Dot-com Bubble: how the tech stock market crashed

March 31, 2021

Alright, so let me make a confession. I don’t know enough about the dot-com bubble, and I should, being a tech company CEO, you know.  And mind, you, I’m 32. I was 12 years old at the change of the millennium, but back in 99’ all I cared about was my N64. 

What I know about the dot-com bubble was this massive overhype on internet businesses that happened in the year 2000-ish, which led to a massive market crash. That I know. And, and,... there are some keywords in my head, like eBay and Amazon. If it was in the 2000’s it must have been connected to Y2K, right? 

But I don’t know, know. So we’re doing this video for my own research, and because you guys asked for it!

To truly get a grip on what happened we need to draw a timeline that starts at the early nineties. And the first, key moment in that time was the release of a Web Browser called Mosaic. 

It was released in January 1993 and it was key to popularizing the internet. 

The internet (as a network of interconnected computers) existed before then, and other browsers like  WorldWideWeb, Erwise,[9] and ViolaWWW, but it was Mosaic that helped bring WIDE access to the web. It was developed by the National Center for Supercomputing Applications, and the credit goes for two developers: Eric Bina and Marc Andresseen. 

They both later went on to found Netscape, and release the Netscape Navigator, in December 1994.  Marc Andressen is, of course, one of the co-founders of Andreesen Horowitz, one of the most important venture capital firms today, a firm that has invested in Skype, Twitter, Facebook, Groupon, Zynga, Buzzfeed, Medium, Figma… just to name a few. 

But I’m getting sidetracked. The thing is Mosaic was the first popular internet browser. We could call it the beginning of a widely accessible internet. And other browsers came along later and stole most of its market share: there were, quite literally, browser wars in the 90s. 

In 1993, the internet was limited to dial-up, with a modem, over the phone. Maximum data transfer for modems was 56K, so we are looking at 42h of steady internet connecting to download 1GB of data: and the connection at this time was anything but stable. Even at the turn of the millennium, 256kb was as fast a connection as you could get in your home. 

Internet Access

Let’s add computer access to that timelines. Households in the US with a personal computer went from 8% in 1984 to 36,6% in 1997 and 51% in 2000

But even in this early internet, entrepreneurs saw a field of opportunity. 

Let’s add the number of websites. From 1991 to 1995, uploaded websites went from 1 to 23,500 and there were no signs of slowing. From 1995 to 1996, it jumped 996% to 257,601 websites uploaded

These factors, along with a few others like the launch of Yahoo, led to people seeing the internet as a goldmine. To me, it’s crazy to think that I was alive for this fundamental transformation in our lifetimes, but I was just worried about other things. 

The point was that in these 5 years or so, the internet stopped being a world exclusive for geeks in dark, stuffy basements. There was a lot of hype surrounding Internet companies.

Netscape goes public

Now, here’s another fundamental episode in this story. In August 9, 1995, Netscape went public, and the world was blown away.

Going public means a company’s shares, which were previously owned by the founders and other private investors, can now be traded by the public. 

Companies define an IPO price, initial public offering price, or the price per share they expect people will be willing to pay. 

The point is, Netscape went public at $28 a share. By the end of the day, the price per share had almost tripled, to $75, and ended up closing at $58. 

Now let’s remember that Netscape was founded by these guys less than 18 months prior to that. Their valuation went from $0 to $2.9B in a year or so. 

This insane soar for Netscape suddenly meant that anything and everything with a .com in its name was a golden ticket to millions. The web promised new fortunes and, like cowboys driving into the new frontier, investors rushed to inject money into companies. But, there was no restraint. These companies needed to grow as fast as possible to have more and more users. 

So, many companies invested mostly in advertising. It didn't really matter that many of these companies weren't profitable at all. All that mattered was getting bigger and bigger. 

In 1999, for example there were, there 457 IPOs, many of them Dot Com companies. And those IPOs were very successful.

Just for reference. In 1996, IPOs yielded an average of 17% in their first-day returns. This percentage increased to 58% for non-internet companies in 1999. For Dot Coms, the return was a stunning 89%. 117 Dot Com companies doubled their price on the first day of trading. 

In total, from 1995 to 2001, 439 Dot Com companies raised $34 billion in capital

This got mixed up with a bunch of other variables. In the late 90s, US's interest rates were at their lowest point since the seventies.The Government had lowered tax rates on capital gains from 28% to 20%. 

This meant that investing in bonds, for example, was boring and wouldn’t pay well. 

On the contrary, investors were now motivated to favor low-to-no dividend-paying stocks over those that paid considerable dividends.

For reference on that, a company may decide to pay dividends to its shareholders, if it has leftover profits. Dividends are distributed equally, and usually range from a few cents to a few dollars per share. 

For investors, however, it was better, tax-wise, to invest in stocks that gained a lot of value (on paper) and didn’t necessarily pay dividends. 

These dot-com startups were spending like crazy, profitability was not on the horizon, and it didn’t matter. They didn’t want to turn a profit, they just wanted domination! If that sounds strangely familiar, it’s because it is. 

Let’s get back to the 90s. 

In the mix of all this crazy spending, one person thought differently. Alan Greenspan, the Chairman of the Federal Reserve, warned that this spending was too exuberant. But this warning in itself is a topic of debate. In retrospect, some experts have said that, yes, Greenspan did warn of this erratic behavior but did little to correct it. Still, Greenspan's warning reached deaf ears. Until it was too late. 

There's a saying: hindsight is 20/20. Of course, if we look back, we'll see the signs that told people that there was a bubble. But, if you go back then, what you'd see would be an illusion, high hopes, and lots of partying. They don't say: let's party like it's 1999, for nothing. 

Here comes word of mouth: a lot of it was fuel by an endless loop of hype. Hearsay spread like a virus, motivating more and more investors to get into the mix, amateurs and professionals alike. Think of it as a toxic positivity that would vastly damage the economy. 

Does this sound familiar? 

It wasn’t all speculation, though. Companies like Amazon and eBay were born in the 90s and not only showed promise, but were successful business models. The detail here is that there was only one Amazon and one eBay. The reality was that most Dot Coms weren't meant for success

Some examples, for research sake, 

  • was an online clothing retailer that ended up spending $188 million in just six months. It filed for bankruptcy in May 2000.
  • There was a company called Pixelon: a Streaming video startup that hosted a $16 million dot com party in October 1999 that had bands like KISS, Sugar Ray and a reunion of The Who (you are probably too young to understand what that means). 

Anyway, the point was that there was inevitable FOMO involved here. Such a return was too much to pass up, but at the same time, it became the perfect storm. 

Market crash: It’s about to blow. 

When you look past the hype at the end of it all, a company must generate cash and produce a profit. It's that simple. But, when you're high, it's hard to see reality.  

These companies were spending like crazy on marketing and aspects that had nothing to do with generating revenue or improving cash flow. If they can continue raising money, why focus on revenue? Right? 

Part of the problem was that the expectations created by these massive investment rounds and IPOs was so much, that the value these companies promised far exceeded their capacity to respond. 

 HSBC once reported that companies would've had to grow their revenue by 80% per year to satisfy the valuations during those crazy years. 

Microsoft was one of the best-performing companies at the time, and it "only" managed 50%.  

On March 10, 2000 the NASDAQ index reached an all-time high of 5132,52 points. But, the needles that would prick the bubble were creeping in. 

But hold on, we’ve made it to 2000 and we haven’t talked about Y2K. 

Let’s go back for a sec. 

You, children of this millennium won’t get it. The theoretical problem that Y2K brought was that computers in the past century often counted years with two digits. 88. 95. 

This wasn’t programmers being lazy, on the contrary, it was optimizing for the very limited storage at the time. Additional bits were required to store a full year, and bits back then were expensive. 

So when the computer clock changed millenia, it would go to 00. But how was 2000 different from 1900. 

Other problems were that some programmers had misunderstood the Gregorian calendar rule that states years that are exactly divisible by 100 are not leap years, assuming that the year 2000 would not be a leap year. 

While that rule is correct, there’s an exception to it that states years divisible by 400 are leap years – thus making 2000 a leap year.

Finally, there fear with that people could confuse the day/month/year format on the date. When you have a 99 at the end, it’s easy to tell which one’s the year. But what if it’s 01-11-05. Which is which? (Which by the way, would be simpler if everyone just adhered to the logical DAY-MONTH-YEAR, rather than mixing them pointlessly). 

There was fear, widespread fear, that the world would collapse. Your bank accounts could be locked because you weren’t born yet. 

The US Secretary of Defense said that The Y2K problem is the electronic equivalent of the El Niño and there will be nasty surprises around the globe

Companies like AT&T revealed that "60% of the time and money needed for its total compliance efforts" would be devoted to testing the source code changes made to address the issue. 

I kid you not, I remember having conversations with my friends in school on whether the world was going to end over the December vacation. 

The US had braced the country for the financial chaos that Y2K would cause, and that included lowered rates. But, in February 2000, when it was clear that we had survived, Alan Greenspan announced the need for a dramatic rise in interest rates

He had long warned about the overheated, exuberant economy and that these increases would be necessary. But, as soon as he mentioned the increment in interest, speculation grew rampant, as it was unclear how the higher borrowing costs and increased interest rates would affect Dot Com stocks

Then came another big hit.  

Just three days after the NASDAQ had hit an all-time high, Japan announced that it had entered into a recession. From October to December of 1999, the Asian country had seen the third-largest quarterly decline since World War II.

Japan was a crucial player in the tech market, so this news spread like wildfire, starting a worldwide sell-off of already vulnerable stocks. In no time, NASDAQ fell -39% in 2000 alone. This drop showed the fragility of internet stock as the market suffered significant losses while other markets rose. 

 By March 13 of 2000, the NASDAQ had seen its fourth-biggest point loss in history.

And we were just getting started. On March 20, like a swift sword slaying any remaining hope, the Federal Reserve raised interest rates. Interestingly enough, at first, the Dot Com market believed it wouldn't affect them, and the numbers suggested they'd be safe. 

Add another punch to the market, Microsoft was facing anAntitrust lawsuit by the US Government. Just like the one Facebook is facing right now. 

At the time, Microsoft was said to have created a monopoly using the legal and technical restrictions it put on the abilities of PC manufacturers (OEMs) and users to uninstall Internet Explorer and use other programs such as Netscapeand Java

A failed early settlement of the case hit Microsoft with 15% in losses, and an 8% drop in the NASDAQ.

It was then, and only then that investors, analysts, and experts all raised red flags. To them, it was finally time to look at the numbers. But, it was too late. There simply was no more money. All the hype was gone, all those promises of overnight millionaires disappeared when hit after hit reminded the world that a bubble might be a perfect sphere, but it can also burst easily. 

The year 2000 turned into a rollercoaster with only one direction: down. Tech companies were falling and fast. By November of that year, they had lost $1.75 trillion. In that year alone, 22 000 people had lost their jobs in the Dot Com world. 

All those overvalued Dot Com companies lost 75% of their value in a matter of months. 

 There’s a funny metric to show this insane drop in value, and that’s SuperBowl ads. 

In 1999, only two Dot Com companies purchased Super Bowl ads, one of the most expensive thirty-minute slots in history. The next year, twenty Dot Com companies bought ads. And, just one year later? Only three Dot Com companies bought Super Bowl ads in 2001

Unfortunately, and tragically, 2001 was not a kind year. The September 11 Attacks and several major accounting scandals like ENRON only helped in worsening the crisis. 

By October 2002, NASDAQ had lost 78% of its peak value and returned to 1114.11 points, which were 1995 levels. Five years of hype, speculation, advertising, and dreams disappeared in just 14 months. And the consequences are still present, for better or for worse. 

The Dot Com world dried up into a desert. The species that relied on outside money were dying, starved of their food. Investors were more cautious, and many promising companies just ceased to exist.  

But some survived, of course, with names that you might remember like Microsoft, Google, Amazon, and Apple. In fact, those that survived saw that, in these harsh conditions, they had an advantage. Real estate was cheap, labor was plenty and even less expensive, and the competition was limited

That's not to say they weren't immune. Their stocks plummeted. Amazon, for example, went from $107 to just $7, Apple went from $5 to just under $1. Some might say that they survived the crisis, so they should be examples, and they are. First of all, they had a solid business model and brilliant people at the helm. We're not saying the others were dumb, by the way. 

But, focusing on these companies doesn't answer questions such as what happened? And, who's to blame?

Alan Patricoff, the Chairman of a New York investment firm that handled no less than $11 billion at the time of the crisis, recalls looking back and, once the dust settled, coming upon the harsh truth

"Real companies are built on earnings and cash flow. We gave away millions of dollars for crazy projects, and no one did the hard analysis of what companies could realistically earn. Rationality is coming back."

There's a critical comment there: we gave away millions of dollars for crazy projects. Analyst Quinn Mills agrees. He wrote on Harvard Business Review that we shouldn't blame the Dot Com themselves. In fact, the total opposite. 

To him, and to many, the real culprit was the capital markets. In his words: Venture capitalists bear a marked responsibility for the dot-com disaster, as do the investment banks and brokerage houses that hyped dot-com shares. And behind all three stands the Federal Reserve.

Just as the capital markets helped in injecting cash into this growing world, they also mishandled it. They put their efforts into the wrong things, such as rampant advertising, fueled by greed and desire to expand and grasp everyone in their hands. But, they left the business model behind. 

Quinn reminds us of other culprits, too. The powerful and sometimes dangerous alliance between Wall Street and the Federal Reserve created a lot of money, too much, it might seem. Part of it was to prepare for an apocalyptic phenomenon that never occurred.

The consequences of this crisis were so vast that many wondered if the world would ever recover from this bubble. It sounds irrational now because we've seen that the tech world has regained its strength. But, back then, it was a founded fear. 

That of course brings us to today.. Who here has a parachute for 2020? Even with a health crisis, 2020 was the busiest year for IPOs in a very long time. The last time it was this alive? 2001.

Tulips, Dot Coms, Real Estate, we've been there before. So, what do you think? Is it just a matter of when?

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