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Bubble Wrap

When the Net-stock bubble bursts -- thanks, in part, to the increasing flood of dubious IPOs (hello, Prodigy!) -- must serious tech stocks get hit, too?

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If there's a company in America with a less appropriate name than that of Internet service provider Prodigy, I don't want to know about it. When you look at the company's long history of failing to become anything more than an eighth cousin to America Online, its string of years in which the hope of profits has receded further and further into the distance, and its old-school technology, prodigy doesn't exactly spring to mind.

Nevertheless, as we all know, dot-com fever means that every Internet company, no matter how feeble, believes that it has a chance at the brass ring. As a result, Prodigy Communications is scheduled to go public this week, and barring some unforeseen collapse in the IPO market, it should raise as much as $100 million. Unlike some Net companies that had recent IPOs, like Marketwatch.com or Broadcast. com, Prodigy has not only a mediocre present but also an essentially hopeless future. Instead of the stock jumping 500 percent or 600 percent on the first day of trading, then, maybe it'll only double.

Prodigy, of course, is pretty much the same company you remember from the early nineties, when Prodigy, CompuServe, and AOL were slugging it out for market share. But Prodigy hamstrung itself by partitioning off parts of its service and charging premium prices. It also failed to react to AOL's carpet-bombing marketing campaigns, and Prodigy's initial investors watched more than $1 billion disappear before dumping the company at a fire-sale price in 1996.

Things have not gotten better since. The company, which is somewhat improbably owned by a Mexican telecom conglomerate, now has only slightly more than 600,000 subscribers, a third of whom belong to Prodigy Classic, which is what remains of the original Prodigy. And Prodigy Classic will be euthanized in October, because the service is not equipped to handle the arrival of the new millennium (i.e., its technology isn't Y2K-compliant).

Not equipped to handle the arrival of the new millennium: Might this not be a message?

Rhe fact that there's a market for a company that has lost almost $200 million in the last two years, that is not growing the way most Internet companies are, and that has no realistic plan for reversing that state of affairs speaks to the bubblelike nature of the current Net boom. Fed chairman Alan Greenspan has likened investing in Net stocks to playing the lottery. But while serious people might disagree about the business prospects for Amazon.com or eBay, no serious person could believe that you'll win the lottery with Prodigy. You buy it for the trade, hoping you'll find a sucker to sell it to ten minutes from now.

At the same time, the Prodigy IPO is also part of a trend that should deflate that Net bubble, which is the flooding of the stock market with shares in Net-related companies. (The dramatic run-up in Net stocks over the past two years has been driven in part by a simple supply-demand equation. Demand for Net stocks has been feverish, and the number of shares available to buy has been relatively minuscule.) It may seem as if a lot of Net companies went public in 1998, but 1999 will really be the year when the market becomes saturated with Net IPOs. What that means, of course, is that the supply side of the equation will rise dramatically, and prices overall should fall.

The Prodigy IPO also points up one of the weirder and more disconcerting aspects of this current bull market, which is just how unbalanced the bull's advance has been. If you're a large-cap stock -- preferably in the technology sector, but pharmaceuticals will do -- with billions of dollars in earnings, or an Internet stock with zero dollars in earnings, investors can't fling enough money at you. But anything in between, and you're probably floundering. Consider this: Although the major indices we use to gauge the overall health of the market -- the Dow, the nasdaq, the S&P 500 -- have been pointed straight up since 1995, those indices are deceptive, because their performance is inordinately swayed by their biggest and highest-flying stocks. In other words, if Microsoft, Intel, and Dell have huge years, it's likely the nasdaq will soar, even if most of the stocks in the index are just treading water. And in the past couple of years -- last year especially -- the gap between the performance of the biggest stocks and the performance of all the others has widened enormously. In 1998, for instance, the S&P 500 was up nearly 27 percent. But the average stock in the index was up just 11 percent, while the 50 largest companies in the index rose 38 percent.

Now, this does make a certain sense. After all, at a time of global turmoil, falling commodity prices, and declining profits, larger companies, especially in the tech sector, have continued to deliver stellar profit growth, profit growth that investors are willing to pay for. In theory, though, investors shouldn't be willing to pay any price for profit growth. Microsoft's earnings performance has been, and probably will continue to be, incredible. But at a certain point its stock should be too expensive to keep rising. And on the flip side, the stock prices of smaller companies, or of large companies whose profits are steady but not spectacular, should become too low not to rise. That's what buying low and selling high is all about.

Normally, then, you'd expect investors to be bargain-hunting already, grabbing beat-up oil companies or chemical producers, or ferreting out those undervalued consumer companies which never recovered from the summer's sell-off. But let's face it: It's hard to be a value investor when the companies you're buying, even if they're giants like DuPont or Kodak, are watching sales shrink while the companies you're not buying -- Cisco, Dell, and Lucent -- are seeing profits zoom. (Full disclosure: I own shares in both Cisco and Lucent.) Which brings us back to the Prodigy IPO.

The real fear about the Net bubble, after all, is not that it will burst. (Almost everyone seems to recognize now that it's a bubble.) The real fear is that when it does -- whether because of the flood of Prodigy-style IPOs, or because Amazon has a bad quarter, or whatever -- it'll bring everything else down with it. And no stocks seem more vulnerable than the large-cap tech stocks that no one seems able to stop buying. When prices get this high, investors get as skittish as young colts. The end-of-the-week nasdaq sell-off, for instance, was caused by no real bad news. Everyone just seemed queasy.

In the long run, all these fears are overblown. If Infoseek implodes, that shouldn't make a dollar of Dell's earnings less valuable, and the thing about Dell and Microsoft and Cisco is that that they have billions of those dollars in earnings, and a year from now they're going to have billions more.

Still, there's no real question that in the past four months -- as the nasdaq has risen almost 70 percent -- Net mania has leaked into the tech sector as a whole. Lucent, Cisco, Sun Microsystems: These stocks have gotten rocket-size boosts because their businesses are related to the Net. But these companies are among the best in America; when the bubble bursts, they may take a short-term hit, but in the long-term they're going to do much more than merely survive. Five years from now, they're going to be worth a lot more.

The connections between the "lottery" market and the real market are still much tighter than they should be. This market is a lot saner than it was in July. But as long as companies like Prodigy have the chance to soar, it's still not sane enough.


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