dot-com era skeptical of the stock market’s euphoria. In December 1996, the Fed chairman gave a speech to a conservative think tank where a throwaway line (“But how do we know when irrational exuberance has unduly escalated asset values?”) briefly caused markets to seize up.19 “Irrational exuberance” would, somewhat ironically, become a cultural slogan of the dot-com era. But as the nineties wore on, Greenspan—if he did not exactly repudiate the phrase—gave every indication to the markets that he was no longer much worried about speculative excess. In January 1999, a senator asked Greenspan how much of the run-up in stocks was “based on fundamentals, and how much is based on hype?” The chairman answered: “You wouldn’t get ‘hype’ working if there weren’t something fundamentally, potentially sound under it.” In the nearly two years after the “irrational exuberance” speech, the Federal Reserve raised interest rates only once, and, in fact, cut rates several times in response to the various mid-nineties “crises” few now remember, like the so-called Asian Flu of July 1997.20 So, from late 1996 until late 1998—just the time when the dot-com bubble was inflating—the Fed was, to borrow from Wall Street lingo, extremely “accommodating” to the stock market.
Many people, then and now, feel that Greenspan, at the very least, enabled
the dot-com speculative stock market bubble. At the time, American investors came to believe very strongly that Greenspan wanted them to be rich, and if anything went wrong, Uncle Alan would put his finger on the scales and make things right. During the run-up to the 2000 election, presidential candidate John McCain vowed: “And by the way, I would not only reappoint Alan Greenspan—if he would happen to die, God forbid—I would do like they did in the movie Weekend at Bernie’s. I would prop him up and put a pair of dark glasses on him.”21
■
IN THE WORDS of James Grant, editor of Grant’s Interest Rate Observer, writing in 1996, “The stock market is not the kind of game in which one party loses what another party wins. It is the kind of game in which, over certain periods of time, nearly everyone may win, or nearly everyone may lose.”22 By the late ’90s, everyone involved in the stock market seemed to be winning. And the coming of the dot-com stocks only seemed to extend this winning streak. Nobody had any vested interest in questioning the madness, least of all the media. As early as 1997, an estimated 30% of national newspaper ad revenues came from the financial services industry.23 By 1999, ad rates on cable television were up 21% year-over-year and 16% on network television, thanks to an estimated $1.9 billion that young dot-com companies would spend to promote themselves.24
Most important, all those baby boomers, all those CNBC addicts, all those everyday Americans who were invested in the stock market—they were making money too. If they were invested in the right Internet stocks, they were making a lot of money. Fortune estimated that Internet fever was adding $301 billion to the U.S. economy by 1998, and another study estimated that 37% of all new jobs being created were thanks to the Internet.25
All told, approximately 50,000 companies would be founded between 1996 and 2000 aiming to commercialize the Internet, backed by more than $256 billion in venture capital.26 But if the dot-com bubble is remembered mainly for the initial public offerings of stock that made all the headlines, it’s important to remember that the actual dot-com mania, as measured by high-profile Internet IPOs coming to market, happened in a relatively brief window of time. In 1995, 7 stocks IPOed that could be termed “Internet companies.” In 1996, there were 27. In 1997, the first of the real “dot-coms” came to market, totaling 19. In 1998, there were 29. But in 1999, there were 249 Internet IPOs. And those were just the Internet companies that debuted on the stock market. There were untold others that got acquired or went nowhere.
It was perhaps inevitable that, toward the tail end of the bubble, there were a lot of young Internet companies being founded that had questionable business plans at best. Some of the companies were so flimsy as to be just short of outright fraud. Investors (both venture capitalists and the public at large) no longer had any interest in discerning true value; any company with a .com at the end of its name might be the next billion-dollar winner. “You’ve got stocks selling at absolutely unbelievable multiples of earnings and revenues,” the eternally skeptical old-school money manager Barton Biggs said as early as 1996. “You’ve got companies going public that don’t even have earnings. You’ve got people setting up Internet pages to reinforce each other’s convictions in these wildly speculative stocks.”27 By the end of the decade, such Chicken Little cries seemed quaint. If Americans—especially the everyday Americans who were in no way financial professionals, but were suddenly driving the market—were demanding to invest in Internet companies, Silicon Valley and Wall Street were more than happy to supply the demand. And with every new company that enjoyed a 100% first day “pop” on the markets, the increasingly isolated voices that were urging caution seemed all the more discredited. A well-respected, longtime stock market insider weighed in at the tail end of 1998, saying, “It defies my imagination that so many people with so little sophistication are speculating on these stocks.”
The man speaking these words was Bernie Madoff.28
9
IRRATIONAL EXUBERANCE
The Dot-com Bubble
If you were looking for a single company that exemplified the dot-com era, you could do worse than Priceline.com.
Priceline was founded by Jay Walker, a forty-two-year-old entrepreneur with a clever solution to a real problem: every day, 500,000 airline seats were going unsold.1 Priceline would offer these vacant seats to online customers who could name the price they were willing to pay to fill them. Consumers would (theoretically, at least) get cheaper flights; airlines would be able to sell excess inventory; inefficiencies would be ironed out of the market; and Priceline would take a cut for facilitating the whole process: your garden-variety win-win-win-win that only the Internet could make happen.
Launching in April of 1998, Priceline was a dot-com “overnight success,” growing from 50 employees to more than 300 and selling more than 100,000 airline tickets in its first seven months of business. By the end of 1999, it was selling more than 1,000 tickets a day.2 Believing in Amazon’s Get Big Fast business strategy, Priceline attempted to expand into hotel bookings, car rentals, home mortgages—seemingly every market with excess inventory that a consumer might want to name a lowball price for. On the strength of this idea, Priceline was able to raise $100 million in working capital. Airline tickets were just the proof of concept. Walker’s intention was to take this idea to every applicable market. “Priceline is just the beginning,” he told the Industry Standard.3
Walker intended to get to ubiquity the way Yahoo had done: by building a brand through relentless marketing. In its first six months, the company spent more than $20 million in advertising, the keystone of which was clever radio and TV ads featuring Star Trek’s William Shatner.4 The ads were reportedly scripted by Walker himself, and Shatner was compensated with 100,000 shares of stock instead of the originally offered $500,000 in cash (“Wasn’t that a good move?” Shatner asked a Fortune writer in September 1999 when the shares were worth about $7.5 million).5 All of this succeeded in placing Priceline fifth in Internet brand awareness by the end of 1998, behind only AOL, Yahoo, Netscape and Amazon.6
Forbes put Walker on its cover as a “New Age Edison.” He told the Industry Standard: “The long-term legacy of Priceline [will depend on] whether or not we can successfully introduce the first new pricing system in probably 500 years.”7 In March 1999, Priceline went public at $16 a share, and on its first day of trading went up to $88 before settling at $69. This gave Priceline a market capitalization of $9.8 billion, the largest first-day valuation of an Internet company to that date.8 After such a high-profile debut, few investors were concerned about the fact that in its first few quarters in business Priceline racked up losses of $142.5 million.9 Or that it had to buy tickets on the open market—at cost—in order to fulfill the lowball bids its customers were placing, thereby losing, on average, $30 on every ticket it sold. Or that Priceline customers often ended up paying more at auction than they could have paid through a traditional travel agent.10 Investors were more interested in grabbing a piece of a company that was going to change the future of business.
Because hey, by 1999, losing money was the mark of a successful dot-com. And few could lose money as prolifically or creatively as Priceline. The head of a rival travel website named CheapTickets complained that his company couldn’t compete with Priceline’s hype. “We’ve got a policy here at CheapTickets,” founder Michael Hartley groused. “We need to make money. It hurts our valuation.”11
Priceline’s market valuation was doing just fine. At its highs, Priceline had a market cap larger than any of the airlines it sold tickets for, and Walker’s 49% personal stake in the company was worth as much as $9 billion.12
■
SO MANY OF THE COMPANIES that would embody what we think of when we remember the dot-coms shared some or all of Priceline’s traits: a business plan that promised to “change the world”; a Get Big Fast strategy to reach ubiquity and corner a particular market; a tendency to sell products at a loss in order to gain that market share; a willingness to spend lavishly on branding and adverti
sing to raise awareness; and, above all, a sky-high stock market valuation that was divorced from any sort of profitability or rationality.
The dot-coms that tend to have lingered in popular memory were the ecommerce companies, which, like Priceline, were targeting mainstream consumers. Amazon had effectively killed the category of books online, and so, hundreds of ecommerce companies were founded to become the “Amazon for X,” where X was whatever flavor of retail one could imagine.
Children’s toys were estimated to be a $22 billion annual market. (Yearly spend on toys per child? $350.)13 And so, eToys took a crack at this segment. Of course, there were established players in the toy space already, especially Toys “R” Us and Wal-Mart. But then, Amazon had “Amazoned” Barnes & Noble, hadn’t it? So, in a similar way, eToys cofounder Toby Lenk intended to establish an online beachhead before the incumbents could react. “We can out-Barbie and out-Lego the mass merchants out there,” Lenk told a reporter.14 By October 1998, eToys could crow about attracting as many as 750,000 visitors a month. Those were actually great traffic numbers for that time period, but, of course, not all of those visitors bought something. By December 1999, after more than two years in business, eToys could only boast lifetime revenues of $51 million. That was about as good as the combined yearly sales of seven Toys “R” Us real-world stores—and Toys “R” Us had nearly 1,500 stores worldwide.
How the Internet Happened Page 16