Bubble-trouble: What next?

Pratap Ravindran

YOU have, in the second edition of The Internet Bubble, observed that ''the three sectors that had clearly taken the biggest hit were retail e-commerce, content companies and telecommunications-enabling companies.'' This is distinctly intriguing as all three sectors appear to be central to the New Economy. Could you please explain why, in your opinion, these sectors were so badly affected by the bursting of the Internet bubble?

I think that the gross overvaluation in these segments was partially the result of the hyperbole and ''irrational exuberance'' emanating from the notion of the Long Boom. This boom concept was based on the assumption that the US, and ultimately the global economy, was experiencing accelerated growth based on ever-increasing productivity. Proponents of the concept were expecting this boom to last for 20 or 30 years, largely unbroken.

We were always sceptical of this. We agreed with Paul Romer, an economist at Stanford University, who observed that though there had indeed been a steady upward trajectory in the economy in the last 100 years (based in America on a growth in per capita income) this did not mean that the rate of growth was accelerating. Nor did it mean that economic and tech cycles were going away. So we knew that all the overvalued stocks in these segments were particularly ripe for a precipitous fall once we hit an inevitable down cycle in technology and in the economy in general.

You have, in your book, referred to the changing faces of the Web. Could you please elaborate on these?

I think our main point is that the Web will have many faces, not just the primary ones that we see today.

The commercial Internet is indeed still in its infancy. It still has a long way to go in terms of its practical development as a tool for communication and commerce. The challenge now, post-bubble, is to develop new enhancements and products for the Web in the context of rational company-building rather than speculative euphoria. We are confident that there are enough innovative and imaginative entrepreneurs who can make this happen.

The challenge at the moment is coping with the psychology of an inverse bubble where venture capitalists are inclined to overreact to the excesses of the recent past and sit on the sidelines instead of funding new opportunities as aggressively as they should. At the moment, venture firms are hoarding some $45 billion that still can be put to work.

In your opinion, have John and Jane Doe figured out that, during the bubble, they'd got finessed out of their socks by the entities/individuals that you refer to as ''insiders'' - merchant bankers, venture capitalists and so on - and, if they have, how their revised perception of the tech end of the stock market will affect the funding pattern of Internet start-ups/established players in the future?

I am really not sure if the John and Jane Doe investor yet understands how the insider financial food chain operates. If they did, they'd see how the cards are stacked against them, especially for investment in IPOs and ''hot stocks.''

In America, we have a majority demographic that we call ''baby boomers'' who were born in the first two decades after World War II, and that generation has been indoctrinated in the idea that the stock market is always the best place for their retirement savings.

So, even though the get-rich-quick frenzy of the Internet bubble has subsided, this generation is still involved in the market and remains susceptible to stock market momentum trends that lead to financial bubbles. We've already had some evidence this year of some new stock bubbles.

For example, since the September 11 attacks, biometrics companies (which provide security technology such as face-recognition systems) have come very much in vogue amongst investors.

Stocks of biometric companies such as Visionics (VSNX), InVision Technologies (INVN) and Viisage (VISG) have tripled, quadrupled and gone up by 8x respectively since September 11, and they are sporting valuations and P/E ratios comparable to many dotcoms at the peak of the Internet bubble.

The Darwinian shakeout that you'd predicted in the first edition of The Internet Bubble will, in all likelihood, result in a process of massive consolidation. In fact, there is evidence of this process already taking place.

Does this mean that the trust-busters in the US will have their hands full in the next few years or will they just shrug off the whole thing with the argument that information/knowledge economies inevitably create a New Economy version of natural monopolies?

There is already evidence that the Securities and Exchange Commission and the Department of Justice under the Bush Administration are going side by side with the business establishment rather than the little guy.

So I would expect these entities will just shrug off any remaining fall-out from the bubble burst, including any monopolistic mergers that might arise as a result of the Darwinian shakeout.

You have cited, in your forthcoming book, certain ''rules to live by'' as set out by Roger McNamee of Integral Capital Partners. Could you please let us know whether you are in agreement with them, in part or in full? (''Our rules to live by,'' according to McNamee, and carried in 'Making the most of the bubble burst' in eWorld dated November 28, ''represent the collective scar tissue of almost 18 years of investing in technology stocks.'' They include knowing that:

Information is a commodity, but insight is precious.

Product cycles are the only cycles that matter.

Favouring products that are bought, not sold. If a company sells tens of millions of its products, it will not sell them all on the last day of the quarter. They will sell continuously through the quarter.

And keeping in mind that there is only one Microsoft.)

Roger was our main advisor on The Internet Bubble. He is one of the brightest and most forward thinking commentators in the business and has been a very successful investor in technology for a number of years. We included his ''rules to live by'' because we agree with them.

The September 11 terrorist attacks on the US (which took place well after you had completed the manuscript of IB2) have had a significantly negative impact on the US economy. What will be the implications of this impact on the information technology (IT) sector in the US?

On some level, the burst bubble and the terrorist attacks have been a kind of a one-two punch, especially for Silicon Valley. But even prior to the attacks, technology was already well into a down cycle and I believe we were headed for a recession anyway.

The question now is whether this down cycle is a classic 'V' as has been typical in technology markets, or whether it will be more like a 'U' shaped recovery process. A 'U' would make it more like the classic boom and bust cycles that were common at the end of the 19th century and the beginning of the 20th century in the US, such as the one fuelled by the post-Civil War railroad boom that ended up with some $1 billion in railroad stocks being underwater.

One clue is that the bottom of the stock market usually foreshadows the bottom of the economy.

Between now and the middle of next year, it's almost certain that we'll see a closed window for technology IPOs. So things are going to be very slow in that regard for a while. Meanwhile, I don't think we'll see a sustained revival in the overall tech stock market until we have bigger, more established tech companies like Cisco, Intel and HP with good visibility in their businesses that include strong revenues and solid profits.

And without strength in these established companies, it will be very hard for young companies to penetrate markets and sell their products.

pratap@thehindu.co.in

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