Did Netscape Mania Reflect Frothy Market? Maybe Not
Aug. 11, 1995
Netscape Communications Corp.'s breathtaking initial public offering has some of Wall Street's bearish pundits howling. How, they ask, can the stock market be healthy if a company with no earnings can immediately trade with a market capitalization of nearly $2 billion?
``It's certainly not the sign of a market bottom,'' says David Shulman, chief equity strategist at Salomon Brothers Inc. ``To me, this is a sign of froth and enthusiasm that shows investor sentiment has grown overly ebullient. And that's not good news for the market.''
And other analysts note that investors like to link big market reversals to specific events. In 1990, for example, Iraq's invasion of Kuwait helped trip up the market. In 1989 it was the unraveling of the UAL buyout. And in 1987 a dollar crisis contributed to the October stock market crash.
But despite the Netscape hoopla, many analysts and money managers are treating it as a random event. Just one day after the IPO money managers already were turning their focus back to interest rates, which are ticking higher. In addition, economists think it unlikely that the Federal Reserve will cut short-term rates anytime soon, further damping the 1995 bull-market rally which has stalled out since early July.
But for all that, few think the market's current stall will lead to anything terrible. ``We aren't going to see a major correction until the inflation and the interest-rate issues get back on the table,'' says Joseph McAlinden, chief strategist at Dean Witter Intercapital. ``I'm leery about inflation risk over the longer run, but I can't see it becoming a large problem for the market anytime soon.''
A cursory look at some of the standard valuation measures raises few red flags. For instance, the Dow Jones Industrial Average price-earnings ratio, or stock price divided by per-share earnings, is a healthy 14.6, about in line with historical norms. And the pace of earnings growth, while slowing, remains strong with little likelihood of reversing anytime soon. The worst measure is the extremely low dividend yield of 2.43 percent on the Dow Jones industrials, but it has been low for months and many analysts contend that it isn't as important these days because of stock buybacks and aggressive capital spending programs that divert money from dividend payments.
Netscape isn't worrisome to the bulls because it stands alone.
``It doesn't trouble me as much as something like Boston Chicken did,'' says Laszlo Birinyi, head of Birinyi Associates, an investment-research firm in Greenwich, Conn. ``Since it's not the 17th in-a-row, and it has a bit of exotica to it, I'm not especially worried.''
Certainly in the past the occasional red-hot IPO hasn't tended to signal much at all about the overall market. If anything, they're bullish for at least the following six months. According to research by Ned Davis Research Inc., Nokomis, Fla., in the six months following the stunning Oct. 14, 1980, IPO for Genentech Inc., a biotechnology firm, the Dow Jones Industrial Average rose 4.1 percent. In the six months following the December 1980 IPO for Apple Computer Inc., the Dow industrials gained 10.3 percent. And, in the six months following the IPO for Microsoft Corp., the Dow industrials added 2.2 percent.
``It's easy to quip about the toppy nature of the market, but the fact of the matter is that the market often keeps plowing ahead after a deal like this,'' says Mr. McAlinden. ``The market is generally more concerned with issues like inflation and interest rates.''
To be sure, sometimes wild IPOs do come shortly before the market runs into difficulties and Boston Chicken's IPO in November 1993 came less than three months before the early 1994 market top.
More important than the occasional big bang IPO is the pace of offerings. And there's nothing there to suggest any dangerous euphoria. In July, according to Renaissance Capital, 33 percent of IPOs were priced above their filing range, while 63 percent had their offering sizes increased. The combination, analysts say, indicates good price discipline with strong demand.
Interest has even picked up in nontechnology sectors. While Netscape dominated Wednesday's news, investors gobbled up an IPO for UCAR International Inc. The maker of graphite electrodes had its deal size doubled to 17.2 million shares and was priced at $23.75 on Wednesday. Thursday, it rose $3.125 to $26.875 in New York Stock Exchange trading.
Still, there are reasons to be cautious, especially in the technology sector. Netscape's awesome IPO, for instance, showed weakness Thursday, as the Internet software concern's shares plunged $6.875 to $51.375, well down from Wednesday's high of $74.75.
``I hope that the aftermarket, which is resulting in some humble pie'' for those who paid more than $70 ``doesn't sour people on something like the Internet, which has extraordinary dimensions,'' says Neal P. Miller, manager of the Fidelity New Millennium Fund.
Despite Mr. Miller's fears, many Wall Street experts see the second-day weakness in Netscape as a healthy indicator for both Netscape and the broader market.
``It showed some real discipline in the market,'' for investors to push Netscape sharply lower, says William K. Smith, a money manager with Renaissance Capital in Greenwich, Conn. ``The bloom is definitely not off the rose with respect to the Internet, but the opening price of Netscape at 71 added a speculative tint to the deal.''
Roger McNamee, a money manager at Integral Capital Partners in Menlo Park, Calif., warns that the blind success of technology stocks won't last forever. While technology issues moved higher in lockstep during the second quarter, there will come a day of reckoning, he says.
``There's no more certain way to underperform the market in the long run than to own a perfectly diversified portfolio of technology stocks,'' he says. ``The winners win big, and the losers go home. The market, in the long run, will take no prisoners.''