Wake of the crash

The grim toll raises the question of how much investment bankers, who arranged the stock deals for billions of dollars in fees, were to blame for the carnage.

With investors eager to buy into the Internet and high-tech craze, investment bankers abandoned long-held standards about what type of companies were solid enough to be sold to the public. The tech crash that followed could damage the next generation of entrepreneurs -- who find investors wary of trusting valley start-ups and their bankers.

``It could take as much as a generation to recover from the damage done during the bubble,'' said Stephen Diamond, a law professor at Santa Clara University.

Bankers argue that they were simply accommodating an unprecedented level of investor demand -- and greed -- and that there's plenty of blame to go around.

Of 204 companies that made their public debut in the bubble years of 1998 to 2001, 148 -- 73 percent -- have seen their stock prices plunge, or their companies acquired, for half, or less, of their initial price.

Of that undistinguished lot, 82 are dead or in dire straits.

They have been liquidated, declared bankruptcy, been acquired at fire-sale prices, been delisted from trading or face delisting by the Nasdaq Stock Market because of their troubles.

By comparison, in a group of 293 Silicon Valley companies that sold their first shares to the public from 1992 to 1996, only 14 percent were in similar straits in 1997 -- according to a Mercury News analysis at the time.

One critic predicts the banks that got most greedy will pay for it in the future.

``If they choose to discredit their reputation by selling stuff they don't really believe in, they are going to be punished in the future by investors who no longer trust their judgment,'' said class-action lawyer Melvyn Weiss.

Investment banks help companies raise financial backing by selling their stock to the public -- in deals called ``IPOs'' for initial public offerings.

The companies hire investment banks to arrange, market and facilitate trading of IPOs to investors eager to make money.

During the bubble, the IPO process happened at hyperspeed. Bankers, insiders and early investors profited from these deals much faster, and at richer levels, than in the past.

Some got rich

During that time, bankers and select insiders including venture capital investors received more than $1 of every $4 raised for valley IPOs and related stock offerings. Bankers made $2 billion in fees and insiders got $8.7 billion for selling their own shares in the $37.5 billion of offerings.

``Investment bankers and insiders were getting paid,'' said Diamond. ``It's unfortunate that so few companies are left standing.''

Of 204 Silicon Valley companies that investment bankers helped sell their stock to the public from 1998 to 2001:

• Twenty have filed for bankruptcy protection or been liquidated.

• 37 have been kicked off the Nasdaq Stock Market or are at risk of being delisted by Nasdaq.

• Overall, including IPO winners like eBay, the average stock-price performance of the group was a 24 percent decline from their initial IPO prices. However, taking the median, or midpoint, of all prices -- which downplays the impact of big winners like eBay -- the group lost 82 percent.

Bankers shrug off the showing as the result of a ruthless shift in investor sentiment.

In only a few short months at the end of the bubble, investors realized that many of the Internet or high-tech darlings weren't going to make profits anytime soon and sold them off in droves, crushing stock prices and market indexes.

Bankers also point out that the valley's batch of bubble-era IPOs -- despite being an inherently risky type of investment in the best of times -- actually fared better, on an average basis, than the Nasdaq Stock Market, which has plunged 75 percent below its peak three years ago.

But critics say bankers helped rush a number of companies to an early death by unleashing them too early -- before they were making profits or had a strong business plan -- to public investors.

``In retrospect, for the companies that didn't make it, it would have been a much smarter start not to go public,'' said Chris Danne, investor relations expert with Blueshirt Group, who blames a wide range of bankers, venture capitalists and investors for the mess.

After the rush, some investment banks were short on follow-through when times got tough.

``In many cases, companies were led to believe that the investment banks would be there after the IPO dust settled and help create demand for their stock over the long term,'' said investor relations expert Deborah Stapleton. ``But more often than not, companies found that after the check cleared, the banks were on to the next hot deal, and management was left to create that demand on its own.''

New rules

Investment bankers clearly lowered long-held standards for the types of companies that qualified for public ownership. Among those standards:

• Companies should be seasoned and profitable. During the bubble, bankers learned that investors were willing to pay huge prices for the stock of companies like Amazon. com, which was in an exciting new sector but had yet to show a profit.

``Suddenly people said, `Gosh, if they can do that, why can't we?' '' said Stapleton. ``And investment bankers said, `Why not? We can get a big chunk of that.' ''

That led to companies like 1-year-old wireless Internet provider Omnisky going public for $109 million in late 2000. The company filed for bankruptcy protection a year later.

By 2000, only 14 percent of the 77 valley companies going public that year were profitable, down from 69 percent in 1995.

The average IPO in 1995 had made $900,000 in profits before it went public. The average IPO five years later, by contrast, had a $38.9 million net loss.

``At the end of the day, because these companies came public at such an early stage in their life cycles, not all of them ended up executing,'' said one banker.

• Companies should be leaders in proven industries. During the boom, bankers began bringing out unproven runners-up in hot sectors.

Autoweb.com raised $70 million in an IPO at about the same time its competitor, Autobytel, went public in the spring of 1999. After a brief spike, Autoweb's stock price plunged, and it was bought by Autobytel for around $9 million in stock two years later.

• Companies should be able to show results right out of the gate. Because investors were willing to take risks on unproven companies, investment bankers got lax in the ``due diligence'' that, in normal times, would have reassured investors that the performance a company was counting on would actually materialize.

Bankers say that ``due diligence'' in still-developing sectors was often impossible, and that investors were fully informed in investment documents of the risks that these untested, unproven companies might not ever make profits.

``It was a unique period of time when it was unclear which business models were going to pan out,'' said Stuart Francis, head of technology investment banking for Lehman Brothers in Menlo Park. ``It's hard to `due-diligence' the future.''

© 2003 San Jose Mercury News.