Businesses With Webbed Feet
“My mother…was a French prostitute…with webbed feet… My father…would make outrageous claims, like he invented the question mark…He would accuse chestnuts of being lazy…”
— Dr. Evil tells the story of his childhood to a support group
If the gains from the Bubble market of ’98 to ’00 were only “on paper,” will the losses also be only paper ones?
That is the serious question I pose in today’s letter.
I also ponder the role of the past in determining the present and the future.
“Character is fate,” said Aristotle. Of course, to the ancient Greeks, character was everything. Almost every summer the free men — mostly farmers — called hoplites — of the Greek city-states would be called out to do battle. Rarely trained, they followed a very simple battle strategy. They stood shoulder to shoulder, rank upon rank, and pushed toward the enemy. Every man counted on every other man to do his duty. To fight. To die. But never to run.
This, perhaps exaggerated, sense of duty to the community informs much of philosophy of ancient Greece.
Even today, a person is hectored to pay his fair share…to pitch in and help…to take part in the process of politics that turns almost everyone into a fool, a stooge or a cynic.
And on Wall Street, short sellers — who bet against their more numerous brethren on the long side of the trade — are regarded with disfavor, and sometimes outright hostility. In times of financial stress – such as in the Malaysian markets of 1998 — speculation is blamed for falling prices…and often banned. In some markets, usually the more primitive ones, short selling is never permitted.
But still, when prices are ready to go down…they go down. Yesterday Charles Schwab reported that its customers lost $56 billion last month — or about 7% of their money. Not bad for one month’s work.
The Nasdaq is down about 30% from its highest point. And some of the shares formerly viewed as particularly high- flying are now gliding at considerably lower altitudes — and many are expected to hit the ground within months. As widely reported, a whole class of Internet companies — the class of `97-’98 — are about to run out of fuel. Unless there is an unexpected updraft of cash — they will crash-land (or be bought out, merged or otherwise disappear) soon.
Not that there isn’t plenty of money around. The venture capital people are raising and investing enormous sums. Recently, at least one of these firms — OffRoad Capital — is advertising directly to the public to find investors.
One ad shows a distressed-looking man standing in the rain, looking in on what appear to be a group of happy, successful people. The poor man, for all his money, can’t seem to get in on the good deals at the seed capital level. He’s doomed to buy the stocks after the venture capital guys have taken their cut.
While the boom was in full explosion, venture capital was the place to be. The margins between start-up and the public markets were enormous. A company could be founded for a few hundred dollars. At the height of the Internet boom, an entrepreneur could raise a million or two of seed capital, set up a website, begin sending out press releases with incomprehensibly pretentious remarks and soon go public. If the fickle finger of the financial gods pointed in the right direction, the enterprise might be capitalized at a billion dollars. The venture investors became not only rich, but celebrity figures among the New Economy cognoscenti — the latte-swilling, Armani-wearing, BMW-driving, McMansion-dwelling tres nouveau riche…who could read George Gilder without laughing.
But venture investing is not always such an easy enterprise. You might expect it to be more profitable than buying common stock — because there’s more work involved. Like owning ghetto apartments or a convenience store in a bad part of town, the return would have to compensate investors for the extra effort and risk involved.
And for every business that venture capital businesses backed — many would never be profitable. That was the “hurdle” that venture capitalists used to have to jump. Businesses used to have to reach a certain level of profitability and stay there for at least three years before they were considered suitable for the public markets. That eliminated most projects. Because making a profit is tough. You have to offer a genuine service or product — that people are willing to pay for. This is how the character of public companies was maintained.
But in the `90s, the VC hurdle was lowered. It became possible to sell businesses to the public that had never made a profit — and probably never would. The public no longer cared about buying businesses. It wanted Pokemon cards. Profits were no longer necessary.
Not only did a business need no profits — it didn’t need any substantial operating history either. Just as modern art required no skill at art…modern business circa 1999 required no business skill…or even a business. In a matter of months, an idea could be transformed into something that resembled a business — like a rusty automobile on cinder blocks behind a West Virginia trailer resembles a work of “art.” Even more unbelievably, people would pay as much — and more — for the imposters as for the real thing.
Finally, the hurdle disappeared altogether in the mud. Greed was unleashed. Money was available for start-ups practically for free. The effect was to change the character of the companies that emerged. They began to grow webbed feet and imagine that they could do, or had already done, great things — like invent the question mark. In pompous prose, they questioned the integrity of chestnuts.
I described a couple of these grotesque companies. Both MicroStrategy (down a lot) and Value America (down 96%) were once worth billions. Each developed its own freakish abnormality.
But these were not the worst of the lot. The scoundrels involved in these businesses actually seemed to believe their hype and acted on their own delusions. Many other dot-com businesses are pure scams — created by knaves to take money from fools. The founders, entrepreneurs and venture capitalists cut and run at the first adversity.
Good begets good; bad begets bad. If character is fate, these businesses are doomed.
But does the money go back to its rightful owners, as the old timers say of a bear market?
Alas, I refer to “Anatomy of the Bubble,” in which Garet Garrett described the aftermath of the ’29 crash. The key to understanding the crash and the period that followed, he said, is to understand the character of the period that preceded them. Garret compares the bad investments of the late `20s to the building of the pyramids:
“A delirious stock-exchange speculation such as the one that went crash in 1929 is a pyramid…Its stones are avarice, mass-delusion and mania; its tokens are bits of printed paper representing fragments and fictions of title to things both real and unreal, including title to profits that have not yet been earned and never will be.
“The labor that is lost,” he wrote, “cannot be recovered…
“You may think that since it was all a delusion on the profit side, the loss also must have been imaginary; that if nothing was added to the wealth of the country, neither was anything taken away. But that is not the way of it.”
Nope. The lattes have been swilled. The imaginary wealth of the stock market boom has been borrowed against, or exchanged directly, for real wealth. And the real wealth has been consumed.
Wishing you a beautiful spring weekend.
Paris, France May 12, 2000
*** After three days of declining prices, Wall Street was ready for a change. Besides, there was a reason to change direction. The latest report showed that retail sales fell by .2% in April, instead of rising .4% as expected.
*** Whoopee! You know what that means? It means the pressure is off the Fed to keep raising interest rates. Which means that the stock market can return to its preferred locomotion — ascension.
*** So the wishful thinkers and cynical speculators bid up prices yesterday in an effort to stay ahead of the trend. The Dow rose 178 points. The Nasdaq went up 114 points.
*** But does a .6% swing in retail sales in any given month — especially April, when people have to pay their taxes — really make any difference?
*** No, but it shows what kind of a market we’re dealing with. No serious investor would buy or sell shares on the basis of this kind of information. Can you imagine Warren Buffett getting on the phone with Charlie Munger:
“Uh…Charlie…we’d better buy some more stock. Because retail sales are down. So Greenspan will probably ease off the rate increases. Shares might go up….”
*** Who would buy or sell a business based on a feeble, insignificant statistic…with a shelf life of less than 24 hours? To many investors, stocks are not businesses, they’re just electronic data…like Pokemon cards for adults…that you trade with your friends.
*** It’s madness. But it’s fun. And today, the PPI — a measure of wholesale prices — comes out. It, too, is likely to send the market reeling in one direction or another.
*** About 2,002 stocks advanced yesterday; 930 declined. There were 60 new highs; 72 new lows.
*** The dollar rose very slightly against the euro. Not much action there.
*** But take gold, on the other hand — please. The yellow metal — the ultimate competitor to both the euro and the dollar — fell $2.20.
*** The CRB (commodities index) rose 1% yesterday — boosted by a $1 oil price increase.
*** “You heard it here first,” says “Real Asset Investor’s” Dan Ferris. “The top of the oil market occurred on March 8, when NYMEX spot crude closed at $32.10 a barrel.” And because of a price band instituted by OPEC…the price will fluctuate between $22 and $28 dollars a barrel. http://www.realassetinvestor.com
*** I argued yesterday that capitalism, as we have known it and as Karl Marx defined it, is doomed. But so what, a reader asked. The answer: the “new metrics” are based on the belief that this new age of capitalism will be very rewarding for investors. As a theoretical issue, this implies that an investor should be willing to accept a lower price/earnings ratio — or less income from his investments — because capital values will be rising. Capital itself will become more productive…
*** Yet, if I am right, businesses might become more productive, but the source of the increase will not be the capital component — but the knowledge component, which investors do not provide. Thus, even if the New Era/New Economy were a reality, investors still may not be able to profit from it. Instead, the people who would profit would be exactly the people who have already profited — the entrepreneurs and the employees.
*** The democratic process becomes a greater farce all the time. Now we have the spectacle of Mayor Giuliani discussing not only his health, but also his marriage, on the front page of the “International Herald Tribune.” “I am not interested in politics right now,” says the candidate for the U.S. Senate. One gets the impression that the mayor has not yet fully mastered his trade. Otherwise, he would have cast his paramour, Ms. Nathan, aside…or at least hid her in a closet until after the election.
*** Mr. Giuliani seems to be the victim of his own common indecency — that is, the indecency that makes middle aged men want to leave their wives. It is a weakness, but a common one. And a source of great hope, if not always pleasure, to men all over the world. His opponent, on the other hand, along with her husband, seems to have risen above common indecency. They have scaled the peaks of indecency — and breathe an air so thin and uncommon that few human hearts could survive on it. If you believe the reports, they are fully capable of shouting obscenities at each other…committing serial adultery, even rape…and still holding hands, clutching bibles and smiling for the cameras. The Clintons are real pros.
*** Among the achievements of the Clinton administration will be Janet Reno’s attack on Microsoft. “Let’s get to the real bottom line,” advised the “Wall Street Journal” in an editorial on the “anti-trust” case against Bill Gates. “Washington’s crusade against Microsoft has fulfilled its purpose, serving as a great lever to pry open the wallets of Silicon Valley. Where three years ago the technology plutocrats spent their surplus earnings on racing yachts and Ferraris and charity, now they patriotically send donations to Washington to support the fixer class and its retinue in the style to which they would like to become accustomed.”