That's what happened last week with AOL Time Warner. It reported the largest quarterly loss in corporate history, a truly mind-boggling evaporation of wealth. Despite this, AOL's stock actually went up after the announcement. What's going on here?
The market yawned because almost the entire loss stemmed from a previously announced accounting change. AOL wrote down the value of goodwill associated with its mergers and acquisitions, principally the combination of AOL and Time Warner that created today's media behemoth. New federal accounting rules require companies to restate purchases as, well, purchases.
Let's not single out AOL. As the biggest deal-maker of all, AOL reported the largest paper loss, though it wasn't at all unusual in its use of goodwill accounting during the boom years. Yet we shouldn't let the industry off the hook for this one. We're now being told that $50 billion of market value was simply an illusion, an accounting quirk.
What a quirk! There are only a handful of companies in the world even worth $50 billion. Something must be wrong with a system that played fast and loose with numbers to such an extraordinary degree.
The counterargument is that everyone knew the $50 billion, and similar billions other companies carried on their books, were phantoms. AOL and others reported honestly how they were accounting for their transactions at the time. This wasn't Enron-style chicanery; all the information was there in plain view. When you think about it, though, the fact that these accounting mechanisms were pervasive makes the situation even shadier. If "everyone" really appreciated that the most admired companies in America routinely reported numbers they knew were illusory, why did those companies bother to go through the exercise?
If "everyone" really appreciated that the most admired companies in America routinely reported numbers they knew were illusory, why did those companies bother to go through the exercise?
That's how a successful company like VeriSign can purchase Network Solutions for $21 billion and two years later, after more acquisitions, be worth just $2 billion as a combined entity. We're all suddenly noticing that the emperor is stark naked.
I'm not trying to point fingers. AOL and many others would have been punished by the market had they not engaged in what were, at the time, routine and eminently legal accounting techniques. And saying that much of the money the Internet bubble generated was never really there doesn't mean it was all a sham. Even at today's depressed stock-market levels, the Internet has created extraordinary amounts of wealth in a short period of time.
Plenty of technology created during the Internet boom is entirely real and enduring. Even after that $54 billion write-off, AOL is a remarkable business success story (though the final chapter has yet to be written...).
The problem the AOL write-off highlights is a collective one, and it comes down to trust. Trust is the foundation of our entire financial system. For thirty years, since we went off the gold standard, the almighty dollar has been backed by nothing more than the promises of the U.S. government. Absent faith in the stability of the United States, it would be worthless.
Similarly, the stock market, and the economy as a whole, can only function if participants believe the game is fair, and that enforcement mechanisms and remedies will take care of the situations, such as Enron, where it isn't.
We're all suddenly noticing that the emperor is stark naked.
Trust becomes endangered when companies, some investors and regulators decide collectively to pretend that two plus two equals five. Trust became debased when so many of us concluded that the numbers we were seeing were irrational and unsustainable, but we should act as though they were real and justifiable.
We're just now starting to regain our collective trust. The sense of dazed confusion in the technology industry over the past two years is as much about psychology as finances. It takes time to reset our expectations. We may have known intellectually that the boom was over, but we didn't really believe it.
I used to think the bookends of the Internet bubble were Netscape's 1995 IPO--which showed that the Web was paved with gold--and the March 2001 IPO of LoudCloud, Marc Andreessen's next company--which sank like a stone and has never come close to its offering price. Now I've found a more appropriate closing event. AOL Time Warner's write-off is the most powerful indication that the house of cards we were living in has collapsed.
Goodwill write-downs, flameouts of well-funded start-ups and even the collapse of Enron are cathartic. These events are painful, but they provide the necessary public confirmation that the environment has really changed. It's the end of an era. And, let's hope, the end of an error.