The psychedelic trip of a Net stock

Yes folks, it's time for a midweek update on one of the most remarkable price surges in the history of the American stock market: the continuing, and even accelerating, rise in the values of the Internet sector.

eBay leaps 766 percent in six weeks
The focus of attention this week? eBay Inc. (Nasdaq:EBAY), the Internet auction site -- a company that has been in business for barely two years, holds no particular lock on its market, yet in the space of just six weeks has climbed an incredible 766 percent in value and as of Tuesday was selling for 812 times projected year-ahead earnings.

These are moments you'll want to cherish for generations as yet unborn, perhaps in the way that some among us still gaze wistfully at the Jack and Jackie collectible plates in the parlor and sigh, "Now there was a First Family America could be proud of." Remember that sentiment when the little tikes come before you and gurgle in delight, "Oh please tell us again, grandpersons, what it was like back in the late 1990s when Internet stocks were worth more than gold!" You'll remember, I trust, to share with them those sepia-toned memories when trees really did touch the sky, whilst from their branches blossomed the endlessly flowering riches of Wall Street on a roll.

For someone who has covered the day-to-day events of Wall Street for 30 years now, there is, I must confess, something at once awful yet fascinating at bearing witness to a Goldman Sachs-underwritten stock that comes to market at $15 and within six weeks is selling for $130. It's like watching every mesmerizing, discombobulated absurdity you can possibly think of, all rolled into one colossal Ur-event -- like watching Mark McGwire step up to the plate blindfolded and hit 400 home runs in a row.

These are the things we just never contemplate happening in life. It's not that they stretch and challenge our frame of reference for what is real and what is not. It's that they totally rearrange all the channel buoys and waypoints with which we navigate through life itself. It just never enters our minds that we might one day pull up to the drive-in window for a Big Mac and medium fries and be handed a coffee cup full of scalding yakk blood by a half-naked steroid freak wearing a sign reading, Hi, I'm the new Governor of Minnesota!

In life as we know it, there just is no place for IPOs that come to market at $15 and within 33 trading days are selling for $130. This changes the rules of the game so fundamentally that the game itself ceases to have meaning. It's like waking up in the middle of that futuristic Woody Allen movie, Sleeper, where genetic engineering produces bananas the size of canoes and 200-year-old Volkswagens start up immediately with one turn of the key.

Goldman Sachs gooses stock
Things like that just aren't supposed to happen. And nor for that matter is an investment firm with the distinguished, white-shoe reputation of Goldman Sachs & Co. supposed to be lending its name -- as it did Tuesday -- to the astonishing statement that it made to the press just before the start of trading.

Specifically, a Goldman Sachs spokesman told wire service reporters that because eBay Inc. had surpassed, within days, the $90 per share "target price" set by the firm back in October, and was now selling for $103 per share, Goldman had decided in its wisdom to lift the target price to $150 -- which announcement instantly caused the stock to spurt four-fifths of the way there by lunchtime.

The rationale given by the analyst for this bald-faced stock hype was an insult to the intelligence. By arbitrarily ramping up its own earlier year-ahead revenue forecasts by 70 percent, then applying a "conservative" (huh?) multiple of 30 times revenues to the arbitrarily inflated number, the firm came up with a per share stock price of $150.

This isn't serious-minded stock analysis, it's just an excuse to put out a statement in which the prestige and reputation of Goldman Sachs is used to lend credibility to a prediction that the stock will go higher. After all, what could possibly have changed to cause such an increase in the analyst's estimated value of the stock in less than a month? Nothing except that the price itself went up!

And Goldman hasn't been the only firm playing this game. The very second after the post-offering "quiet period" expired on Oct. 19, one of the co-underwriters on the deal, BancBoston Robertson Stephens, put out a buy recommendation with the stock at $43 and a target price of $50. Within 24 hours the stock had cracked through the target.

We won't dwell on the fact that if the firm thought the stock was really worth $50, it seems rather odd that they sold it only 20 days earlier for a mere $15. Just forget that for the moment, and focus instead on the fact that scarcely a week passed before a second co-underwriter in the IPO -- Donaldson, Lufkin & Jenrette -- raised the bar still higher by putting a target of $100 on the stock ... which target was supposed to take "six months to a year" to reach but was cracked within two weeks. And now comes the lead underwriter of the bunch -- Goldman, Sachs -- saying the target should really be $150. So, OK: $50 ... $100 ... $150 ... are we beginning to see a pattern here?

Old-fashion stock hyping?
This is full-frontal, right-in-your-face stock hyping, and the best proof is the fact that only six weeks earlier the same trio of underwriters were telling everyone concerned that the stock was really worth $15. Now the same bunch are saying, Oops, we made a mistake, it's really worth $150? (I don't think so!)

eBay is a company with trouble written all over it. Barriers to entry in the Internet auction field are non-existent, and the collectibles and antiques industry is seething with rumors of all sorts of well-established dealers and brokers who are planning to open web-sites of their own. Said one of them to me yesterday, "Inside of a year the entire business will be segmented into special interest sites by known and established dealers, and eBay will be left as a kind of dumping ground for worthless junk like Beanie Babies and crap from your attic."

The company also faces huge potential liability problems. Because it does nothing except bring buyers and sellers together, collecting an average 5 percent fee for items listed on its site that actually get sold, the company never gets involved in checking out whether the items listed for sale are in fact what they are represented to be. Whether the goods are in good condition, bad condition, are legally owned by the sellers or perhaps even stolen, eBay just doesn't know. Like the piano player in the whore house, eBay just looks you in the eye and says, "Hey, what goes on upstairs is between you and your friend there."

Legal pitfalls
In one of the more startling passages in the IPO, the company acknowledges, "The law relating to the liability of providers of online services for activities of their users on the service is currently unsettled. While the Company does not pre-screen the types of goods offered on eBay, the Company is aware that certain goods, such as alcohol, tobacco, firearms, adult material and other goods that may be subject to regulation by local, state or federal authorities have been traded on the eBay service. There can be no assurance that the Company will be able to prevent the unlawful exchange of goods on its service or that it will successfully avoid civil or criminal liability for unlawful activities carried out by users through the Company's service."

To justify eBay's current price level, bulls on the stock are trotting out revenue growth forecasts that simply short-circuit common sense. eBay's reported top-line revenues are, in fact, "net" revenues -- meaning that they represent only the commissions and fees collected on the auctions on its site, not the auction proceeds themselves. Since these fees now run to an average of 5 percent per sale, and since the company's financials reveal that total sales average $40 per transaction, it takes only simple arithmetic to see that Donaldson, Lufkin & Jenrette's wide-eyed forecast of $350 million in 2001 revenues actually translates into an incredible 175 million transactions per year, worth a total of $7 billion. To get the matter down to human scale numbers, that works out to 5.5 transactions, worth $2 each, per second, 24 hours per day, 365 days a year. I predict the costs of keeping even with that traffic will devour the business alive.

The role of day traders
So who's buying this stock? Check out the daily trading volume and you'll see that although the aggregate totals are huge -- 10.1 million shares on Tuesday alone, for a stock with barely 3.5 million shares in the public float -- the bulk of the transactions are for amounts well under 1,000 shares ... the badge of so-called day traders.

These are the Internet's growing army of so-called "mini-mo" traders (individuals who collectively chase -- and thereby aggravate and intensify -- market volatility, both up and down, in hopes of picking up a point our two on a stock in just a couple of minutes, or in some cases, even seconds.)

No one knows how many day traders are now hunched over their terminals, full-time, chasing stocks like eBay skyward in this current blowout phase of the bull market, but the number may easily run to the tens of thousands, perhaps even hundreds of thousands. Says a NASDAQ market maker who was trading eBay up until last week, "If you put up an offer to sell, then turned around to sneeze, you'd come back and find 400 orders smothering you. You'd be short the stock and never be able to get out from under it. What you've got here is nothing less than a huge short squeeze. If you ask me, this stock can go a lot higher... a lot!"

Day trading sites are springing up everywhere -- even in the form of virtual trading rooms on the web. One such site, Trading-Places.net, has been in business since only Sept. 24, and by Tuesday it had 446 members in its trading room. Here is a sampler of comments from the room's chat screen as the day progressed:

"Ebay! Unreal!"
"Ebay and Yahoo ... blowing my freakin' mind...' "
"Ebay outrageous!"
"Ebay, is there any top?"
"Ebay is insane!"
"Ebay is unbelievable!"

Where will this end? I asked a dozen different Wall Street money men that question on Tuesday and not one had an answer. Maybe there is no answer. Maybe this is the "new paradigm" we've been hearing about for years -- the world of investing where earnings don't matter anymore, and neither does quality management or desirable products or anything else. The only thing that matters is that the stock prices keep rising, ever and endlessly, world without end, amen.

Which in closing brings to mind what seems an apt observation by the humorist Will Rogers about how to get rich on Wall Street. It's easy, he said, as he twirled his lasso, "Just buy stocks when they're cheap and when they go up you sell 'em... and if they don't go up, well, then, you don't buy 'em." Ole Will never quite explained how to put the last half of that strategy into practice... or, for that matter, what to do when you tell your broker to sell and he answers, "Great, but to whom? " That's a question I suspect more than a few holders of ebay will one day have asked back at them. Here's hoping they'll know what to answer.