How Steroids Ruined Capitalism
What Happens When Easy Money Mania Stops
“I expect it to go up 50 percent or so on the first day of trading.”
That’s what analyst Richard Peterson of Securities Data in New York said about the Webvan IPO on November 4, 1999. He was too conservative. It rallied ~70% on its first day of trading.
The investing public tripped over itself trying to buy Webvan (WBVN), the hottest new IPO. The company traded roughly the value of its entire invested capital base on that first day. After trading over $30 at one point on that first day, the same shares sold for less than $0.01 just over a year later.
Webvan aimed to deliver groceries to customers, at home. It was a radical concept in the 1990s. People expected pizza delivery, but the idea of having someone do your shopping was totally new.
The company promised to revolutionize domestic life by eliminating trips to the supermarket entirely. It was ahead of its time. Too far ahead in fact.
If you used the internet in the late 1990s you know it was a horse and buggy. Around 80 million people had online access. About half of those reported browsing the web at least one time after gaining access. Only a quarter of them dared to make a purchase online.
Making things worse, most consumers connected through their hard-wired home phone lines. DSL and other direct connections bypassing the phone were still new. None of that slowed down Webvan founder Louis Borders. He had more than a vision. He had access to what at the time looked like an endless pool of investor cash.
The company set out to create from scratch what we have easy access to today. Its visionary, yet primitive service, sometimes required your order days in advance. There were issues with pricing, nobody trusted it. Then there was the 1990s-era website. Compare this to what you’d use today to order groceries.
The idea wasn’t the problem. It was access to excessive amounts of easy money that ruined Webvan. The company made unrealistic plans. The bigger the idea, the bigger the checks from hopeful investors flush with cash.
Easy Money is to Capitalism what Steroids are to Sports
Mr. Borders had retail pedigree. He and his brother opened a small used book store in 1971. They grew the eponymous chain into the retail bookselling giant Borders Books. They eventually sold out to Kmart in 1992.
Louis Borders wanted to do to groceries what he did to books two decades prior. He leveraged his success to go big. He aimed to do in months what took him decades in the book business.
In the mid-90s, money flowed freely to good tech ideas. As the decade wore on, even crazy ideas found funding. By the time Borders wanted to upend the grocery business, money flowed like water from a breached dam.
“Webvan is trying to do something no other company has ever done. It’s a matter of how many steroids you’re taking. Some companies are pumped up, and some companies are really pumped up.”
What Staff means here is Webvan injected the capitalist equivalent of steroids. Quickly after formation, and with almost no revenue, the company took on upwards of ~$500 million in venture capital funding. That happened over several fast-paced investment rounds before raising another ~$375 million on its public debut. Within a few quarters, it went bust.
Easy Money Encourages Reckless Spending
Webvan quickly staffed up. It hired the best and the brightest. Former head of Accenture (Anderson Consulting) George Shaheen agreed to join in September of 1999 just before the IPO. He demanded, and received, a reported $100 million worth of stock options to make the move according to an SFGate.com story about the company’s dramatic collapse.
After Shaheen’s brief reign, Robert Swan stepped in. He negotiated a salary of $375,000 for life, as long as the company stayed in business. Unfortunately for Swan, it didn’t exist for long. This type of blank-check hiring paired with huge business losses doesn’t work when the easy money dries up.
The personnel decisions weren’t the only problem. Webvan enlisted private mega-construction firm Bechtel Group to build 26 state-of-the-art distribution facilities. It envisioned futuristic robots picking grocery orders at peak efficiency. The price tag, $1 billion.
While corporate staff dreamed big, Webvan workers intermixed with shoppers at traditional grocery stores. They picked items by hand using regular push carts.
That’s the way it works with easy money. There’s less accountability. Less pressure to prove the idea. It’s the equivalent of adding the next floor of a high-rise before the concrete dries.
No project is too ambitious when you spend someone else’s money. Pictures of robots make great talking points in an investor presentation. Someone has to pick the groceries until the robots arrive.
In the end, the easy money always dries up. When it does, there better be a real business left to keep the lights on.
That wasn’t the case for Webvan. In 2000 it booked $178.5 million worth of grocery sales. It lost $525 million fulfilling the orders.
Someone Has to Sell This Stuff
For company backers, employees, customers, and especially shareholders, Webvan was a bust of epic proportions.
Keep in mind, $1 billion of wasted or lost capital back then was a huge amount of money. Those were the days where most people thought a $1 million net worth was enough to retire early.
The bankruptcy process sorted out the Webvan wreckage. The company had some assets. Much of that was actual groceries. The bankruptcy administrators sent those to Grocery Outlet (GO).
Grocery Outlet, private at the time, sold Webvan’s food inventory for a tidy profit. The no-frills discount food outlet is a central-California chain. It sells closeouts, dented cans, and any food product it can buy for less than wholesale.
GO is not a glamorous business. In fact, it’s pretty boring. But it makes money on every dented can of soup that crosses the checkout line. Plus, no fancy robots. You pick the can off the store shelf yourself.
The Fed Blew The 90s Tech Bubble, And the Current One
Basic, boring, yet profitable businesses like Grocery Outlet (GO) have been out of favor for years. The Fed’s radical money experiment injected fresh new funding into the economy at the first sign of trouble. The thinking was, that new cash would trickle through the system saving all of us from the pain of recession.
Back in the 90s the numbers seemed so innocent. By last decade, gobs of fresh cash piled up in odd places. Bad ideas, even crazy ideas, kept finding new sources of fresh cash to carry on. Companies pitched pie in the sky plans to eager investors. It’s a perfect combination...until it’s not.
Fed officials these days parade around like media celebrities. They make coordinated statements, subtly telegraph their next move, and always seem to correct things if the market gets too off script. Make no mistake, this is centrally-planned capitalism.
The Fed created our current bubble, the same way it created the 90s tech bubble. The difference is, this one is a lot bigger. But the Fed thinks it can cool things off without causing too much pain for you and me. Even if the plan looks set to fail, we should pay attention as it plays out. Going against it could leave us far behind.
Hiking rates from 0% to more than 5% in roughly a year was part of that plan. It turned off the money spigot. People seem not to notice, but they will.
Investors overpaid for companies using cheap borrowed money. If those companies can’t raise prices fast enough, they’ll face a reckoning when the debt comes due. 5% interest is unmanageable if you borrowed heavily when rates were 0%. If some decide to hand over the keys to creditors, it may set off a deflationary chain reaction.
A Wave of Deflation Comes Next
If you poll your friends about inflation, they’ll likely say it’s on the way up. That’s the common view. People adapted to a surge in prices in 2021. That surge is over.
What comes next is sporadic inventory gluts, weak demand for some products, falling consumer spending. If indebted companies start going bust these trends would pick up steam in a hurry.
The news of student loan debt payments restarting may speed this up. It marks the end a three-year reprieve. Bloomberg estimates around ~$400/mo in payments from 40 million borrowers. Morgan Stanley estimates ~90% of that monthly payment will come from reduced consumer spending. That’s money that won’t go into retail store registers anymore.
Things are about to slow down, quickly. With prices falling, debt costs surging, consumers facing big, unexpected cutbacks, companies may see sales tumble in the second half of the year.
Profitable Business Models to Thrive
It’s times like this where profitable companies with sound business plans take the spotlight.
After dotcom mania turned into a financial disaster for investors, some companies thrived. From the 2002 lows through 2006, profitable firms stood out.
Notice in the chart below how the S&P 500 Index, shown in blue, performed far better than the tech-driven Nasdaq after the 2002 recession low.
Companies do not have to make money to be included in the S&P 500 Index. However, in the wake of the 2000 tech bust, S&P 500 companies were largely more stable than their techy rivals in the Nasdaq. And, those stocks did much better over the next few years.
Today the two indexes are more similar. Positioning for the aftermath of a market correction this time around won’t be easy. We’ll need to own the right individual companies.
So far this year, the average stock in major indexes does not look good. You might know this by looking at your own portfolio. A handful of stocks represent most of the gains touted in the market today. Here are some of the notable returns so far this year through the end of June:
· S&P 500 Index +15.9%
· Nasdaq Comp +31.7%
· Microsoft +40%
· Alphabet +36%
· Amazon +53%
· Salesforce +59%
· NVIDIA +189%
Meanwhile, old-line businesses like energy producers and industrial companies fell far behind:
· ConocoPhillips – (9%)
· Occidental Petroleum – (5%)
· John Deere – (4%)
· Danaher – (10%)
Some of the tech companies listed above make money, plenty of it. But they trade at large multiples, with excessively large market values. They might suffer a period where shareholders need money to recoup other losses, pay taxes, or just live life. If euphoria fades in the second half of the year, share prices could sit idle for some time.
Better Than Webvan’s Liquidated Grocery Inventory
It’s a good time to own things people need.