As we watch the Dow make its way past 10,000--just another 26,000 points to go until James Glassman will be content!--and as we watch Internet stocks continue their dizzying ride upward, it's worth remembering the obvious, but sometimes overlooked, point that prices are set at the margin. In other words, a company's stock price on any given day is not determined by all of its shareholders. It's determined by those few (or in some cases, many) thousands of investors who buy its shares that day. Yet those investors, by spending millions of dollars, can increase the value of the company as a whole by billions.
Consider iVillage, the Internet company which went public last week and immediately saw its stock price leap from $24 a share to $80 a share on its first day. (The stock traded as high as $96 before falling back a little.) iVillage sold only 3.65 million shares to the public, which meant it raised $87.6 million in its IPO. But iVillage's market capitalization is now $1.8 billion, because the company has 22.5 million shares outstanding, most of which are owned by employees, venture capitalists, and minority investors.
The fact that the company's "float"--the number of shares that are actually available to buy--is one seventh of its total shares outstanding undoubtedly helped drive up the stock price, since there wasn't enough supply to match demand. But that some investor, on the last trade of the day, was willing to pay $80 for a block of iVillage shares meant that the company as a whole was now worth $1.8 billion.
You might say that's purely a function of this crazy day-trader-driven Net market. As more of those 22.5 million shares come on the market--either when insiders sell shares or when the company sells more of itself to raise money--the market will react accordingly, and prices will drop. If all 22.5 million shares had been available last week, the stock price would never have risen to $80 and the company's market cap would be smaller than it is now.
Well, maybe. But a lot of people--including yours truly--thought that as more and more Internet companies went public, and as companies like Amazon went back to the public markets to raise more money, the added supply would soak up traders' seemingly insatiable appetite for these stocks, and that prices would fall. That hasn't happened (although Amazon and Yahoo are still trading below their 52-week highs). And while there are a lot more Net companies in the IPO pipeline, it's possible that supply alone isn't going to deflate the bubble. The incredible thing about Net stocks is that it isn't just day traders who are willing to pay these prices. Companies acquiring Net firms are paying them as well.
When At Home bought Excite, for instance, it actually paid a 40 percent premium, shelling out $6.7 billion. (That deal hasn't yet closed.) When Compaq bought Shopping.com, it spent $220 million for a company that had $4 million in revenues and that has been sued by the SEC for stock manipulation. And when USA Networks, in making a deal to merge with Lycos, neglected to include a huge premium for Lycos shares, Lycos shareholders bolted. Paying what the market says a company is worth isn't good enough, apparently. You have to pay a lot more if you want the whole company.
That makes sense if you think that the market is systematically undervaluing stocks. In the early 1980s, entire companies were able to be bought for a song because stock prices had been beaten down so heavily. But can anyone plausibly argue that those investors at the margins--the ones who are setting prices--are undervaluing Net stocks? Does it really make sense that day traders are determining what an entire company is worth?
If any of these Net acquisitions were being done with cash, you might see more strict scrutiny on the part of acquirers. As it is, companies like At Home are using their own inflated stocks to buy other inflated stocks. And it's perhaps telling that whenever non-Internet companies--like USA Networks or Disney--have cut deals with Internet companies, they've driven tougher bargains. Still, the next time someone suggests that the only people willing to pay crazy prices for Net stocks are day traders or gullible investors, remind them of all these Net mergers. Crazy as it sounds, in some boardrooms iVillage probably is worth $1.8 billion.