The Internet Bubble
Written before the crash, naming Yahoo among the overvalued.
Summary
Anthony and Michael Perkins founded Red Herring, the magazine covering technology venture investing, and published this in 1999 arguing that internet stock valuations were unsustainable.
Their analysis was straightforward and correct. They computed what revenue and profit growth would be required to justify the market capitalisations of the leading internet companies, showed that the required numbers were implausible for most of them, and identified the specific mechanisms producing the valuations: the small share of stock actually floated, which allowed a high price to be set on marginal trading; the lock-up structures that concentrated selling pressure at predictable dates; the incentives of investment banks whose research analysts were compensated on banking revenue; the venture capital model, which requires exits and therefore requires public market appetite; and the retail investor participation drawn in by media coverage.
They published a list of companies they considered overvalued and were substantially vindicated within eighteen months. The book is a period document and its interest now is as an example of a correct contemporaneous call made by people inside the industry, and of the specific structural mechanisms that sustained the valuations. The authors were themselves participants in the ecosystem they criticised, which they acknowledge. The analysis of analyst conflicts contributed to the regulatory settlement that followed in 2003.
Key takeaways 7
- The revenue and profit growth required to justify 1999 internet valuations was implausible for almost every company examined.
- Floating a small share of a company's stock allows a high price to be set on marginal trading volume.
- Lock-up expiry dates concentrate insider selling pressure at predictable moments after an offering.
- Investment bank research analysts were compensated from banking revenue, which made their recommendations advertising.
- The venture capital model requires exits, which creates a structural interest in maintaining public market appetite.
- The authors published specific overvaluation calls that were substantially vindicated within eighteen months.
- The authors were participants in the ecosystem they criticised, which they acknowledge and readers should weigh.
Who should read it
Investors who want a documented example of a correct contemporaneous bubble call and of the structural mechanisms that sustain inflated valuations.
Where it sits in the reference 2
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