The Twilight of The Internet Gods

Another big merger was announced on Monday. Glaxo and Smith Kline are getting hitched.

But here’s something interesting: unlike the merger of AOL and Time Warner, neither of the big drug companies will have to discount its stock to get the deal done. The drug companies come together as equals. AOL and Time Warner do not.

You will remember that Time Warner chief Levin announced that the valuations for the new economy stocks were “real.” That was, he said, what makes the deal possible. TMX has accepted the fact that AOL is a real company… with real earning potential.

But when the cards were turned over, Levin was only willing to do the deal if AOL’s paper were discounted by 40%. The newspapers reported the Time Warner stock was being taken in by AOL at a 60% premium. The other way to look at it is that AOL stock is being taken in at a 40% discount. Either way — it does not look as though Levin and Case think the Internet stock of AOL is as real as the TMX stock.

And neither does the market. AOL Time Warner will be a real company in the real world, with real earnings and real problems. Once combined, the curtain that hides the Internet wizard from the light of day is pulled back. And the Great God of the Internet… with whom and by whom All Things are Possible… all of a sudden looks rather mortal. AOL stock has fallen — it is down nearly a third from its high.

Anything is possible in cyberspace. Internet companies typically have no earnings — and no business models to show that they will ever have earnings. Anatole Kaletsky, writing in today’s “TIMES of London” points out that since they have none of the indicators by which businesses are customarily evaluated, they can be priced like tulip bulbs. During the Tulip Mania, he writes, “a single tulip bulb was worth more than a large house in [London’s fashionable] Mayfair or a thriving french brewery.”

But the better comparison, he suggests, is with the South Sea bubble. The 18th century South Sea Bubble was based on the premise that trade with the Americas would create the greatest explosion of wealth in history. Investors actually had a New World open to them, which they believed would make them rich.

Sir Isaac Newton invested some money in the South Sea scheme. He made 7,000 pounds profit. So he went back for more. Alas, even the man who discovered gravity seems to have been levitated by a manic market. When it was over, Sir Isaac had lost the 7,000 pounds and 13,000 more.

If market knowledge grew over time, like our knowledge of celestial forces, investors would know better than to put their money in today’s But, manias blow up like storms — unpredictably and episodically. Each generation has to learn from its own bad weather.

AOL is not the only Internet stock in trouble. AMZN is on a raft of trouble floating down the big lazy river of no return. It’s down about a third from its high too. So is eBay. Ameritrade is down 50%. And eToys? It looks like it is disappearing altogether.

How do I know? Because the smart-looking young people on CNBC told me. They say the e-tailers are all in trouble. Because the Walmart of the Internet is going to be… mirabile dictu… Walmart! It’s “clicks and bricks”… the convergence between the old economy and the new economy… that’s going to pay off. Not e- tailing alone.

And Biz to Biz e-commerce — that’s going to pay off big too. These are the Next Big Things, according to the prophets of the airwaves. They seem to believe that the boom will never end. “There may be a little uncertainty until February,” cautioned one, “but it should be smooth sailing after that.”

Or not.

George Soros wrote in his “Crisis of Global Capitalism” that there comes a “moment of truth” in markets, “when reality can no longer sustain investors’ exaggerated expectations. This is followed by a twilight period when people continue to play the game but no longer believe in it.”

“This leads,” he says, “to a catastrophic acceleration in the opposite direction, commonly known as a crash.”

What is “commonly known as a crash” is coming to the Internet stocks. And while it is impossible to say exactly when, the “moment of truth” seems to have passed. Now, it is the twilight period, when evening is stretched out, to use T.S. Eliot’s phrase, “like a patient etherized upon a table.”

People still talk about it. It still makes spirits glad on CNBC. But do they still believe in it?

We will have to wait to find out… as the greatest show on earth continues.

Until tomorrow,

Bill Bonner

London, England January 18, 2000

*** Markets were closed yesterday. No news is good news.

*** But life’s major expenses are rising. Oil is over $28. Taxes are at a 25-year high. And Barron’s reports that housing costs were up 10% last year. Consumer inflation, however, rose less than 3%… thanks to the way the government tallies the figures. Computers became more powerful, and cheaper… and depressed the CPI. This cheats the people who rely upon the inflation adjustment figures — the widows and pensioners — to whom computers may be of marginal importance.

*** When Henry I of England found his money changers cheating people by debasing the coinage, he had their testicles and their right hands cut off. But those were less sensitive, less feminine days.

*** The amount of money going into venture capital start-ups last year is estimated to be 10 times as much as 5 years ago.

*** And the number of people benefiting from stock options is enormous. Nobody really knows what effect it will have.

*** Corporate executives, for example, are now taking home 419 times as much compensation as the average factory worker — 1,000% more than they did in 1980. And most of the increase comes from options. The 200 largest companies in the US gave out options in 1998 alone equal to 2% of their total equity. Added to previous years’, stock giveaways reach to 13.2% of the available shares — or $1.1 trillion.

*** Last year, Apple Computer gave 18% of its shares to employees. If anyone is going to come out ahead in the New Era it’s going to be the employees and managers — not the investors.

*** Companies buy back shares in order to award them to managers. Investors applaud because they see the share price rising. But the real effect is a deception. Investors misperceive the higher stock price as reflecting greater investor demand for the shares… when actually it is a labor cost! The acquisition is not treated as an expense item by the company, but a capital transaction — even though the shares are used to compensate employees. So real profit is overstated too.

*** The London firm, Smithers & Co., estimates that US companies earned only half as much as they reported in 1998 — because of the deceptive effect of stock options. (More on this… maybe tomorrow.)

*** Russia is apparently in the midst of a major assault on Grozny. The mothers’ group says that more than 3,000 Russian troops have been slain so far in the Chechen war.

*** I’m here in London enjoying the English newspapers. They have a quirky slant on the news — favoring stories of jilted lovers and naughty priests. Today’s paper has the story of a woman who chose a bad time to tell her husband she wanted a divorce. They were walking along the edge of a cliff by the sea — a large photo of which The Times supplies on page 3. The husband, not yet in tune with the sensitive and feminine impulses of the 21st century, pushed his wife off the cliff… and the family dog too. They washed ashore a week later.

*** Sensitivity hasn’t made its way to Scotland either. The Catholic Cardinal, Thomas Winning, urged his flock to “rise up” against the “perverts.” He was responding to legislation that would remove restrictions against homosexuality.

*** What is it with these Ferris wheels? They lined the Champs Elysees with them for the Y2000 celebrations. And there’s a huge one in central London too.

*** Mark Ford and I wandered down through Soho last night to eat in Chinatown, near Leicester Square. Mark commented on how the feminizing trend had already transformed the business world. Gone are the thundering, cigar-chomping tyrants of the old days… replaced by the sensitive, team-builders in the smoke- free offices of today. It’s business lite.

*** Mark also noted that the financial news had gotten a feminine makeover. Watching CNBC is like watching the daytime talk shows. I saw one yesterday. A pretty blonde woman sat in the middle of a group of young guys. They all looked good… some in suits, some not… and all talking about how they felt about this stock or that one. Never was heard a discouraging word.

*** Leaving the restaurant, we got to see femininity in an entirely different light. Chinese women set up stools in the pedestrian area and give shoulder massages to passers-by. We happened upon what must have been a turf battle. Two women were yelling at each other. Suddenly, one attacked the other, rushing at her and pulling her hair. They went at it for a few moments until a tall young killjoy — who looked a bit like Mao TseTung in his pre-Long March days — interceded. He seemed to be embarrassed by their behavior. A crowd had formed. Still, the women continued arguing in Chinese. Then, one ran to the other’s stool and threw it about 20 feet down the street, barely missing a couple who looked as though they might have been American tourists.

The other woman retaliated instantly, grabbing the purse of her adversary and sending it flying. A young European woman, who was having her neck worked on, got up to get out of the way. And soon, they were at it again as Mark and I headed back to the hotel.

The Daily Reckoning