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The Voice of the Market

Think that Internet companies are immune to the discipline of investors? Think again.

Last week, Intel (INTC) - Get Intel Corporation Report Chairman Andrew Grove gave a videoconference presentation to the crowd at the Economic Strategy Institute in Washington, D.C. The topic of his speech was sure to prick up a few ears. Grove drew a parallel between today's Internet companies, the recipients of "free" money from today's investors, and the government-sponsored semiconductor companies that got free research money from the government in the 1970s and '80s. Grove's implication? The former, like the latter that preceded them, are being set up to fail.

The heart of Grove's speech lies in the following quote, courtesy of



It remains to be seen whether the Internet companies that have essentially infinite access to capital will be able to grow up to be self-sufficient institutions and adjust to a future when money won't be free.

With all due respect, I think Grove's statement misses an important point. He's dead right about government-sponsored enterprises, of course. Crony capitalism, whether it's in America in the 1970s or Malaysia in the 1990s, always fails. The simple reason is that, with no checks and balances to curb excesses, good money follows bad until these government-sponsored companies collapse under their own weight.

But he's wrong in thinking that Internet companies lack checks and balances. Internet companies benefit both positively and negatively from the stock market's immediate feedback on their every move. The voice of the market is constantly telling them -- make that


them -- to behave in certain ways. The feedback can often be quite subtle, but it is always there.

This voice of the market, for example, made itself heard on the

Lycos-USA Networks

deal well before



most influential shareholder, David Wetherell, began bad-mouthing it. There are a number of reasons why, but the biggest in my mind is that

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USA Networks'

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other television assets simply don't offer the scalability of Lycos' Net business. By lack of scalability, I mean that their revenues can't grow exponentially the way those of a Net business can.

That's why I can't figure out why Lycos CEO Rob Davies and USA Network's Barry Diller keep pushing this deal. The market's already voted. Maybe these two know something we don't, and maybe the stock market is wrong, which happens all the time. But it is an important input, and I say beware to those who miss its signals.

Similarly, when

Charles Schwab



Merrill Lynch


in market value, I don't think the message was missed by a single existing broker-dealer, from

Goldman Sachs

(GS:NYSE) on down. Not long after, Merrill Lynch bought a developer of online trading software from

D.E. Shaw

, while Goldman took an interest in e-banker

Wit Capital


The latest example of this phenomenon is

(AMZN) - Get Inc. Report

. The company enjoys a near-cultlike following -- inside the company, among Internet analysts and among Internet shareholders. The line from Amazon is, "We are building something big." Of course, it has already built something valuable -- Amazon's market cap is some $24 billion. But it had better build something big to fit its already grand plans.

I was thinking of this while standing in the back of a huge room at the recent

Hambrecht & Quist Conference

, where I heard Amazon CFO Joy Covey speak. With a straight face, she informed the gathered assembly that Amazon doesn't care about performance as measured by generally accepted accounting principles such as operating profit or net income.

She made it clear that Amazon will willingly show larger and larger losses as it builds out this business. It will invest in other businesses like pets and drugstores that will ruin its profit-and-loss statement. Not that it has stopped caring about its stock price: The latest round of financing was convertible debt, not equity, because it wanted to minimize equity dilution.

As she went on, I stood between two influential money managers. One leaned over and questioned Amazon's move to sell convertible debt, which "has to be paid back." The other said he was hoping to see the company prove itself by showing profits in one business, say books, before he was willing to give it more rope to build other ones. This is the kind of back-of-the-room feedback that ultimately finds its way into stock prices.

Despite a number of analysts pounding the table, Amazon's shares peaked at 221 1/4 April 27 and now stand at 150, which is a 30% drop. Can they drop 30% again? Sure they can. And further after that? Absolutely.

I've said before that it is the high-multiple end of the growth curve that is always the most dangerous, and that each of these companies can drop in value by as much as 90%. Not only are they prey to changing growth-rate assumptions, but they are also vulnerable to spikes in interest rates. Either of these can bring down a company's P/E multiple in a hurry.

Any company that can go from zero to a nearly $1.2 billion revenue run rate in such a short time is earmarked for greatness. But Amazon must pay some attention to investors' feedback -- or risk having its access to capital pulled from it. Other examples of the market's voice abound.

America Online


was seriously contemplating buying


(CBS) - Get CBS Corporation Class B Report

, but the market's vote -- evident in the ensuing falloff of AOL shares -- told Steve Case such a purchase would surely derail its great stock performance.

I see the same sentiment at work in the fact that


(T) - Get AT&T Inc. Report

shares are down 10% since the company offered to overpay for

MediaOne Group


. At this point, AT&T will probably end up getting MediaOne because



refuses to dilute the Roberts family's monopoly on voting shares (without economic control). Plus, AOL and


(MSFT) - Get Microsoft Corporation Report

can find better uses of their cash than funding Comcast's control of more cable lines.

And yet AT&T may be surprised by what it ends up with. The idea of cable lines being regulated as common carriers -- at least for Internet protocol, or IP-based communication -- has merit. If so, that would mean that anyone can have access to MediaOne's or Comcast's cable lines for a small fee.



agrees, then AT&T will be stuck with yet another regulated business, again. Maybe that's what the voice of the stock market is telling AT&T CEO Michael Armstrong. If so, he'd be wise to listen.

Andy Kessler is a partner at Velocity Capital and runs a technology and communications fund out of Palo Alto, Calif. This column is not meant as a solicitation for transactions; it is instead meant to provide insight into the methods of venture capital, technology and investing. At time of publication, neither Kessler nor his firm held any positions in the companies discussed in this column, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. While he cannot provide investment advice or recommendations, Kessler appreciates your feedback at