The Internet is probably the most profound cultural, economic and financial development since the Industrial Revolution. The countless examples during 1999 of the pervasive impact of the Internet included:

• Merrill Lynch, the largest full-service stock brokerage in the world, introduced discount online trading
• IBM announced that it would stop selling PCs through retailers in the U.S. and would sell PCs only over the web
• Encyclopedia Britannica placed its encyclopedia for free on the Internet, swapping two centuries of book sales for an online advertising strategy
• Microsoft and Intel became the first "new economy" companies, and the first Nasdaq issuers, to be included in the Dow Jones Industrial Average

Against this backdrop, it is hardly surprising that initial public offerings by Internet-related companies (" iPOs") dominated the new-issues market in 1999. Still, the extent of the domination was remarkable:

• 289 iPOs raised $24.66 billion in 1999, compared to 42 iPOs raising $1.96 billion in 1998
• iPOs represented 60% of the total number of IPOs in 1999, compared to 14% of IPOs in 1998
• the average i PO ended the year 266% above its offering price, compared to an average appreciation during 1999 for non-Internet related IPOs of only 59%; the Nasdaq Composite was up 86% in 1999 and the Dow increased 25% for the year
• the average iPO closed 90% above its offering price on its opening day
• of the 30 largest first-day gains in IPO history, 29 occurred during 1999, and nearly all were iPOs

The only IPO statistic not dominated during 1999 by iPOs was total proceeds. iPOs represented 60% of all IPOs in 1999 but accounted for 40% of total proceeds, reflecting smaller deal sizes, on average, for iPOs than other IPOs. This was primarily due to seven IPOs over $1 billion each during 1999 by non-Internet related companies, led by UPS ($5.47 billion), Goldman Sachs ($3.66 billion) and Charter Communications ($3.23 billion). Interestingly, even UPS could not resist Internet positioning entirely, noting in its prospectus that during the 1998 holiday season it shipped 55% of the goods purchased over the Internet.

Trends and Observations

Confounding Valuations. iPO valuations confounded observers throughout the year. Profitability was elusive for most Internet companies, and valuations were driven much more by growth potential than traditional financial measures. In some respects, valuations appeared to reflect a portfolio approach, akin to a venture capitalist who trades the certainty of many losers for the hope of a few big winners. Over time, investor patience with delayed profitability may grow thin, as shown by the market's punishment of Amazon.com for its July and October announcements of widening losses.

Hot Sectors. Even within the Internet industry, some sectors were hotter than others. Early in the year, iPOs by "e-tailers" engaged in business-to-consumer e-commerce dominated. As the year progressed and the supply of e-tailer iPOs swelled, enthusiasm cooled and a number of these deals were cancelled or postponed, or had lackluster performance in the aftermarket. By the second half of 1999, the most successful i POs were from providers of Internet network equipment and e-commerce software -- the so-called "plumbers" who support the Internet infrastructure -- as well as companies in the business-to-business (B2B) and Internet telephony spaces.

Unseasoned Issuers. The trend toward younger and smaller companies pursuing IPOs continued in 1999, with 81% having less than $100 million in revenue and 57% being less than five years old. This trend has become extreme among iPOs, with numerous examples of Internet-related companies going public less than two years after formation. The speed and extent of wealth creation as a result of the most successful iPOs in 1999 was without precedent.

Brand Strength. With the surge in Internet companies and iPOs in 1999, brand strength proved as powerful in the online world as on Madison Avenue. The market positions of early Internet titans such as Amazon.com, Yahoo! and eBay were solidified due in part to their name recognition, while scores of newcomers struggled to build up brand awareness. Despite an ad blitz from newer competitors, Media Metrix reported in early January that the 50 most-visited Web sites in the 1999 holiday season were dominated by a handful of well-established Internet companies and the new online initiatives of traditional retailers transitioning their brand strength to the web. None of the e-tailers devoted to health and beauty products, luxury gifts or gift certificates made the top 50 list. It remains to be seen whether the multi-million dollar Super Bowl ads of various dot-com startups will catapult them ahead of the pack.

High Volatility. Beginning with startling jumps on their first day of trading, iPOs in 1999 showed a high degree of volatility. Subsequent price performance of many Internet-related companies, even those with the most successful iPOs, was often dizzying.

Valuation Shifts

Regardless of the ebb and flow of individual Internet stocks, there has been an economy-wide shift of valuation from brick-and-mortar businesses to their online counterparts. The following table compares the market valuations at December 31, 1997 and 1999 of selected long-established, traditional companies (most of which have now introduced online components) and newer, Internet-based counterparts:

^x Company was not public on December 31, 1997. The market valuation for these companies has been calculated by multiplying the company's IPO price by the number of shares outstanding immediately after its IPO.

¹Barnes & Noble owns approximately 40% of barnesandnoble.com.

²Delta has an airline participation agreement with priceline.com and, at the time of priceline.com's IPO, owned warrants to acquire approximately 13% of priceline.com's common stock.

Click and Mortar

Internet companies are beginning to use their highly valued stock to acquire old-line institutions and create "click and mortar" companies. For example:

• In May 1999, eBay, founded in 1995, acquired Butterfield & Butterfield, founded in 1865 and now the third largest auctioneer of fine and decorative art and collectibles in the U.S., for $235 million in eBay stock.
• Wit Capital, an Internet investment banking and brokerage firm established in 1996, acquired SoundView Technology Group, an investment banking firm founded in 1979, for $310 million (paid mostly in Wit stock) in January 2000.
• In January 2000, Charles Schwab, the largest discount online brokerage, agreed to acquire U.S. Trust, a money management firm founded in 1853, for $2.9 billion in stock in order to create a full-service brokerage and wealth management company.
• In the biggest M&A transaction in history, America Online agreed in January 2000 to acquire Time Warner, the largest media and entertainment company in the world with roots dating to the 1920s, in a stock merger valued at $350 billion.

Monthly Data

The number and proceeds of i POs for each month and quarter of 1999 were:

Winners and Losers

Throughout 1999, and especially in the fourth quarter, iPOs provided some spectacular opening days for IPOs. VA Linux Systems closed 698% above its offering price on its first trading day, the largest first-day gain by an IPO stock in history. Other iPOs that were fast out of the blocks included Foundry Networks (525%), FreeMarkets (483%), Cobalt Networks (482%), MarketWatch.com (474%), Akamai Technologies (458%), CacheFlow (427%), Sycamore Networks (386%), Ask Jeeves (364%) and priceline.com (331%). The average first day gain for i POs was 90% for all of 1999 and 107% in the fourth quarter of 1999.

As measured by increases from the iPO price through December 31, 1999, the biggest winners of 1999 were:

^xadjusted for subsequent stock splits

There were also some iPO flops in 1999. First-day losers were led by Cobalt Group (down 24% from its iPO price), Streamline.com (also down 24%) and US SEARCH (down 23%). Through December 31, seven 1999 iPOs were trading down more than 50%, led by Value America (down 78% at December 31 from its iPO price, after closing 140% above its offering price on its first day!), Fashionmall.com (down 66%) and Intelligent Life (down 65%).

Overall, there were far more winners than losers in 1999, with 82% of the iPOs closing on December 31 at a higher price than their i PO prices. The average iPO in 1999 closed 266% over its offering price on December 31, including 16 that increased by more than 1,000% and 46 that increased by more than 500%. The average non-Internet related IPO in 1999 closed 59% over its offering price on December 31

West Coast Tops East Coast

The West Coast generated more iPOs than the East Coast in 1999, primarily due to a flood of California-based iPOs. Overall, of the 289 iPOs in 1999, 162 were by Internet companies based in the Western U.S. (west of the Mississippi River) and 127 were based in the Eastern U.S. California led all states with 115 iPOs in 1999, followed by New York (40), Massachusetts (23), Texas (18), Washington (11) and Virginia (8). Another 20 iPOs were by companies based outside of the U.S.

Leading Underwriters

The underwriters lead-managing the most iPOs in 1999 were:

Top Law Firms

The law firms participating in the most Eastern U.S. iPOs in 1999 were:

Outlook

The iPO market was nothing less than sensational in 1999. Key factors that will influence the iPO market in 2000 include:

Growth in E-commerce: Online spending in the 1999 holiday season surged, but sustained growth is needed to boost e-tailers and related e-commerce companies. Recent events also demonstrate that consumer concerns over credit card security and personal privacy need to be addressed if e-commerce is to be widely embraced.

Interest Rates: The overall market and the market for iPOs appeared to ignore three increases in interest rates by the Fed as yields on 30-year Treasury bills increased 30% during the year. The Fed indicated in October 1999 that it is leaning toward higher rates, and Chairman Greenspan indicated in January 2000 that the Fed is likely to raise the federal funds rate in February.

Smooth Y2K Transition: So far, concerns over possible market turbulence in general, and e-commerce activity in particular, due to Y2K have not materialized. The apparent smooth Y2K transition may boost confidence in e-commerce and free up capital budgets for further expansion during 2000.

Supply and Demand: Supply and demand still matter, and there was a large pipeline of pending iPOs as the year 2000 began.

Star Power: Prominently successful IPOs can have a ripple effect, inducing more offerings and inciting investor interest. Potential stars on deck for 2000 include AltaVista, AT&T Wireless, Palm Corp. (maker of the Palm Pilot) and Pets.com (the pet portal backed by Amazon.com).

On balance, conditions seem favorable for continued strength in the iPO market in 2000, even if the market enthusiasm characterized by Chairman Greenspan as "irrational exuberance" cools. The coming year is also likely to produce a spate of follow-on public offerings and M&A transactions, as Internet companies seek to capture some of their market appreciation of use their highly-valued stock for acquisitions. In the longer-term, the iPO market should remain vibrant as the shift to a web-based economy continues.

David A. Westenberg
[email protected]

Notes on Data: All data in this review was compiled by Hale and Dorr LLP. Offerings by foreign issuers, REITs, bank conversions and closed-end investment trusts are excluded. Offering proceeds exclude proceeds from exercise of underwriters' over-allotment options, if applicable. The data came from a number of sources, including IPO Central, IPO Data Systems, SEC filings, Thomson Financial Securities Data and the Washington Service Bureau.

Copyright 2000 Hale and Dorr LLP. All rights reserved.
January 2000