Europe's Net Stocks: So Much For Flying High
Investors practically trampled each other to grab shares of Hamburg-based Netlife when it debuted on Germany's Neuer Markt on June 1. Netlife was one of those Internet plays that made the Neuer Markt, an exchange specializing in high-growth companies, so sexy and exciting. But passion has a way of cooling off. Shares of the electronic banking software provider, which began trading at $27, are down over 60% as of Sept. 28. Analysts blame management mishaps, overly ambitious sales projections, and the global meltdown in technology stocks.
Netlife isn't alone. In the last two weeks of September, a chill has settled over Europe's fledgling market in Net stocks. Of the dozen Internet stocks that listed on European bourses in June, July, and August, all but two are below the price reached on the first day of trading. The Neuer Markt is down 30%, its lowest point this year. Ten companies recently shelved plans to list there.
Ouch. It's making European Internet companies and investors wonder if the party is over before it even started. If Europe's tech startups and the fledgling stock markets are broadly discredited, the Continent's progress in developing a U.S.-style New Economy could be set back. A prolonged sell-off could discourage badly needed entrepreneurialism as financing becomes scarce.
BAIL OUT. Internet jitters already have spread to the biotech sector. Germany's Evotech was forced to pull its planned listing on the Neuer Markt for the second time on Sept. 17 because of market volatility. "Everyone coming up for an IPO will be watching the market closely," says Andrew Carruthers, director of NewMedia Investors Ltd., which plans to launch Britain's first publicly traded Internet fund by the end of 1999. "There's a lot of nervousness."
The slide in U.S. Internet stocks has definitely helped set off a corresponding collapse in the European net sector. But don't blame just the U.S. markets. A number of homegrown problems accelerated the rout. According to analysts, many of the 65 European Internet stocks are illiquid and overvalued. They're often brought to market by second-tier investment banks, which bid up the price to generate investor enthusiasm, then quickly sell once official trading begins. Market capitalizations are small, so share prices tumble when institutional investors bail out. And many European investors, newcomers to the stock market as well as the Internet, are spooked by volatility. It's no surprise that Bloomberg's index of European Internet stocks is down 35% since its high on Apr. 14.
Oversupply and overvaluation are the two biggest problems. A glut of new technology initial public offerings has overloaded the still-immature market. Three years ago there were no publicly traded European Internet companies. Today the Neuer Markt lists an estimated 20 companies each month, the vast majority of which are tech-related. At the beginning of September, there were more than 50 in the pipeline. The flood of new issues has been so great that the "market isn't capable of absorbing it," says Alex Magona, a Neuer Markt analyst with Robert Fleming & Co. in London. Retail investors are overwhelmed. Even institutional investors don't yet have the expertise or manpower to do research on that many new stocks.
Investment banks are responsible for the high valuations. Under pressure to do deals and generate revenue, many are skimping on due diligence. Some of the newly public companies are clones of U.S.-originated ideas, with marginal viability as businesses. Ingo Queiser, an analyst at B. Metzler seel. Sohn & Co., a private German bank, believes that the market is still significantly overvalued despite the decline. "We haven't seen the end of the rout," he says.
German online art auctioneer artnet.com is a good example of the flaws in Europe's emerging technology markets. The IPO price was way too high, the company was too small, and its business plan wasn't well developed, says one investment banker whom artnet.com had previously approached to do the deal, but declined. Smart move. As of Sept. 28, artnet.com's shares had fallen 72%, to $14, earning it the dubious distinction as the Neuer Markt's worst-performing IPO.
WAR CHEST. Even more substantial equities are suffering from the blight, as investors discover the perils that face even established Internet companies. Freeserve, an Internet service provider valued at $2.1 billion, has lost more than 24% of its value since its July 26 listing on the London Stock Exchange and Nasdaq. Growing competition, plus a cut in phone rates, could threaten its game plan of offering free Internet access to subscribers. Britain's second-biggest Internet flotation, personal finance group eXchange Holdings, has dropped 15% since its August IPO, despite its war chest of $82 million and plans to make a European acquisition by the end of this year.
The effect of Freeserve's free fall is getting severe for other would-be stock stars. Since the tumble in prices, online auctioneer QXL.com has seen the estimated value of its Oct. 6 IPO cut to $350 million, less than one-third the amount analysts initially expected.
Some analysts think the slump might actually prove healthy over the long run, provided it does not kill the market altogether. "Values of European high-tech stocks were becoming so high they were more like virtual values," says Stefano Micossi, director of Assonime, who heads the Italian Association of Incorporated Companies in Rome. The recent downturn could signal the start of more rational pricing and attract a new influx of money. "The market is becoming more discriminating," says Miles Saltiel, director of technology research at WestLB Panmure in London.
In fact, more firepower may be coming from overseas just when local investors are becoming discouraged. For instance, U.S. buyout firm Thomas H. Lee Co. is creating a London-based fund to offer pre-flotation finance to European Internet companies. GE Equity, the private equity arm of GE Capital, has allocated $50 million for early-stage financing of European Internet companies. In October, the London Stock Exchange plans to create a new index, the FTSE 100 Techmark to compete with Frankfurt's Neuer Markt. The new index will reduce the cost and risk of investing in Europe's tech sector by allowing investors to put their money in a whole basket of companies ranging from blue-chip plays to higher-risk Internet outfits.
There's also a growing drive by governments to finance technology. Britain is working on tax incentives for entrepreneurs, while Germany has already spent $1 billion on subsidies for the high-tech sector. Most important of all, e-commerce is projected to grow even faster in Europe than in the U.S. in the coming years as Europe's Internet users--now 34 million--more than triple by 2003. "The fundamentals that will drive the Internet sector in Europe are better than in the U.S.," says Bruce Gunyea, head of Global Technology Research at Paribas in London. But if they are going to catch the wave, Europe's Internet startups and their backers have some growing up to do.