The Magazine

Irrational Exuberance

Life in the dot-com boom and bust.

Feb 9, 2004, Vol. 9, No. 21 • By DAVID DEVOSS
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LEDBETTER'S INTRODUCTION to Internet culture came in a Manhattan nightclub at a party celebrating Lycos's purchase of Tripod, a website design company started by a twenty-six-year-old Williams College student. Lycos paid $65 million for the company despite the fact Tripod gave away its service for free. "My first impression was of youth," Ledbetter writes. "Here were more than 150 people, and at the ripe old age of 33 I could plausibly have been the oldest person in the room. . . . Here were enormous sums floating around to create a medium I didn't understand--but my younger, more energetic colleagues seemed to."

By the winter of 2000, the New Economy was in the middle of what Standard editors called "the fat year." So much money was pouring into the stock market that Internet companies were experiencing "viral growth." The previous year, investment banks handled more than 200 dot-com IPOs alone. There was plenty of capital for new ventures. Editor Kurt Andersen told the Washington Post that getting $28 million to start up his online media magazine, Inside.com, was as easy "as getting laid in 1969."

Once the province of early adapters, the e-tailers, e-brokerages, and websites selling virtual real estate (Find Your House With a Mouse!) were now mainstream. Since few were making money, most attempted to validate their existence with advertising. Indeed, Internet companies spent $687 million on advertising in 1999, an increase of 347 percent over the previous year.

New Internet publications such as InfoWorld, Interactive Week, Upside, Business 2.0, Red Herring, Forbes ASAP, eWeek, Information Week, CFO, CIO, and CRM helped sop up the gravy, but much of the new ad money went to the Standard. By August 2000, an issue of the Industry Standard was twice the size of Newsweek. And by the end of the year, it had sold 7,440 pages of advertising and had a net worth approaching $450 million.

Internet magazines spent money as fast as it rolled in. At Wired, every employee received a daily backrub from a massage therapist and a company subsidized lunch prepared by a gourmet chef. At the Standard, there was a hosted cocktail party every Friday, temps were hired to fill out expense reports for Excel-challenged staffers, and any woman who complained of stress was told to get a complimentary facial.

How did the Standard manage to get rich so quickly? By using a technique called "controlled circulation." "A good portion of the magazine's circulation was given away for free," Ledbetter confides. "Traditionally, the gamble is that advertisers will be so enticed by the demographic desirability of a publication's readers that they will overlook the fact that those readers aren't paying for the publication."

Giving the magazine away saves a publisher the considerable expense of soliciting subscription renewals. Upscale readers pay for the magazine by periodically submitting information about themselves that the publisher then can sell to direct marketers. The process, called "customer relations management," in theory should produce a second revenue stream. The problem, of course, is that it's nearly impossible to verify the data your freebie subscribers submit. And when times turn bad, as they soon did for the Standard, both advertising and the amount marketers will pay for information decline in tandem. By August 2001, a year after its peak, the Industry Standard was defunct.

BY THE START OF 1999, AOL had become the most powerful Internet company in the world. The 16-year-old Internet service provider was more valuable than General Motors and Boeing combined. But Steve Case, AOL's billionaire chairman and CEO, knew he needed an established bricks-and-mortar partner if his company were to survive a Wall Street slump or an attack by Microsoft. AOL's pursuit and eventual purchase of Time Warner is documented in three new books, which dissect the biggest merger in U.S. history from complementary perspectives.

In "Fools Rush In," Vanity Fair contributing editor Nina Munk notes that the two companies seemed to have little in common. Time Warner had revenues of $27 billion and 70,000 employees, while AOL had less than $5 billion in revenues and fewer than 15,000 employees. "But from the perspective of the stock market," she writes, "AOL, a company with one-fifth the revenues of Time Warner was worth almost twice as much: $175 billion versus $90 billion." What AOL did not have was the Warner Bros. film library, a publishing company like Little Brown, or a cable news network. Time had all these things plus something even more valuable: the country's second largest cable system.

Time also had a CEO in Gerald Levin approaching retirement age who was looking for a "transforming transaction" to cap a remarkable career. Levin's rise to the top began in 1975 when he convinced the Time board to rent space on a communications satellite. The technological gamble made HBO a national service overnight for the bargain basement price of $6 million. Levin thought lifting Time Warner out of the analog world would be his greatest accomplishment, and it might have been if he hadn't allowed AOL, a company with less than one-third of the operating cash, to grab 55 percent of the newly merged company.

A technology reporter for the Wall Street Journal, Kara Swisher (with Lisa Dickey) brings the cast of corporate characters to life in the deftly written chronicle "There Must Be a Pony in Here Somewhere"--a title that makes sense once you're in on the joke. According to Swisher, the deal that created AOL Time Warner, worth $310 billion at the time of the merger, sputtered from the beginning.

Time's overseas correspondents went into near revolt when forced to use AOL's kludgy software. Expected synergies failed to materialize; corporate cultures clashed. By January 2002, AOL Time Warner stock was worth just $25 a share, reducing the value of the company to $147 billion. Time magazine's art critic Robert Hughes asked Gerald Levin in a very public email: "How can you face yourself knowing how much history, value and savings you have thrown away on your mad, ignorant attempt to merge with a wretched dial-up ISP?"

A DIP in web advertising in the second half of 2000 combined with the plunging value of AOL Time Warner stock should have sent a warning to savvy investors. But it didn't. At the November 2000 Comdex--the annual Las Vegas trade show for computer resellers that had morphed over time into a massive Nerdapalooza for hundreds of thousands of corporate executives, electronics manufacturers, and software retailers--the faithful showed up again to hear Microsoft CEO Bill Gates's annual "state of the industry" speech. In fact Gates's address invariably was an extended commercial for Microsoft products. But that was okay with the 12,000 people shouting, "Bill! Bill! Bill!" in hopes of hastening the appearance of the man who made employee stock options a national currency.

Gates's arrival was followed by a moment of homage worthy of Leni Riefenstahl, during which photographers rushed the stage while affluent spectators, comfortably settled on the far side of middle age, joyfully saluted the world's richest man with the illuminated faces of their cell phones and Palm Pilots.

"Ninety-nine percent of the great Internet applications have yet to be written," Gates said once the frenzy abated. "Consumers will see immediate benefits from our ability to tear down the walls that prevent people from using information in a really meaningful way."

To clarify exactly what he meant, Gates introduced designer Ralph Lauren's son David, who explained how he used Microsoft software to create a website (www.polo.com) that helps the fashion-challenged select attire for business trips and learn how to prevent cashmere from pilling. "With our 'Ask Ralph' feature we've gone beyond the flat screen to create what I call 'merchantainment,'" Lauren beamed. "Now it's possible to not only buy clothes but also book a spa vacation at the same time."

MORE THAN 200 dot-coms declared bankruptcy in 2000. Those that remained found it almost impossible to acquire venture capital because of accounting shenanagins of the sort described by Washington Post reporter Alec Klein in "Stealing Time." Klein's dissection of AOL's accounting procedures is frightening, if only because it shows how easy it is for dishonest executives to inflate the value of corporate stock.

At every party there's a first to leave and last to arrive. Steve Case sold massive amounts of AOL stock just before and during the merger, according to Kara Swisher, pocketing nearly $400 million before taxes. About the time Case was getting out of the market, New Yorker film critic David Denby was getting in. Denby ended up losing nearly $900,000, a sum that more than justifies the name of his book, "American Sucker."

In need of cash following the breakup of his marriage, Denby looked around, saw everybody getting rich, and decided he, too, would make his million. Unfortunately, he turned to Merrill Lynch stock analyst Henry Blodget and ImClone head Sam Waksal for investment advice. It's easy to blame Denby's New Economy misadventure on the envy and avarice of Manhattan's Upper West Side, but readers with diminished 401(k)s, wherever they live, will identify with his futile effort to swim with the sharks.

TODAY, tech stocks are on the rebound. IBM is back in the black. Yahoo! just recorded a $238 million profit. Time Warner's revenue is rising despite the defection of millions of AOL subscribers. Even Henry Blodget, who once earned $12 million a year for dispensing misleading advice, is back in the game, assigned to cover the Martha Stewart trial for Slate.com. By next year it may even be a compliment to say a fast track executive has "digital DNA." But before you jump back into the NASDAQ, hearken to what these dot-com journos have to say.

Strict accounting can measure the performance of a corporation, but the value of its stock floats on conjecture and romantic dreams. It's easy for business professionals, professors, and, yes, even journalists to abandon restraint when secretaries are getting rich from IPOs and your college roommate just quit his job to become a day trader. Now that the NASDAQ is climbing, you'll soon be buying tech stocks once again. You can't fight human nature.

David DeVoss, editor of East-West News, covered the dot-com boom for a variety of publications.