Doom Stalks The Dotcoms

When the stock market careened out of control last Tuesday, Rick Neely could only hold on tight. Neely, the interim chief executive of , a struggling software seller, had 200,000 options priced at $7 a share riding on every lurch. Last April, when stock hit $37, such options would have been worth $6 million--chump change by dotcom standards but far better than last week's figure. With down to $3.75, his options were "under water"--worthless. "The drop this week was so dramatic, you can't even comprehend it," says Neely, who took over in January after the previous CEO quit. "Everyone is dealing with the same problem."

Indeed, everyone is. The violent swings of the NASDAQ over the past month have overshadowed the virtual collapse of many battered online companies--e-tailers such as grocer Peapod and music seller CDNow and information-and-advice sites like a year ago were among Wall Street's highflyers but now may be down for the count. Stock prices of these hemorrhaging have plunged 50% to 75% below their 12-month highs, and many trade below their initial offering price. Case in point: shares of , a financial-news-and-advice site, peaked at $71.25 on the day it went public last May but closed at $7.63 last week.

It's not that Americans don't love surfing the Internet and shopping online. Consultant Forrester Research predicts that Web spending will soar from $20 billion in 1999 to $184 billion by 2004. But superheated competition in everything from apparel to videos--e-shoppers can choose from 100 look-alike pet-supply sites and more than 200 toy stores, for example--virtually guarantees mass extinction. "The reality is that many of these companies are simply running out of cash," says Tom Wyman, who watches online shopping for J.P. Morgan. "They are losing anywhere from $10 million to $30 million a quarter." By year's end, Wyman says, "a majority of the owners will be forced to turn out their lights and go home."

The collapse of these new-economy stocks is both a predictable and rational phase of economic development--though it may not feel so rational if you've been burned by them. Launching a dotcom company in recent years has been a bit like getting a license to collect money. Venture capitalists showered you with cash, and Wall Street snapped up your stock at five or 10 times the offering price--sometimes all in the same day--in the hope that you would soon become the next Intel or Microsoft. That money was a magnet for executives of boring old-economy companies, who joined dotcom start-ups for the thrill of working 20-hour days in return for wheelbarrowfuls of options. And certainly, lots of people got filthy rich.

But with many dotcoms declining, neither venture capitalists nor Wall Street is eager to give them a dime, prompting a flurry of IPO postponements. "You'd be a fool to invest in an e-tailer that sells books today or wants to go into any other well-recognized market," says Michael Moritz, a general partner at Sequoia Capital in Silicon Valley, which launched the popular Internet portal Yahoo. "The large waterfront properties have not only been purchased but developed."

The plight of the e-tailers and information providers sharply separates them from their more resilient Internet and technology brethren that have been able to show--ta-da!--actual profits. Companies like Cisco, whose routers switch bits and bytes around the Internet, and Yahoo have seen their stocks rebound after each recent tumble. Shares of Cisco, a company with $12 billion in 1999 revenues, fell to $64 during the worst of Tuesday's carnage but at week's end rallied to $74.94, about 10% off their peak of $82 for the past 12 months.

But the failure of most e-tailers to generate anything resembling income has exposed their strategy as essentially hollow. That's because their game plan has called for spending whatever it takes to attract the millions of eyeballs--and open wallets--that any site must have to turn a profit. And "whatever it takes" has too often meant shelling out more for marketing ploys like Super Bowl TV spots than typical customers spend on online products. Wyman estimates that it costs a company like music retailer CDNow more than $70 to win a customer who may spend less than half that amount before departing forever.

Many companies are only now wising up. "We've had the opportunity to learn the lessons of the Internet," says Glenda Dorchak, CEO of Value America, a discounter that once sold everything from crackers to computers but has narrowed its selection to electronic equipment for home and office. Lesson No. 1, Dorchak says, is that "spending tens of millions of dollars on ads on national TV" doesn't make any sense. In fact, Value America is still trying to recover from its overzealousness. The company laid off nearly half its work force in January and has been scrambling for funds. Its share price has fallen from a high of $74.25 a year ago to just $3.13 last week.