In life after the bubble, tech takes a backseat

Five years after the dot-com implosion, has Wall Street learned its lesson about high-tech start-ups and IPOs?

Dawn Kawamoto Former Staff writer, CNET News
Dawn Kawamoto covered enterprise security and financial news relating to technology for CNET News.
Dawn Kawamoto
5 min read
Five years ago Thursday, a pin pricked the Internet bubble.

And in that five-year span, the tech-heavy Nasdaq has fallen by more than half, corporate America has pulled back its IT spending, a large swath of jobs have been cut across a number of industry sectors, consumer confidence has waned, and the tech sector, which garnered the biggest benefit during the go-go years, has suffered a black eye.

"It took 86 years for the Red Sox to win the World Series. It may take a little less for the Nasdaq to hit 5,000 again," said Richard Peterson, chief market strategist at Thomson Financial.


What's new:
The dot-com bubble burst five years ago. But tech financiers have learned some lessons since then.

Bottom line:
Venture capitalists are focusing more on profits and less on market growth. But while the IPO market has returned, it's not necessarily ready for tech.

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Those in the tech-financing community have learned some lessons in the last five years. Venture capitalists are placing a greater emphasis on investing in more mature companies than in early-stage start-ups. And investment bankers are floating out largely old-economy companies as initial public offerings.

What makes a bubble?
A bubble is not defined by its financial size, nor is it a case of rapidly rising share prices due to irrational exuberance, said Carl Haacke, a White House economic-policy adviser during the Clinton administration.

He defines a bubble as quickly rising stock prices that are not sustainable. Those stock prices are fueled by a cascade of bad investment decisions and encompassed by competitive pressures by the companies in that industry.

Venture capitalists, who now acknowledge that they contributed to the feeding frenzy of the Internet bubble, say they've learned their lesson and have returned to the practice of funding companies that not only have an enticing idea, but they also carry a strong business plan. Profitability prospects carry more weight these days than revenue and market growth.

In part, that has played a role in the way VCs now fund companies.

"It took 86 years for the Red Sox to win the World Series. It may take a little less for the Nasdaq to hit 5,000 again."
--Richard Peterson, chief market strategist, Thomson Financial

Historically, venture capital firms allocated a third of their funds to invest in new companies, with the remainder going to more mature companies. But last year, the slice of funding to early-stage companies accounted for only a fifth of investments, said Adam Reinebach, vice president of research firm Thomson Venture Economics.

"VCs are now being criticized for not doing enough early-stage deals and spending a larger share of their money on later-stage investments," Reinebach said. "Some people are saying they're getting away from what made them great. But the VCs say its just responsible investing."

Although the composition of the funding pie has changed, the

pie, overall, has grown. Last year, venture capital firms invested $20.9 billion into companies in all industries, reversing a three-year sequential decline.

Wall Street looks for what's next
Overall, the group of 385 companies--including a number of technology businesses--that underwent an IPO in 2000 is performing poorly, according to Thomson Financial. According to the firm, 71 percent of the companies are either trading below their offer price or not at all. The companies in the latter category--including Pets.com and Genuity--have either been delisted, folded or sold.
stock levels

Now Wall Street is starting to embrace the return of initial public offerings, after a long hiatus. But it's not looking to tech.

Last year, companies across all industries raised more than $40 billion with their IPOs, marking the best year since the go-go days of 2000. While there have been a few notable exceptions, such as Google and Salesforce.com, the winners of this renewed investor interest have largely been nontech companies such as automotive supplier TRW Automotive and mortgage insurance company Genworth Financial.

"Technology issues are taking a backseat to old-economy deals," Peterson said. "This year, for example, technology companies accounted for only 29 percent of the IPOs. The question going forward is, will tech be able to regain its momentum?"

A few companies are testing that; during the first three months of this year, Korean online-game company Gravity has filed for an IPO and online retailer Buy.com said it would take another run at the public markets.

Lessons learned
Professional financiers aren't the only ones who have learned from the Net boom. The rise and fall of the bubble had a significant impact on the way ordinary investors view the markets, experts said.

"Many investors ventured into areas where they had little knowledge or experience but loved the expectations of a (large run-up in the stock). They were deeply disappointed. The pie-in-the-sky deals suffered the most," Peterson said, noting that investors are taking a closer look at a company's fundamentals and financial performance.

One economist pointed out that a number of Internet companies born in the late 1990s had reasonable business models but simply overestimated the size of the potential market.

Webvan, for example, had a reasonable business model that was later validated by brick-and-mortar grocery chains Safeway and Albertsons,

which now offer online shopping, said Hal Varian, a business and economics professor at the University of California at Berkeley.

And that business model has also worked for some Internet pioneers such as Peapod, which received a cash infusion from international food provider Royal Ahold.

Varian pointed to Pets.com as another example of a noted online retailer whose business plan was not all that far-fetched. While that company was possibly more well-known for its sock puppet mascot, today retail chains such as Petco Animal Supplies and Petsmart offer online shopping for pet supplies.

And while tech financing has changed in the past five years, one economist notes that the Internet bubble wasn't the first--and likely won't be the last.

A number of booms have emerged since the Internet bubble burst in 2000. Nanotech, Wi-Fi, voice over Internet Protocol and search engines are some of the bubbles that have formed over the last several years, Haacke said.

Nanotech or Wi-Fi may not affect the global economy to the degree that occurred with the Internet bubble in 2000. But the popularity of building businesses to serve China and investments in the country may have such a worldwide effect, said Haacke, author of "Frenzy: Bubbles, Busts, and How to Come Out Ahead."

"One of my concerns is China," Haacke said. "China knows it has a big bubble in their country and is trying to moderate it to avoid a crash. It could have a dramatic effect because so many companies are doing business there...and a lot of banks are helping U.S. business and other companies there."