Flood of IPOs Puts Net Stocks Underwater

SAN FRANCISCO — Coming soon: the great Internet shakeout.

While previous predictions of the imminent demise of highflying Web stocks have proven erroneous, two seemingly contradictory facts make it more likely than ever that the seas will get rougher.

* Fact No. 1: Shares of Yahoo, America Online and other Internet “blue chips” have fallen 40% or more in the last two months, their worst losses since the Net frenzy began in early 1998.

* Fact No. 2: Despite the weak market, more Internet-related initial stock offerings were registered in May than in any previous month. June is on track to produce yet another record. And the quality of the businesses issuing these shares is dropping--some say by quite a lot.

Demand down, supply up: That spells trouble in paradise.

“I’m a true believer in the Internet, and there are some excellent companies going public,’ said Scott Russell, a venture capitalist with Softbank who sits on the boards of Buy.com and E-Loan--the latter among many companies hoping to launch an IPO soon. “But there are also a lot of crappy companies coming out. There’s going to be a lot of volatility in the future.”

There already has been a lot of volatility, of course.

Take Yahoo, the leading Internet guide. It traded at a split-adjusted $27 or so one year ago. By January the stock reached $207. The shares then plunged as low as $124 in February, before rocketing back up to a record $244 in April.

But then the price began a tortured descent that took it as low as $119.25 last week, before bouncing to close the week at $144.44--still down 41% from the peak.

Of course, Internet investors have become accustomed to such wild price swings. But the latest slump is the most prolonged since Net mania kicked off.

And while some Net IPOs of late 1998 and early 1999 set new standards for first-day price gains, more recent stock offerings have recorded smaller initial gains. Some are even trading below their offering prices--potentially disastrous for companies that hope to raise more money down the road.

Theglobe.com, a Web site community, went public in November at $9. It flew above $48 briefly, but has since sunk to a more earthly $16.63 as of Friday.

Autobytel.com of Irvine, one of several Internet car-buying services, closed at $22 Friday--below its issue price of $23 on March 26. The stock had been as high as $58.

In one of last week’s new Net offerings, Streamline.com--a Westwood, Mass.-based firm that offers a Web-based goods ordering and delivery service for consumers--went public at $10 on Thursday and plummeted to close at $7.63 on Friday.

“There has been severe weakness [in many Net shares], and there’s a real question whether investors will walk away,” said Richard Peterson, a spokesman for Thomson Financial.

Yet Thomson data show that 38 of 82 IPO registrations in May were Internet-related, as were 23 of 35 in June, through last Thursday.

“There’s still this heavy appetite by Wall Street to do these deals, regardless of the price,” Peterson said.

Certainly there’s still an appetite for some higher-profile Net stocks. Pasadena-based GoTo.com, a search engine that allows companies to pay to secure high Web site rankings in search results, surged $7.38 to $22.38 on its first day of trading Friday--a 49% one-day gain.

Still, that reception was much more subdued than the first-day run-ups of Net IPOs late last year and early this year.

To be sure, IPO gains have in part been held down by changes in the way individual investors submit orders for the stocks on their first trading day. Fewer investors may be using “market” orders that require them to pay the prevailing price.

But some investment experts say the waning IPO gains may reflect a long-awaited phenomenon. The sheer quantity of Web-related IPOs has placed so many Internet shares on the market that the original scarcity of Net investments--which helped fuel the price boom--is coming to an end.

That has led some investment managers to move their proposed Net IPOs to the sidelines, perhaps to await a new surge of investor enthusiasm.

“There are some postponements that are starting to happen,” said Andy Sessions, co-head of technology investment banking at Thomas Weisel Partners in San Francisco.

Among California-based Net companies whose IPOs are on hold are service provider CRL Network Services and insurance information firm InsWeb, according to IPO Financial Network.

Institutional Venture Partners, a leading venture firm based in Menlo Park, has invested in several companies that have filed to go public recently. But not long ago, said Geoffrey Yang, an IVP partner, there would have been at least one more face in the crowd.

“There was one company, we were right on the edge on whether to file it [for an IPO] or not,” Yang said. “There was more work to do on rounding out the management team and on nailing down contracts, but the bankers said we could go.”

Instead, the firm decided to wait, he said. “We thought maybe we should hold off for a while. Five months ago, we would have filed.”

Other companies should wait, experts say, but can’t afford to because they are in dire need of capital.

“Some of them don’t have much choice if they want to remain solvent. They’re running on fumes,” said Randall Roth, an analyst at Renaissance Capital’s IPOs Plus Aftermarket Fund.

Many of these companies also have business plans that seem all too familiar, he said.

“There are just too many companies, with too many similar stories, going after the same kind of investor,” Roth said.

Take e-mail hosting. Three companies now in the IPO pipeline offer that service: Usa.net, Software.com and CommTouch.

But they can’t be cheered by the experience of Mail.com, another competitor, which went public last Thursday. The stock sold at $7 a share, down from a planned $12. The stock’s first-day gain Friday was just 25%, to $8.75.

“Eventually, investors are going to see that although the surface looks the same, when you peek a little further into the story, some of these firms are quite rickety,” Roth said.

One irony is that just as ordinary individuals have been getting their best chance to buy IPOs, the spectacular instant returns are evaporating.

Of course, the silver lining in the cloud of Net stocks’ woes is that the slow leak in share prices in recent months may make a drastic collapse less likely.

“A lot of the air has come out of the proverbial balloon,” said venture investor Yang. “That bottoms have started to form [in some stocks] is a really good sign.”

Another unexpected benefit for the youngest Net companies is that hiring and retaining talented people is getting easier. Employees hired at publicly traded Internet companies over the last three to six months are generally holding currently worthless stock options, because the stocks have fallen below the options’ issue prices. Those workers can therefore be more easily recruited by even newer companies that hold out the promise of lucrative options yet to come.

Finally, some companies will now be forced to go through several more rounds of private financing, which may make them financially and conceptually stronger before selling shares to the public.

Beyond that, many Silicon Valley veterans see a future that looks more like, well, the rest of corporate America.

That is, Net companies that have unique technology and dominate their markets will continue to command premium stock prices, while the also-rans will trail off. Some will become takeover targets for stronger firms. Others will simply fail.

No one believes that the beginning of the end of the Net gold rush will cripple emerging technology or long-term financing for the sector overall.

Said legendary technology venture investor John Doerr of Kleiner Perkins Caufield & Byers: “As supply and demand balance we’ll return to a rare period of normalcy, where really good companies can go public and marginal ones cannot.”

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Mania Interrupted

Internet stocks have suffered several pullbacks since the mania for the sector began in early 1998, but the latest decline has been the most severe. Weekly closes for the Chicago Board Options Exchange index* of 12 major Internet shares:

Friday: 468.66

* Index members: Amazon.com, America Online, @Home, Cisco Systems, CMGI, Earthlink Network, EBay, Infoseek, Lycos, Mindspring Enterprises, Network Associates and Yahoo.

Source: Bloomberg News

NET IPOS

A look at deals in the pipeline and performance of recent offerings. C10