NEW YORK-The worst is just behind or dead ahead for technology stocks, depending on whether you believe the bull or the bear who shared the dais at the New York Society of Security Analysts’ “Internet Economy Conference.”
Federal Reserve Board Chairman Alan Greenspan has become more villain than hero in the view of Richard Bernstein, chief quantitative analyst for Merrill Lynch & Co. Misplaced reliance on the Fed to limit downside potential for share prices caused a “liquidity bubble” during the past two years, and the potential exists for a repeat performance, he said.
“The tech bubble was more than a set of over-valued companies. It was created by the artificially low cost of capital that lowered barriers to entry and resulted in over-capacity. Deals done in 2000 were termed `pre-revenue’, which means there’s nothing there,” Bernstein said.
“If you want a Nasdaq 3000, there will be more over-capacity and more companies on life support. Look at telecom companies and how much they want to raise; $20 million was raised in the last week, and that means more life support.”
As early April arrived, Arnold Berman, managing director and technology strategist for WitSoundView, began to believe that the light at the end of the tunnel was not an oncoming train.
“By the end of early April, the worst was over. From here on out, the fundamentals are far from perfect, but there are some bright spots: software purchases; corporate spending and things going on in the cellular phone and semiconductor world,” he said.
“In certain segments, like communications, the long-term promise is great, but it’s not delivering yet, so the result is increasing (stock price) volatility.”
But even Berman tempered his bullish outlook with the expectation that there will be a global recession this year, which he characterized as a normal phenomenon that seems unusual only to Wall Street and the technology sector.
“The most important influence on technology is not the economy but group think. Tech spending in the late 1990s resulted from the view that Y2K and the Internet were emergencies, but (generally) tech spending is motivated by pervasive incrementalism, not emergencies,” he said.
“As to what sectors will come back first, New Age stories will have trouble in the next few quarters. Nothing in the communications complex looks good in the short run, and service providers will bear the brunt of this. Semiconductors will lead us out, as they have in the past.”
Bernstein said he would welcome a declining Nasdaq as a remedy to purge unhealthy companies from the system.
“I’m not that bearish on technology to think Nasdaq will go to 1000. If it goes to 3000, that’s OK, provided aggressive growth funds demanding deals from Wall Street don’t suck all the capital into technology and telecom,” he said.
“That’s what damaged the U.S. economy. It was a tremendously inefficient use of capital. Think of what would have happened today had Californians invested three years ago in energy supply instead of dot-coms … Venture capitalists are supposed to fill in capital voids, but they rushed to finance technology at the expense of energy.”
East Coast and West Coast venture capitalists tend to have different investment preferences, but the West Coast typically serves as a trendsetter, said Jesse Reyes, director of Venture Economics. Therefore it is significant that communications companies placed first during the first three months of this year among investments favored by Silicon Valley venture capitalists. Internet companies traded places with communications by dropping into third place after computer firms, which retained their second-place ranking.
Venture capitalists invested $100 million last year in start-up companies, more than the combined total of all such financing from 1980 through 1992, Reyes said.
“The first quarter of 2001 is stronger than (the same period of) 1999, but there is a bit of paranoia by VCs about not being able to raise follow-on financing. Investors also are over-allocated to this asset class, so leverage has returned to the hands of venture capitalists from those of start-up companies,” he said.
Of the companies that went public in 2000, 65 percent were backed by venture capital.
Only three venture capital-backed companies went public during the first quarter of this year, but many others merged or were acquired, Reyes said.
“IPOs have never been fairly judged as an exit strategy for VCs because your shares are still locked up and you still are involved in the management of the public company,” said Gil Fuchsberg, principal of JP Morgan Partners.
Today, there are about 300 public technology stocks trading below their companies’ enterprise value, but “people are frozen” and no one has stepped up to the plate to acquire them, he said.
“We are returning to the pre-bubble exit cycle of three-to-four years, instead of less than a year, and there is more focus on making sure the winners will succeed,” Fuchsberg said.
Ryan Moore, principal of Grand Banks Capital, a new Softbank venture fund, criticized start-up companies and private and public market investors for shirking necessary discipline during the recent technology bubble.
“In some cases, there wasn’t an (ongoing) relationship. Because of easy capital availability, everyone was guilty of bad habits that compromised metrics and discipline. I’m not a public equity guy, but I think there still is too much money out there in the public and private markets.”
In some areas, venture capitalists likely will be more inclined to provide additional rounds of financing for companies in which they already hold stakes than to seek out new start-ups in need of first-round funding.
“Look at emerging telecom companies, like XO (Communications Inc.). Most are far from cash-flow positive. Most are good companies. Some are bad,” Moore said.
“XO just got another round because the (original) bet was so huge by private investors that they are willing to see it through.”
Start-ups seeking initial funding will have a harder time getting it, especially in large increments.
“No one who has taken a bath on a handful of $100 million investments is likely to do so again anytime soon,” Fuchsberg said.
JP Morgan Partners, which has $24 billion in venture-capital investments, is looking for companies positioned to “solve today’s problems instead of assuming behavioral changes by large numbers of consumers, (an assumption) that caused a third of Internet-related company failures,” he added.
In a worst-case scenario, Reyes said there are likely to be “more mergers at distressed, but not fire sale prices.” A number of hybrid leveraged buyout/turnaround funds have been established in anticipation of this.
