Looking back at the dotcom bubble

Evolution of the dotcom bubble

At some point in the mid ’90s, the internet went from being a niche toy for nerds to something that most people were at least aware of. Providers like AOL and Prodigy were making access easier, and investors were starting to envision what an online economy would eventually look like.

While it was accurate to believe that internet adoption and digital commerce would increase, investors also overstated the growth potential – and the time frame for tech’s economic dominance. The result was a rapid appreciation in stock prices, followed by a painful crash that slowed tech investments for almost a decade.

A similar dynamic appears to be heating up in the NASDAQ these days: it’s true that tech’s economic rise has accelerated, but investors are likely getting ahead of themselves and bidding up asset prices beyond what they’re fundamentally worth. Let’s take a look back at the dotcom bubble, and see if there are any other lessons we can derive from this history.

Mosaic to Yahoo

In 1993, Mosaic hit the market. It handled many internet related protocols such as FTP, Telnet, and Gopher. Most importantly, though: it was a web browser. For a lot of people, it was the first web browser they’d ever seen, and its licensing terms made it freely available for non-commercial users.

While AOL and Prodigy had already provided a window to the wider web, access was still thoroughly curated and options were relatively limited. These online services – like the Bulletin Board Systems they sought to improve upon – provided an opportunity for online interaction, as well as organized directories of handpicked resources.

Mosaic offered something else: freedom from these systems that resemble today’s “walled gardens” of Facebook and Instagram. With access to a free browser, people started to drive traffic to sites that were organically popular – the ones that other people chose to share links to.

This also created a huge economic opportunity. Web publishers were no longer reliant on editorial access from directory curators at the big ISPs. If you built a website people liked, they would come. Soon, people realized that web traffic could also be turned in to sales and advertising revenue.

In 1994, “Jerry and David’s guide to the World Wide Web” went online. It was a hierarchical directory of interesting websites, and although it wasn’t that different from the directories that large ISPs had previously published, it was also very publicly available to all internet users, regardless of which ISP they were using. It also had a huge future: the next year, Jerry and David would register their new domain name… Yahoo.com.

Irrational Exuberance

When Yahoo stock went public in 1996, it more than doubled in its first day of trading. Over the next two years, it would appreciate more than 600% from the IPO price. In some ways, it made sense. Yahoo had become the most popular website by 1998, and it was the first site that allowed users to search the internet. Even if that search function was extremely limited by today’s standards, it was revolutionary for the time.

Other early web companies thrived in the stock market, as well. In five years, the NASDAQ index would quadruple, led by even larger gains in specific dotcom companies like TheGlobe.com. TheGlobe was an early social network, and although few remember it now, it is infamous in the dotcom bubble hall of fame for appreciating more than 600% in the first day of stock trading. Within a year, that valuation would crash and wipe out 95% of the company’s previously stated market cap.

Y2K and the return of fear

In 1999, a large amount of tech spending was diverted from innovation to maintenance. Fear grew that the “Y2K bug,” as it was known, would disrupt computers and the systems that relied on them. While the worst case scenarios were laughable in retrospect, people were just starting to grapple with the increasing reliance we had on technology. This was also a period where new features slowed down – but the markets were still in overdrive.

In early 2000, the Y2K problem was quickly laughed off and tech appeared poised for another great year on the markets. Dotcoms were buying up to 20% of the SuperBowl advertising slots, and AOL announced they were buying out Time Warner for a staggering $156 billion. At that time, it was the second largest corporate acquisition in market history, and it seemed to cement the supremacy of digital media over more traditional broadcast channels like TV and radio.

From January to March of 2000, the NASDAQ would soar another 25%. But by the end of 2000, it would crash by more than 50%. For all the hype, revenues and profits simply didn’t materialize fast enough.

“Technology is the name of the game. It continues to underperform. The Nasdaq has just been decimated and sentiment is very, very negative.”

12/20/00: Michael Murphy, head of equity trading at First Union Securities

The crash

Prices in tech stocks, telecommunication providers, and even airwave spectrum continued to crash through the second half of 2000 and early 2001. Just as a recovery seemed imminent, 9/11 shocked the nation and created an environment of fear that made Y2K look quaint.

NASDAQ hit rock bottom in October, 2002, with a low price of 1114. Just two and a half years earlier, it was at a peak of 5048.62. Total losses exceeded 75% of the index’s market cap and more than half of all dotcom companies were liquidated in bankruptcy.

Some companies were able to survive by trimming expenses and focusing on core competencies. Amazon, perhaps the most successful of the survivors, used the opportunity to found their web services division. The hardware would’ve been on sale and the market was flooded with programmers who were suddenly looking for a job. It was a bet against the trend, but it was a bet that paid off. These days, Amazon Web Services accounts for more than half of Amazon’s total profit.

The lesson for today

The companies that did survive are among some of the largest in the world, and ultimately, markets were not wrong about the inevitable growth of computer technology as a share of economic activity. They were wrong, though, about how large that share would get, and how quickly it would happen. Many investors paid for that with bankruptcy, and others were rewarded with billions. It wasn’t always “fair,” either. Some CEOs who led doomed startups cashed out early and became billionaires. Others had brilliant ideas and bad luck.

The world today, though, largely resembles what those most forward-looking investors had predicted back in the mid-1990s. The world’s largest companies provide internet services, online shopping, and digital advertising.

We’re experiencing another shift – another acceleration in the digitization of the economy – but it’s also likely that we’re overstating the effect and rushing ahead of this evolution’s time frame.

Big things are certainly coming in technology. Nvidia’s new 3xxx line promises 60 FPS for up to 8k resolution. This will certainly revolutionize gaming, but it also has huge implications for visual AI applications, movies, and small scale video production. Electric cars continue to become more affordable while batteries gain capacity and reliability. Companies are increasingly open to remote work and work from home options, and the tools that enable it will open up a whole new world of remote collaboration.

Just remember: people do want to go back outside at some point! The disruptions we’ve seen in 2020 are unlikely to persist indefinitely, even if the market has already priced it in that way.

A friend of mine has a great line. He says: “Nothing important has ever been built without irrational exuberance.” Meaning that you need some of this mania to cause investors to open up their pocketbooks and finance the building of the railroads or the automobile or aerospace industry or whatever.

And in this case, much of the capital invested was lost, but also much of it was invested in a very high throughput backbone for the Internet, and lots of software that works, and databases and server structure.

All that stuff has allowed what we have today, which has changed all our lives… that’s what all this speculative mania built.

Fred Wilson

Be the first to comment

Leave a Reply

Your email address will not be published.