When an Internet Company Goes Public, Will Its Stock Price Dictate Strategy?
A business professor theorizes that executives take cues from the market
To most people, the wild swings in the shares of small, newly public
Internet companies look like irrational exuberance. Not to Arun Sundararajan.
The New York University business professor thinks they actually contain
thoughtful assessments of cyber-companies' strategies, which he claims
to have decoded.
Moreover, he contends, Internet company executives are absorbing market
information and acting on it, whether they realize it or not. This is a message
that Internet companies considering a public offering might find alarming.
For the last six months, Sundararajan, an assistant professor at NYU's
Stern School of Business, has studied what happened to the stock prices
of 100 Internet companies that have gone public since August, 1995. First,
he observes, Internet companies' prices rise more abruptly in the first
week of trading than companies in other industries -- 36% compared with a
16% average rise -- something he attributes to the difficulty of pricing
this little-understood sector accurately. (In the six months following
their IPOs, about two-third of the companies that Sundararajan surveyed saw
their stocks increase and one-third reported a decline.)
Then, Sundararajan tried to put their stock prices together with news that came out about the companies'
strategies. Taking a counterintuitive tack, he
concluded that as the stock price went up and down -- presumably from investors
who vote with their wallets on what they heard about the companies' contracts,
alliances, earnings, etc. -- some companies would change strategy
in response. Moreover, he says, they may do it subconsciously, since few
executives would admit to adjusting their business in response to wild
In particular, Sundararajan contends, an Internet company that goes
public with dreams of being a leader in the business might back off and
adopt a niche strategy -- if its shares aren't well received by the
market. "Once the firm goes public, it observes how high its price rises,
and it gets an estimate about how good it thinks its prospects are," Sundararajan
says. "They change or choose the best strategy, within a set of strategies,
given the information they have received from the market through the IPO."
SILLINESS. Some small-business experts say the idea that companies adjust their
business to their stock price fluctuations is like saying they consult
a Ouija board. "The vicissitudes of the market have little direct effect
on the actual business of the company itself," says Miles Spencer, founder
of Money Hunt Properties, a multimedia enterprise in Norwalk, Conn., that's devoted to entrepreneurs. "Marking your company's strategy to the fluctuations
in the stock price after an IPO is crazy."
Scott Smith, partner at Howard, Smith & Levin, a New York law firm
that specializes in Internet IPOs, says the stock price isn't saying
anything in particular. But, he concedes, if it goes up astronomically,
and the company suddenly has a $3 billion market capitalization, the business will certainly
get attention. "You can command more respect from the counterparties
who are big software companies, big advertising companies, and others, and
you get respect just because of your size," says Smith.
Still, Sundararajan insists that he has evidence -- though he admits it is
only circumstantial. (The professor says he hasn't queried the companies
about this because their responses would be biased.) He cites Yahoo, whose stock price rose 122% from an initial offering at $13 a
share ($4.43 when adjusted for two stock splits) in its first week of
trading in mid-April, 1996. The shares now trade around $217. Yahoo has gone
on to an array of partnerships and service: with Visa for E-commerce and
shopping services; with Granite Broadcasting Corp. for integrated Web and
television news; and it provides Microsoft's MSN.com with directory services.
Yahoo is considered the top Web portal with $53.6 million in revenue and a
profit of $16.7 million in the third quarter. Media Metrix, a New York
Web marketing company, reports that Yahoo had 30 million viewers last month.
By contrast, Infoseek's stock fell 2% from an initial offering of $12.
Shares now sell for around $34. Revenues for the third quarter were $19.2
million, and it had a loss of $2.6 million. In October, Infoseek sold a
43% stake to Disney for $70 million in cash. The deal allowed Infoseek
to acquire Starwave Corp., which produces ABCNews.com and ESPN.com. But, Infoseek
has only 13.5 million viewers, according to Media Metrix.
Sundararajan also cites Lycos. But here his theory gets
a bit shaky. Lycos' shares, which started at $16 when the company went public in mid-April,
1996, rose a mere 11% a week later. The shares now trade around $63. It
formed partnerships with Bertelsman, the German publishing conglomerate,
to build Web sites in Europe; and with AT&T, where subscribers to the
long-distance company's Internet access service enter the Net via Lycos.
Lycos had third-quarter revenue of $24.8 million and a loss of $2.6 million,
but its viewership -- 28 million last month -- comes close to Yahoo's.
Yahoo Chief Financial Officer Gary Valenzuela, thinks Sundararajan's theory is
backward. What's important, says Valenzuela, is how well a company
delivers on its expectations. Those that live up to their promises well will ultimately
be rewarded with a high stock price. Besides, he says, "There are a lot
of market dynamics that can play into whether an IPO pops and whether the
stock trades well in the aftermarket that could be somewhat independent
of the company's long-term performance."
Harry Motro, chief executive officer for Infoseek, is blunter. He calls
Sundararajan's theory "hogwash." Infoseek has not consigned itself to a
niche category based on price signals from the market. "We have a great
chance to go to the No. 1 position in this industry," says Motro.
"With Disney behind us, we have a great opportunity to grow the brand."
A Lycos official also roundly dismissed the idea that his company is
No one really knows how Internet stocks as a class will fare in the
future. Alhough with America Online Inc. acquiring Netscape Communications
Corp. on Nov. 24, the next big Internet stock plays may be merger bets. But
Sundararajan is convinced that he'll have plenty of opportunities to prove his
point. "The recent slowing down of IPOs in the last few months is only
a temporary glitch," Sundararajan says. One thing does seem certain:
Executives and investors will continue to eagerly look for ways
to predict the performance of those tantalizing Internet stocks as long
as they give such a wild ride.
By Jeremy Quittner in New York