Financial Statements and Dot-Com Crash 2008

Business analysis and valuation
ANALYST
outside
Business analysis Valuation
FINANCIAL STATEMENTS
Step 1: Business strategy analysis

Step 2: Accounting analysis
Step 3: Financial analysis
Step 4: Prospective analysis
1
Financial statements
Separation between ownership and management
Owners keep track of firm’s

financial situation
Income statement Balance sheet
FINANCIAL
STATEMENTS
Statement of changes
Cash flow statement
in equity
2
Business Analysis
The main framework
Financial Statements
Securities analysts Corporate Managers
basis for
a wide range of business analysis Investments bankers
Bankers
Management consultants Independent auditors

3
1
The role of Financial Reporting
in Capital Markets
Savings
CAPITAL MARKETS
Business ideas
Asymmetrical MARKET Incentive

information BREAKDOWN problems
4
“LEMON” PROBLEM
Business Ideas
50% good ideas 50% bad ideas
Expected Value
value value
€ 1,250
€ 1,500 € 1,000
Bad ideas CROWD OUT Good ideas
Emergence of intermediaries 5
The role of Financial Reporting

in Capital Markets
Savings
Financial CAPITAL MARKETS Information

intermediaries intermediaries
Business ideas
Critical role of financial reporting

6
2
Financial Statements’ value
Efficient capital markets
Focus outside capital Market partecipants rely

market context on analytical tools
From Financial Statements

to Business Analysis
True information Financial Statements Distortion and noise
Intermediaries rely on their knowledge of the firm’s industry and its competitive strategy
Step 1: Business strategy analysis
Step 2: Accounting analysis
Step 3: Financial analysis
Step 4: Prospective analysis 8
Dot-Com Crash of 2000

The technology bull market
The 1980’s and 1990’s…
PC-focused technologies and companies
Market Capitalization
COMPANY
(January 3, 2000)
Microsoft $ 603,000,000,000
Intel $ 290,000,000,000
IBM $ 218,000,000,000
Dell Computer $ 131,000,000,000
Hewlett Packard $ 117,000,000,000
9
3
The technology bull market
The 1990’s…
… global information network
Old Economy the internet New Economy
“brick and mortar” AOl, Netscape, Cisco Systems…
… “the next Microsoft”…

10

The New Economy
From July 1999 to February 2000
Dow Jones Industrial Average Nasdaq Composite Index
fell by 7.7 % rose by 74.4 %
11

The New Economy
NEW ECONOMY
GAIN MARKET
SHARE
benefits of to cover high fixed
network effects costs
companies operated at profitability wasn’t the

losses main concern
Revenue growth was the true measure of success

12
4
The New Economy
Market Capitalization Net Income

COMPANY (January 3, 2000) (99/00)
$ $
Amazon,com 30,800,000,000 - 720,000,000
BoubleClick 30,100,000,000 - 56,000,000
Akamai Technologies 29,700,000,000 - 58,000,000
VerticalNet 12,400,000,000 - 53,000,000
Priceline.com 8,400,000,000 - 1,055,000,000
E*Trade 7,100,000,000 - 57,000,000
EarthLink 5,200,000,000 - 174,000,000
Bdrugstore.com 1,600,000,000 - 116,000,000
13

The New Economy
Scient Corporation
• 1997: Founded as Internet consulting firms to lend information technology and expertise
to traditional “old economy”.
• 1999: IPO $ 10 per share. In march 2000 Scient traded at $ 133.75. A valuation of 62
times the company’s revenues.
• 2000: net loss of $ 16 milion on revenues of $ 156 milion. 2,000 employees.
• 2000 (June): Scient’s stock fell to $ 44 as most of the technology sector.
• december 2000: lowered revenues and earnings expectations due to the slowdown for
Internet consulting services.
• december 2000: plans to lay off 460 positions worldwide (over 20% of its work-force).
• february 2001: stock was trading at $ 2.94. 14

The New Economy
IPO Peak % Change Price at end of % Change

COMPANY
price price IPO to peak Feb 2001 from peak
Scient 10 133.75 1,238% 2.94 -97.80%
Viant 8 63.56 695% 3.06 -95.20%
IXL Enterprises 12 58.75 390% 1.25 -97.90%
Lante 20 87.5 338% 1.81 -97.90%
Razorfish 8 56.94 612% 1.16 -98.00%
US Interactive 10 83.75 738% 0.56 -99.30%
Xpendior 19 34.75 83% 0.69 -98.00%
March 2000 NASDAQ February 2001
5,132.52 2,151.83 15
5
Capital Market Intermediaries
How could the dot-com bubble occur in a sophisticated capital market

system like that of the United States?
Why did the market allow the valuations of many Internet companies to go
so high?
What was the role of intermediaries in the process

that gave rise to the stock market bubble?
16

Venture Capitalists
Provide capital for

companies capital market
companies in their early
stand on their own through an IPO
stages of development
The public market changed the way VCs invested during the late 1990s
expectations of high stock ready availability of

market valuations money
17

Investment bank underwriters
advisor financial price the offer underwrite the introduce companies to

services shares investors
… commission based on the amount of money raised in offering
18
6
Sell-side analysts
Follow 15 to 30 Make buy or sell

Form relationships Follow trend in the
companies recommendations
with managements industry
… very influential with investors and market…
Companies were The future price is equal Analysts’ compensations

growing at to what someone is come from investment
astronomical rates willing to pay banking fees in a limited
component
19

Buy-side analysts
Analysts Portfolio managers

The same duties as the Actually manage money
sell-side counterparts
COMPENSATION
How well their stock Performance of their funds

reccomandations did relative to an appropriate
benchmark return
20

Buy-side analysts
Did they really believe the companies were worth what they were trading for?
NO
Stock prices would go up Threat to lag their benchmarks and

even if they were clearly overvalued their competitors
21
7
The Role of Information
The accounting profession
Accuracy of financial Freedom from fraud

statements
91% of internet IPO’s audited by the Big Five accountants
no “going concern” clauses
It’s subjective “The outcome may not have been materially different…”
22

The Role of Information
FASB
some accounting rules were obsolete for the new economy
i.e. i.e.
barter revenues value of intangible assets
(customers, employees, organization)
23

Retail Investor
“Dumb retail investors”
New Internet stock brokers 18% of trading volume of

the NYSE and NASDAQ
Sophisticated institutional money managers bought overvalued

companies
… to sell later even higher valuations…
… retail investor didn’t understand much about the companies

whose shares they were buying
24
8
The companies themselves
benefits
Issue equity In labor market
25
THE BLAME GAME
Can it happen in the future? Are market bubbles an

inevitable part of the economy?
Crashes
The Tulip and the Bulb Craze
The Florida Real Estate Craze
The Great Depression
The Crash of 1987
The Dot-com Crash
26
…

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Business analysis and valuation

Business analysis Valuation

Step 1: Business strategy analysis

Separation between ownership and management

Owners keep track of firm’s

Income statement Balance sheet

The main framework

Securities analysts Corporate Managers

Management consultants Independent auditors

Asymmetrical MARKET Incentive

50% good ideas 50% bad ideas

Bad ideas CROWD OUT Good ideas

The role of Financial Reporting

Financial CAPITAL MARKETS Information

Critical role of financial reporting

Efficient capital markets

Focus outside capital Market partecipants rely

From Financial Statements

True information Financial Statements Distortion and noise

Step 1: Business strategy analysis

Step 2: Accounting analysis

Step 3: Financial analysis

Step 4: Prospective analysis 8

Dot-Com Crash of 2000

The 1980’s and 1990’s…

PC-focused technologies and companies

… global information network

Old Economy the internet New Economy

“brick and mortar” AOl, Netscape, Cisco Systems…

… “the next Microsoft”…

Dot-Com Crash of 2000

From July 1999 to February 2000

Dow Jones Industrial Average Nasdaq Composite Index

fell by 7.7 % rose by 74.4 %

Dot-Com Crash of 2000

companies operated at profitability wasn’t the

Revenue growth was the true measure of success

Market Capitalization Net Income

Dot-Com Crash of 2000

• 2000: net loss of $ 16 milion on revenues of $ 156 milion. 2,000 employees.

• 2000 (June): Scient’s stock fell to $ 44 as most of the technology sector.

• february 2001: stock was trading at $ 2.94. 14

Dot-Com Crash of 2000

IPO Peak % Change Price at end of % Change

March 2000 NASDAQ February 2001

How could the dot-com bubble occur in a sophisticated capital market

What was the role of intermediaries in the process

Dot-Com Crash of 2000

Provide capital for

expectations of high stock ready availability of

Dot-Com Crash of 2000

Investment bank underwriters

advisor financial price the offer underwrite the introduce companies to

… commission based on the amount of money raised in offering

Follow 15 to 30 Make buy or sell

… very influential with investors and market…

Companies were The future price is equal Analysts’ compensations

Dot-Com Crash of 2000

Analysts Portfolio managers

How well their stock Performance of their funds

Dot-Com Crash of 2000

Stock prices would go up Threat to lag their benchmarks and

The accounting profession