A Wild Ride

by Gary Chapman

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Investment advisers are divided on the question of whether the Andrew Buseys of the world are too hot to handle. Brian Goffman, a principal in Austin Ventures, a venture-capital firm that has backed both living.com and Vignette, believes it would be inadvisable for new Internet companies to focus on profits in the short term when the competition for market share is so tough. "Not being profitable is not a liability when capital is so inexpensive to raise," he says. "These are once-in-a-lifetime opportunities." He concedes that a lot of these companies are unstable, but, he says, "that doesn't mean you don't invest. It means you just need to follow basic strategies of portfolio management and consider your ability to handle risk." Others, however, are far less optimistic. "The valuation levels of these companies do not meet our criteria," Hester says. "We're not putting our clients' money there. It's expensive. Eventually there'll be a shakeout, and there will be plenty of time to invest in the winners. People seem to have no fear these days. There's nothing like seventeen years of a bull market to make you drop your guard."

"If you have a chance to invest at an initial price in an IPO, you're good," says Bonnel. "But if you have to buy in secondary markets, it's too dangerous. It's very difficult to invest in Internet stocks."

That's especially true when the stock is volatile. Mark Stryker, the CEO of CyBerBroker, an online securities trading firm in Austin, maintains a list of seventeen to twenty companies—among them Broadcast.com and Internet America—whose share price is on enough of a roller coaster that they warrant a higher margin requirement. The Securities and Exchange Commission requires a margin of 25 percent to hold a stock, but in the riskiest of cases, CyBerBroker requires a 50 percent equity ownership, which makes buying and selling more expensive. Other brokerage firms are following suit. One thing the experts do agree on is that the nature of the Internet suggests that potential investors should pay careful attention to a company's talent, such as management and technical expertise. But there's a catch. "When you're a private company," Goffman says, "you have much more flexibility in valuing your company, and therefore more flexibility in pricing stock options. Once you go public, you lose this flexibility. Your stock options are priced for you." This is a problem because stock options are a big part of compensation packages these days. If options are priced low in a company with a potentially high value, they are more attractive to talented people. But if a public company's stock is overvalued in the market, it becomes harder to convince new hires that stock options are worthwhile. Vignette aggressively hired new people just before its IPO for precisely this reason, a source close to the company says. The apparent easy money available in the public securities market these days may tempt some companies to go public earlier than they might have five or ten years ago—possibly before they're ready. "Many managers of these companies underestimate the value of venture capitalists," says Doug Le Bon, the managing director of Pathway Capital Management, which is based in Irvine, California. "When they turn to the public securities market for financing, there's a cost to their company. They often forgo the experience and management capabilities that can be offered by venture capitalists." In addition some find the paperwork and management overhead of going public a serious distraction from their core business. After Iron Computer, an Austin company that developed a PC for harsh environments, went bankrupt in December, CEO John Opincar told the Austin Business Journal, "I spent two years focused on [our] IPO, so when it fell through, there wasn't much room to go anywhere else."

The big question for investors is whether the Internet frenzy is a speculative bubble that might burst at any time or whether it represents a fundamental realignment of commerce that will make many people rich. Some experts attribute the wild gyrations of stocks to the phenomenon of day trading, the activity of the estimated 5 million individual investors who are buying and selling stocks on the Internet itself. Others point out that the money volume of the activity in these stocks is too large to be attributed to individuals alone and that large institutions are equally to blame.

The most common piece of advice you hear is that all investors—not just those interested in Internet stocks—should forget about the prospect of short-term gains and hang on for the future. "Over the long term," Stryker insists, "the stock price is going to reflect the basic health of the company." "It's very hard to make money day trading," Bonnel says. "Probably ninety-five percent of people will lose money day trading. If you have high expectations, you'll get low rewards." "I can't tell you where this ends," Hester says, "but I doubt the market will appreciate fifteen percent per year, more like eight and a half percent to ten percent." The Gold Rush of 1849 made a handful of people rich, but it stranded thousands of unlucky souls on worthless, rocky land. What will be the fate of the ninety-niners? Probably something similar: There will be a few big winners, and the rest of us will have to keep right on panning.