Matteucci’s office, furnished with castoff furniture from his own house, looks like a suburban rumpus room, in sharp contrast to the slick, over-designed offices of many of Silicon Valley’s moguls. Salon Technology got Matteucci on the couch to talk about how to compete in the tech business, the Stanford mafia, and the length of his commute.

How has the atmosphere in Silicon Valley changed since the 1980s?

I see fewer people coming to me in their, let’s say, mid-20s to early 30s and saying, “Hey, I want to work with a mentor for a period of time and learn how to be a general manager and then maybe eventually become a chief executive of a start-up in the Valley.” More people think, “Well, we want to figure out how to make a lot of money pretty rapidly so we have more life choices when we’re 33 or 34 years old,” as opposed to, “I’m just going to build my skill set so I can manage more interesting and more challenging companies in the future.”

It will be interesting to see sort of what this new wave of folks that are focused on [getting] to the point of material comfort are going to do with it. Are they going to sit back and just enjoy their blessings? Or are they going to then contribute their lives and time to helping the poor or helping children or solving world poverty or whatever? Are they going to express themselves in the arts? I don’t think we know yet. I don’t think we know what’s going to happen with the new sort of cadre of very, very wealthy 30-year-olds coming from Silicon Valley and the development of the Internet. It could be great if they devote the second part of their lives to things that are beneficial, or it could be kind of self-indulgent.

You started at Texas Instruments when personal computers were just a blip on the technology radar. T.I. tried and ultimately failed to make a dent in the PC business. Did you take away any lessons from that experience that you brought to Silicon Valley?

At T.I. the PC was pooh-poohed. But there was an underground movement to use personal computers at T.I. and every department had their guy. And I was kind of the guy in the corporate relations department. I was kind of the pusher.

I learned a lot of things from that experience. In fact, I wrote a case [study] while I was at Stanford Business School on the home PC competition between T.I. and [companies like Commodore Computer]. If I had to pull one major lesson I’ve applied again and again — um, mostly successfully — is that business is really not about competing. It’s about making money. T.I.’s culture was so competitive that they would destroy entire market segments in order to make a competitor lose — even if it meant they lost too. In electronic watches and calculators [T.I. drove] prices down way faster than they could get costs down. To the point where the markets just went away.

Competitive strategy is a means to an end. It’s not an end in itself. That’s lost in the way some people learn competitive strategy. In our world we get rewarded by avoiding competition — by building things that are truly innovative, creating markets where none existed before. It really bugs the heck out of me when I’m [advising] a small company and they’re focused so much on competition that they’re spending way too much time thinking about how “We head this guy off or we head that guy off” rather than building a product that will generate revenue and profit.

You’ve spent many years in Silicon Valley in the hardware business. Now you’re at a Net company, you’re running it and you’ve gone public. How does it feel to run a public company? Do you feel intense pressure from Wall Street to keep your stock price up?

I had the benefit of being at a high level at Adaptec when we were a public company, so I was used to meeting the numbers every quarter. That hasn’t really bothered me so much. When I was in the PC peripheral space if you met and exceeded your numbers you were going to get rewarded.

[But on the Internet,] when you don’t have objective numerical metrics by which to judge and compare companies, you begin comparing stories. For example, if a company has a choice of getting a bad deal with a portal or five really, really good deals with other companies, the bad deal with the portal will probably generate more market capitalization for them than the five really, really good deals with five other good companies. There’s too much credit being given to the size of the relationship that you have with another firm. And not enough credit, frankly, being given toward just showing a steady progression of revenue growth and profitability. An AOL deal is worth a lot of market cap — whether or not it’s a fundamentally sound deal to the company.

After Texas Instruments you went to business school at Stanford — the most active spawning ground for tech execs anywhere in the world. I run into Stanford Business school grads at least several times a week. Is there a Stanford mafia?

Yeah, sure. It’s a big secret! We all — we all sit with our backs to the wall and look out windows, you know, so that we don’t get surprised by what’s coming.

No, typically, you’ll find people that you’ve worked with before — in either other companies or in the V.C. world. And you’ll kind of re-institute those relationships. It’s funny. It’s not something that kind of starts when you leave business school and lasts for a lifetime. I do have friends that I’ve kept in touch with ever since business school. But it’s more like we all left business school, we kind of went through some formative years in our career, and now we’re in leadership positions in various organizations — and now we reunite. There’s a level of credibility there. We understand each other. We know what a guy was like 10 years ago. We assume that he’s still as smart and as trustworthy and all those things. I’ve renewed relationships with people from my class of ’86 that I didn’t see between then and now except at reunions.

Will Silicon Valley ever be supplanted by the next tech hot spot? What would make that happen?

It’s likely that [what pushes technology companies to other places] will be a failure of the Silicon Valley infrastructure, rather than the success of some other location. In the five years since the Internet took off you can just see the Bay Area infrastructure almost being brought to its knees in terms of traffic and housing prices and being able to get young employees at a reasonable wage. I just see it getting more difficult every year. Almost by the week you can see traffic get worse and infrastructure begin to crumble. It used to be that San Francisco was just a little ways away from San Jose. Now it can be two and a half hours away from San Jose.

The Internet substitutes for good physical infrastructure to some degree. But I don’t think we’re there yet. I don’t think we’ve really built the tools to make remote productivity a very good thing. It’s now a tolerable thing, but it will get there.

The infrastructure is basically at its knees at this point. I have a 13-mile commute and it can take me an hour to an hour and 20 minutes on a bad day — with no accidents. I mean just a bad day. People used to talk 10 years ago about flextime and shifting work hours. Well, people are just doing it by showing up late. The day starts at 11 for some people because of their commute and it ends at 8, instead of starting at 8 and ending at 5. There’s sort of this grass-roots time shifting going on everywhere.

Are you talking mostly about programmers?

It’s not just engineers anymore. Five years ago I would have said, “Yeah, software guys — they just like to work ’till 2 in the morning.” How many times have we gotten asked in the last two years, “Are you going to open an office in San Francisco?” Well, you know, seven years ago or eight years ago it would have been no big deal to commute down or up to the city. Now it’s like [San Francisco residents] don’t want to come work for you unless you have an office in the city. Or conversely, if they’re [Silicon Valley] engineers, they don’t want to drive up to the city.

I know you have a ranch in Montana. Is that a kind of release from the pressures of Silicon Valley? A release from work?

I get there about five or six times a year, probably 40 days a year. Those 40 days in Montana are kind of working at half pace. Almost every day I’m in Montana the Federal Express guy’ll be coming by and he’ll drop me off some stuff to do and I’ll do a few calls in the morning and stuff like that. And then by mid-afternoon I grab my fly rod and go out to the river and catch some fish or go up to the park and see some geysers, some animals, or, or whatever. It’s really a time for me when the pace of my work changes. It doesn’t ever really go away.

But don’t think colors will be enough for true fashionistas. Gateway will abandon plans for a line of laptops decorated with its trademark Holstein splotches, opting instead for genuine cowhide coverings. But it will be the Be operating system that really comes into its own. BeOS creator Jean-Louis Gassie will team with fellow Frenchman Jean Paul Gaultier on a new BeOS-powered machine decorated with superfluous and scary-looking belts and buckles.

‘Cuz pets can’t drive

Inspired by that hand-puppet pooch singing “Spinning Wheel” on TV, e-commerce entrepreneurs will unleash a pack of pet portals across the Web. By late spring we’ll be reading of violence spawned by the 25 new pet-supply sites: pet portal representatives will come to blows in public parks as they vie to pass out their branded pooper-scoopers. But the market will cheer on this competitive spirit and by mid-summer pet-portal stocks will incite a new Wall Street frenzy, with PetPooch.com making quick work of the VA Linux IPO to become the greatest first-day gainer in public offering history. Its record will last for no more than a week, however, before Biped-Pets.com hits the NASDAQ and rises 1,200 percent on its opening day. By October that record will have been successively laid to rest by Pettrific.com, Iguanas-and-piranhas.com and Petrified.com, while the massive traffic generated by the launch of CelebrityPets.com will slow the Net enough to disrupt day trading. Of course, those in the know will keep up with all this bitingly important activity by reading the Petly News.

Berlinification of Redmond

Microsoft will fail to reach a settlement with federal regulators and, boy, will Bill Gates regret it. Judge Thomas Penfield Jackson will not only break up Microsoft, but will install a military government in Redmond. Following high level negotiations at the World Trade Organization, Microsoft’s campus will be “Berlinified,” with British, French, Russian and American soldiers governing four occupied zones. Thanks to Madeleine Albright’s careful diplomacy, the United States will wind up with control of the applications group, while the Russians will be stuck with the aging, soot-stained factories of the operating systems unit.

And what about Bill? Using a fraction of his stratospheric wealth, he will lure a few biogeneticists from Monsanto and put them to work creating bug-resistant clones of himself. (The future Microsoft leaders are an incredibly tough strain — although they might suffer a chemical meltdown when ingesting pesticide-producing Monsanto potatoes.) Gates then retires and finally makes peace with Netscape founder Jim Clark. The two undertake a round-the-world voyage on Hyperion, Clark’s ultra-computerized yacht, and head for Argentina, which Gates will have bought in a private transaction for an undisclosed sum; the tech duo are reportedly at work on a stand-up routine when they are lost at sea after a computer glitch sinks the 155-foot sailboat.

Finnux redux

Having resolved in a national referendum that it was high time that the country of Finland should be known for something more than saunas and the world’s highest per-capita cell phone use, the Finns will declare an open-source country. Citizenship will be open to anybody who writes any portion of the new constitution. The Finnish parliament, the Eduskunta, will be replaced by a high-powered array of computers that will be responsible for key political decisions such as the appropriate length of time for streetlights to stay yellow. Linux creator and open-source demigod Linus Torvalds, however, will be left out of the decision-making process because of widespread confusion about whether he is a Finn or a penguin.

Dow Lowdown

Dow 36,000? Why stop there? The stock market will (inevitably) continue its inevitable flight toward the firmament; the Dow Jones Industrial Average will finally peak in September at 1.174 million. At that point, someone will finally realize that no one actually knows what the heck that darn number means anyway and start investigating. By October the trail will lead to a rogue day trader, who by that time will have accumulated a staggering $84 trillion of losses with an online brokerage.

“I thought it was just like the adventure games I played when I was kid,” the trader will tell Barbara Walters. “You just hack into the program for five minutes and give yourself infinite hit points.” The discovery will cause a temporary worldwide economic collapse, but global markets will quickly rebound when the legions of indigent laptop owners find Net-centric ways to make a living — like auctioning Beanie Babies on eBay.

Transmeta revealed

After years of total secrecy about its modus operandi, Linus Torvald’s company Transmeta will finally unveil its product. At dawn on the day of revelation, thousands of free-software geeks will gather outside Transmeta headquarters, brandishing stuffed penguins and hoping to be the first to hear about a new chip structure or open-source breakthrough. At noon exactly, Torvalds himself will appear at the doorway with a laptop and a sheaf of press kits and will reveal the secret he’s spent years developing: his new pet portal, Linuxpet.com.

Mahir Spice

Mahir Cagri’s fame will continue to grow, and he’ll be offered the job of Global Goodwill Ambassador for the United Nations where he’ll be introduced to Ambassador Geri Halliwell, nee Ginger Spice. The two will fall madly in love and swiftly marry (“I just love the way he looks in a Speedo,” Halliwell tells the British tabloids); for the top-secret ceremony in Moldova she’ll wear a Union Jack minidress, he’ll have Gucci custom-make an especially shiny suit. Together, they’ll form a band called The Goodwills — Cagri, of course, playing the accordion — and the happy couple will tour the world to sing their message of peace, love and Turk Power.

Titanium butlers

In an attempt to outdo Webvan (the $6 billion online grocery store) and Kozmo.com (the one-hour snack delivery service), two enterprising Stanford MBAs will launch MyRobot.com. The service promises to deliver groceries within an astonishing 20 minutes and will send along a robot to cook a meal for you. Got a hankering for a cappuccino but feeling too lazy to get out of bed? Tap on that laptop: MyRobot.com will send over a titanium butler with a built-in espresso machine to satisfy all your caffeine needs — only $6 a shot. These speedy robots will whip up 12-course meals in seconds flat, and you won’t even need to own a souffli pan (all appliances included!).

The service will prove especially popular in Silicon Valley, where overworked IPO millionaires with empty houses (no time to buy kitchen knives, let alone cook) will discover the pleasure of insta-dinner parties. LVMH Moet Hennessey Louis Vuitton will immediately invest $12 billion; John Paul Gaultier will clamor for the privilege of dressing the robots.

Amazonian

Unsated by its progression from “Earth’s biggest bookstore” to “galaxy’s most dept-ridden department store,” Amazon goes into closed-door meetings to redefine its strategy. Its stock will be at an all-time high after a merger with Wal-Mart/Neiman Marcus (the “We are all things to all people” people), when rumors slip out that Amazon will trade shares worth $13 billion to gain control of an entire e-commerce category. Speculation runs rampant and the story dominates the front page for days as the press struggles to figure out what new direction Amazon is heading in. Finally, as the year 2000 draws to a close, the announcement hits the Web: Amazon will buy all 25 new pet portals.

Of course, there was a little more to 1999 than shopping, although many noteworthy events did seem to revolve around money. Here’s our take on all that came to pass in the final year of the millennium.

Microsoft is a monopolist

Could there have been any bigger story in the tech world in 1999 than Judge Thomas Penfield Jackson’s definitive declaration on Nov. 6 that Microsoft is a monopoly? Not likely, although Jackson’s stronger-than-expected denunciation of Microsoft was considerably watered down just a few weeks later, when he appointed a noted foe of antitrust enforcement, Judge Richard Posner, as a mediator between Bill Gates and the Department of Justice. Even so, Jackson’s 200-plus-page learned treatise on Microsoft, the software industry and the game of monopoly proved that the judge really was paying attention to the interminable hearings that have had Wall Street analysts and technology reporters gnashing their teeth for what now feels like a couple of decades. In devastating detail, Jackson set forth an analysis of Microsoft’s competitive practices that could only have seemed like a very, very bad dream for Redmond, Wash., lawyers. Still, we’re far from closure on this story. Will the two sides reach a settlement? Will Microsoft actually be broken up? Or, worst of all for the Lords of Windows, will the company be forced to give up its all important source code to the greedy scrutiny of the general public and a host of salivating competitors? Check our wrap-up for 2000 — there’s an outside chance we might know the answers to these questions by then.

Dot-com mania

We may be stating the obvious, but Internet mania this year reached ludicrous heights. Venture capitalists disbursed a boggling $9.67 billion to thousands of Internet start-ups in 1999, and the resultingly flush marketing budgets led to an absurd array of pricey TV ad campaigns — $2 billion worth of indistinguishable ads, according to some estimates. By mid-year, you could not watch a sitcom, or even pick up a copy of the New Yorker, without being solicited to visit some site you’d never heard of. As the venture capital trickled down (or would that be up?), celebrities, including drag diva RuPaul, made out like bandits as, um, spokespersons for the identity-desperate dot-coms. Even technology journalists were invited to share the wealth — through a deluge of unbidden PR gifts.

Other consequences: Every news magazine is dedicating half of its coverage to what has been dubbed Riches.com, and wannabe boy billionaires are flocking to Silicon Valley in droves. Worst of all for locals, the cost of living in the San Francisco Bay Area has skyrocketed while, some say, the quality of life has plummeted.

Free software worth billions

In 1999, free software — software for which the underlying source code is by definition always publicly available and free — became big business. Before Red Hat (the leading U.S. distributor of packages of Linux-based operating systems) went public in August, you could still dismiss the argument that there was money to be made in free software as so much hype. You would have been wrong, but at least you wouldn’t have been laughed out of cyberspace.

But by mid-December, Red Hat’s stock market valuation was hovering around $15 billion, and new free software-related IPOs from Andover.net, a publishing company, and VA Linux Systems, a hardware vendor, were rocking the market. VA Linux went so far as to set a new record for the best first-day performance, gaining 698 percent in its first day. Call it a herd mentality on the part of investors or call it day-trader hysteria, but you still can’t ignore the reality. Based on stock valuations alone, companies like Red Hat and VA Linux now have the wherewithal to purchase established players in the technology marketplace. Could there be any better demonstration of how passion can affect the economy? These stock market valuations are fueled in part by the belief of thousands of small investors that Linux is well on its way to world domination. Their willingness to pony up their cash is making that belief come true, provided Red Hat and VA Linux use their market clout wisely.

How now, Mr. Dow?

The Dow Jones industrial average started the year at a shade over 9,000. Then for 58 seconds on Mar. 16 it broke 10,000. The euphoria was quickly stamped out by talk of a psychological barrier that was holding traders back from the five-figure mark. Whoever thought investors were afraid of a little bull couldn’t have been more wrong. They rallied and the market now looks poised to end the year somewhere over 11,000. We used to think that what goes up must come down. But this year, to be really au courant you had to embrace the notion that what goes up will just keep going up forever. Or, at any rate, nearly forever: “Dow 36,000,” one of the year’s most influential business books, argued that the Dow will hit a plateau — years from now, at 36,000. But remember this: Even the authors don’t have all their money in stocks.

Day-trading tribulations

How to get rich, circa 1999: Quit your job; get an account with a cheap online brokerage like Datek; buy 500 shares of stock in a company that you know nothing about; sell them an hour later; repeat five times a day. It seems that thousands of America’s best and brightest have given up on professional careers to turn their extra bedrooms into gambling parlors. The good news is that online trading and lower commissions have made speculating in stocks a lot cheaper and easier for individual investors. That’s the bad news, too. When you’re wheeling and dealing with tens if not hundreds of thousands of your own dollars, it doesn’t take much to bring on your own private Black Monday.

The day-trading bogeyman has been blamed for everything from increasing volatility in the markets to (yes) mass murder.
(In July, Mark Barton opened fire in the Atlanta day-trading office where he apparently had lost a good deal of money.) Day trading has also created its own gurus and celebrities, like New York’s Tokyo Joe. Get past the hype, however, and you find that the real danger of the day-trading craze might be that, as study after study has shown, the more you trade, the less likely you are to make money.

Valley of the vanities

If Silicon Valley is like Florence in the Renaissance, shouldn’t there be some art and literature to go with all those chips and stock options? Well, there is, sort of. In 1999 we saw the glimmerings of a new literature of the valley, with books like Po Bronson’s “The Nudist on the Late Shift,” David A. Kaplan’s “Silicon Boys” and Michael Lewis’ “The New New Thing” all struggling to illustrate the Silicon Valley state of mind. Bronson preaches that Silicon Valley isn’t just about money, but found himself in the minority (alas, except for a brief reference in the introduction, we never did get to read anything about the “nudist”). Kaplan and Lewis, by contrast, think that money, in all its dirty glory, is exactly what Silicon Valley life is about, and took palpable pleasure in cataloguing all the permutations of unadulterated greed.

End speed limits

Here is one iron law of the Network Age: Content expands to fill the available bandwidth. No, scratch that. Content expands faster than the available bandwidth. Ever tried to look at some of the newest shopping sites on a pokey home connection? No wonder people are doing more and more of their Net surfing from work. But in 1999, high-bandwidth home connections blossomed. Excite@Home, the leading provider of high-speed access through cable lines, saw its subscriber numbers quadruple, while all the major telcos began offering high-speed access over phone lines. Some, like SBC, sharply cut prices at the beginning of the year, promising cable some serious competition. No one seems to know whether cable or DSL is better, but consumers with either are loving goodies like streaming video and always-on connections.

And there was more good news for consumers: AT&T, now the country’s biggest cable service provider, went into 1999 saying that if consumers wanted to get high-speed access over their cable lines, they’d have to do it through Excite@Home, the Internet service provider partly owned by AT&T and other cable companies. Now AT&T — faced with pressure from local governments around the country — has decided that open access might not be such a bad idea after all, and has even signed a deal that will let one big ISP, Mindspring, start providing access over AT&T’s high-speed lines in a couple of years’ time.

Bye-bye beige box

Tangerine? Blueberry? What hue smells best to you? This was the year of color computing. Yeah, we know the iMac hit shelves in 1998, but it was in 1999 that the rest of the market caught on to Apple’s ingenuity and began to redefine the computer. The market was thick with iMac copycats — like the all-in-one computer and monitor in bright hues from eMachines and Future Power that prompted lawsuits from Apple. But even staid corporate computer providers IBM and Dell were touched by the rainbow: IBM turned out an i Series of the ThinkPad, with a choice of seven cover colors. Dell did it up with the Web PC — a sleek two-tone machine with round edges.

While geeks went nuts for the slim silver Sony Vaio, computer makers plied kids with pink Barbie computers and blue Hot Wheels computers. Of course, we also saw heaps of Nokia’s 5100 series cell phones in lime green, cherry red and day-glo orange; and just as 1999 was coming to a close, we got a peek at the Handspring Visor, a handheld organizer running the Palm OS, in a host of vibrantly colored translucent cases. We love the colors and groovy shapes. Now we want to know, what’s up with the promise of computer appliances?

Mahir mania

If you don’t know who Mahir is, you must have had your head under a rock for most of November. The home page of the Turkish Stud was the oddest Net phenomenon of the year, as millions flocked to this anonymous accordion player’s Web site to giggle at pronouncements that he “likes sex” and wants to “invitate” women to stay at his home in Izmir, Turkey. It was eventually revealed that the site had been created by an anonymous prankster, but no one seemed to mind, not even the ping-pong-playing Mahir. At last check, Mahir had made appearances in Time and People and was making a two-week tour of the United States, compliments of an Internet company, of course. While his fan pages multiplied like rabbits, his Web site now serves as a pulpit advocating world peace.

Worlds of elves and ogres

Last year, Ultima held the title of most innovative online role-playing game; this year, bored gamers were auctioning off their Ultima characters on eBay — sometimes for thousands of dollars — and buying EverQuest instead. By the end of the summer, Sony had convinced hundreds of thousands of players to spend their free time cavorting about as elves and druids in the online land of Everquest. Everquest, in turn, is now being challenged by the release of Asheron’s Call, Microsoft’s equally massive world of knights and ogres.

Meanwhile, Sega returned from near defeat in the console wars with the release of its own, network-capable game machine. The Dreamcast, which boasts fancy128-bit graphics and an internal modem, was subject of one of the most hyped product launches in history, including a $100 million marketing campaign. The money was apparently well-spent: Barely two months after launch, Sega had already sold a million units, putting it in good shape to compete against the upcoming next-generation consoles from Sony and Nintendo.

Gamers under fire

Before we knew much of anything about what happened at Columbine High School, we learned that killers Eric Harris and Dylan Klebold were avid gamers — fans of Quake and Doom. This, and a Web site left behind by Harris, sent the media into paranoid paroxysms about how the Internet and video games were breeding violence in America. The Clinton administration jumped in with a summit on teens and violence, dissecting activities like gaming to find their correlation to a plague of playground massacres, even as the gaming community rushed to defend its play. Could the millions of gamers happily shooting it out with animated foes and blowing them to pixelated smithereens really be mass murderers in waiting? they asked. Isn’t it possible that blowing off steam through these violent fantasies could actually be good for you?

The debate raged on, but when dial-a-quote “experts” linked violent games to violence, we found that studies didn’t back them up. A few rueful gamers reconsidered their love of killsport games, and some game makers toyed with self-regulation. But by year’s end — and after a spate of killings by people who may never have had their trigger finger on a joystick — the political pressure on gamers seems to have dissipated into the same thin air that brought on the initial panic.

Apocalypse now?

We heard hardly a peep from the Chicken Littles of the world, crying about the sky falling and investing in survival gear to greet the year 2000. That was last year’s trend. Instead, in 1999′s age of “money money money,” we were treated to the smug chuckles of Y2K profiteers, eagerly anticipating a global systems meltdown. Their plan? Convert all your stock and real estate to cash before New Year’s Eve, then sit back with a little bubbly and toast the Millennium Bug as it wreaks havoc on power grids and incapacitates manufacturing systems. Once the Fortune 500 has been properly bound and gagged by the ensuing madness and investors have run screaming from the market, you can leisurely pick through the blue-chip stocks going for bargain-basement prices. Consider yourself charitable, they say, when you hand over a couple of thousand greenbacks for an Atherton, Calif., mansion; that ex-millionaire has nothing to eat but the memory of a luscious electronic stock portfolio, converted into a jumble of ones and zeros.

Those more intimately familiar with the systems at risk profess more confidence. Still, scads of programmers and tech execs –including Microsoft’s Steve Ballmer and Cisco’s John Chambers — promise to ring in the new year at the office, just in case they’re wrong when they say their systems are ready for Y2K. The cops will be on red alert too, to defend an otherwise functional world from kooks who might try to hasten the apocalypse. Most folks, however, say they’ll be home for the holiday — maybe even reading a Y2K romance novel by the fire.

And, indeed, there is good reason to think that buying into a super-hot IPO, however promising the company, is not a great idea. Studies have shown that explosive IPOs often under perform the market. Such stocks tends to rise sky-high, and then drop. Often it keeps falling for a very long time. Of 15 IPOs that doubled on their first day in 1995 or 1996, nine are now below their first-day closing prices, according to data compiled by Professor Jay Ritter of the University of Florida. The Globe.com, the previous record holder for price run-up in the first day of trading, went public at $9, opened at $87 and closed at $63.50 (all pre-stock-split prices); it now languishes just above $10 a share.

By Friday afternoon, anybody who had bought VA Linux at $320 had already lost $102 a share, as the new issue closed the week at $218.

But there’s something missing from this picture. Everybody knows that IPOs that run up to astounding heights lose a big part of their value within days. So who are the investors naive enough to buy into them?

Conventional wisdom holds that these stocks are bought by small investors who are willing to buy into a good story at any price. According to this theory, the buyers for VA Linux are true believers who think that Linux-based computers will eventually displace the Microsoft monopoly.

In this case, the conventional wisdom seems wrong. In scouring hundreds of messages on investor bulletin boards, I did not find one person who admitted to buying VA Linux at $320. This is significant, because investors who like a stock tend to be vocal about it. Many will happily go on Internet message boards to defend their purchases - in part because the buzz helps keep up the price of their holdings. If individual investors are not out in force defending the companies prospects, you have to figure they’re not holding the stock.

There is another possible theory, and that is that the investors who bought VA Linux the moment it opened did so largely by accident. Something like that happened in November 1998 with TheGlobe.com. Naive individual investors put in orders to buy the stock before it opened without specifying a “limit,” or top price. The next day some of them were shocked that instead of buying the stock at a little bit over the IPO price, their trades had been executed at $90 a share.

In this case, I don’t think that happened, either. After TheGlobe.com went public, many brokerages instituted tighter control to make sure this didn’t happen again. Most will now not let investors ask to buy a new issue without putting in a limiting price.

So who was it who bought VA Linux at these astonishing pricing?

There’s one theory that has gotten a lot less notice than it should. Earlier this year, TheStreet.com’s Cory Johnson reported that investment banks were asking institutional investors who got shares in hot IPOs to buy additional shares after trading opened. In other words, a large mutual fund might get 30,000 shares of a hot stock at the low offering price - but only if fund managers indicated they would buy 60,000 more shares after the stock opened for trading.

“It might not be stated explicitly,” says Johnson, “But investment banks will give shares to funds that will buy more shares in the after-market and support the stock.”

Why would investment bankers want institutional investors to do this?

Simple. It assures that when trading opens there will be significant demand for the shares. That keeps the price up, gives company insiders a healthy profit, and makes the investment bank that underwrote the offering look good. (It’s the investment bank’s job to generate investor interest, and there’s no better proof of investor interest than a blockbuster first-day opening price.)

Now look at it from the point of view of the mutual fund or other large institutional investor that might have purchased these shares. Let’s say Bigshot Internet Fund got 10,000 shares of VA Linux at $30 a share. Then let’s say it bought 20,000 shares more at $280 a share. The stock ended the day $239 - let’s say $240 to keep the math simple.

Here’s the final result. On paper, Bigshot Internet Fund made $210 on each of the shares it got at the offering price. It lost $40 on each share it bought at $280. That’s a $2.1 million paper gain, and an $800,000 paper loss - a total profit of $1.3 million. So it works out well for everyone involved. The company has a great opening day, the investment bankers look good, and Bigshot Internet Fund still makes plenty of money.

The funny thing is that there’s a very good chance that Bigshot Internet Fund sold its low priced initial allocation. In other words, Bigshot Internet Fund could be both buying and selling stock in VA Linux.

I can’t prove that’s what happened. But right now it sounds like a better explanation than the idea that there are tens of thousands of small investors putting lots of money into a stock that has jumped above $200 - if only because I can’t find those naive investors.

I like this theory, also, on epistemological grounds. The market is a lot more sophisticated than it is given credit for being. It is generally a bad idea to assume that investors who buy a stock do so because they are simply silly or inexperienced. Sometimes, of course, that is the case, but more often it turns out that the market behaves quite rationally, and it is only the observers who are naive.

Surely, not every firm that can boast of some relationship to the Net deserves a stratospheric valuation. Yahoo’s market capitalization — the total value of its stock — is now over $80 billion. That’s more than Disney — a huge media conglomerate that owns a television network, movie studios, and, yes, its own Web portal. A share of Yahoo now costs over $300, and for each share Yahoo earned all of
25 cents in its last quarter. That leaves a ridiculous amount of ground for Yahoo to cover before its stock becomes a sensible purchase by any traditional metric.

But investment bankers continue to roll out companies they hope will catch the fancy of dot-com investors. The trouble is that many of these companies are unlikely to ever show a profit, and the bankers must know it. If truth be told, a lot of them seem designed to attract speculators who hope to make a quick buck selling their shares to someone else before the bottom drops out of the market.

What in more rational times would be considered mediocre IPOs are plentiful. Dozens of companies have filed documents with regulators that tell prospective investors that they have never made a profit and, moreover, expect no profits in the foreseeable future. There are more than a few — like Buy.com, or video retailer Reel.com — that lose money on everything they sell and hope to make it up on volume. There are others, like RealNames that have little more than one idea (in RealNames’ case, giving Web browsers shortcuts to popular Web addresses) and an unusually punctuated name. Still others are just older companies with a dot-com smiley face drawn on them. Harris Black has been in the polling business since 1959, but it took a name change to Harris Interactive to get to an IPO and a $600 million market value.

Among the surrounding pitiful prospectuses, some soon-to-be-public Net companies stand out as more egregiously awful than the norm. How bad have things gotten at millennium’s end? I took a tour through the upcoming offerings to find the mangiest dogs — companies that might make a killing in the public markets, but look awfully unlikely to be big successes for the long term.

There were two criteria for getting on this short list. First, the initial public offering had to be underwritten by a major, reputable investment bank (there are plenty of blatant rip-offs among the tiny offerings underwritten by marginal investment bankers, and spotting those is just too easy). Second, there had to be something badly wrong with the company — not just bad ideas or big losses, but the faint stench of a company that’s a non-starter at best or a rip-off at worst.

How2.get big bucks

If you follow the parade of emerging dot-coms, the name “How2.com” may sound vaguely familiar. If you follow Silicon Valley goings on, you might think that it’s a start-up funded by the prestigious venture capital firm Hummer Winblad, a kind of guide to anything and everything on the Web. But no, sorry, that’s eHow.com. You might, if you happen to live in San Francisco, think you’ve seen dozens of billboards advertising the company’s Web site. Wrong again, but close. That’s Learn2.com.

How2.com has a lot in common with those other start-ups. Like them, it manages a Web directory that gives advice in a question-and-answer format. Mostly obvious advice, like this introduction to a section on how to cook shrimp:

Like most things that are worth doing, cooking shrimp is worth learning to do well. Shrimp is a delicious, succulent, mild-tasting crustacean that complements any type of cooking and crosses many ethnic culinary boundaries.

You have to click through to the next page to find any actual instructions.

The How2.com guide to how to choose fresh fish lists the habitats of 28 species of fish, taken from the National Fisheries Institute — but not one way of telling if the fish lying on the supermarket counter is really fresh or has been sitting on ice for a week.

One big difference between How2.com and its lookalike competitors is that How2.com’s founders and backers have a superabundance of chutzpah. In October, the company announced plans to sell $125 million of stock to the public. That’s a lot of money — a lot of tech company IPOs raise under $100 million; Yahoo’s IPO in 1996 asked investors for only $37 million.

If you ask me, How2.com is hands down the worst major upcoming dot-com offering. Start with its history:

How2.com is a spinoff of a small security-software company called Citadel Technology. Just a little over a year ago, Citadel completed a stock offering of its own. The offering price was a mere 75 cents a share — penny stock territory, a sure tip-off of a marginal company whose founders are looking to cash out with a quick pop in the stock’s price. Right now, Citadel’s stock trades for a little over $2 a share on the Over-the-Counter Bulletin Board, a happy hunting ground for companies too small and risky for the NASDAQ national market.

Before he invested in Citadel, company
CEO Steven Solomon ran a chain of five Miami Subs fast-food restaurants. The
relationship between Solomon and Citadel’s finances is awfully close. Over
the past year, Citadel has given Solomon more than $1.5 million in low-interest loans
(most of which he has repaid). Solomon is a busy man — in addition to
running Citadel he also serves as CEO of, yes, How2.com.

Take a close look at How2.com. Naturally, it has existed only since January 1999. But going public within a year of launch is just about on par with the average dot-com. In the first six months of this year How2.com has had revenues of just $872,553. That’s not much for a company trying to go public, but there’s nothing really extraordinary there.

No, the really strange thing about How2.com is that its main line of business isn’t Net-related at all. In May, How2.com acquired a company that administers consumer rebate programs. If you buy a VCR in a store and get a coupon that you mail in to get $20 back, your coupon might go through How2.com or a company like it. The company’s prospectus doesn’t break down the revenue from its different lines of business, but says that what revenue it did have came primarily from its rebate operation. So if you read the fine print, you find that How2.com isn’t a Net business at all — it’s an insta-Net company that bought a traditional rebate business, apparently to pump up its revenue line, and is trying to get $125 million from the public with a catchy dot-com name.

The “concept play”

If ever there was Net company ready to go public on the strength of hype alone, it’s the Digital Entertainment Network. In September, DEN filed a preliminary prospectus with the SEC as thick as a telephone book.

It’s not likely that many people read all the fine print; DEN had all the right keywords. Prestigious New York money, a Santa Monica office near enough to Hollywood and a great story about providing broadband entertainment over the Internet to “Gen-Y.” It’s not clear what exactly Gen-Y is besides a fancy term for “people in their teens and early 20s,” but marketers do love it. Most of all, DEN seemed to have real technology chops.

The founders, Marc Collins-Rector and Chad Shackley, had earlier founded a successful network-services company, Concentric Network. Collins-Rector was the businessman and Shackley, DEN’s chief technology officer, was the techie boy wonder. Shackley, in fact, had been just 18 years old when the two started Concentric. Concentric has since gone public and hit a $1 billion market valuation — though Shackley and Collins-Rector have not been involved in management since 1995.

DEN’s founders were undoubtedly aware that big media companies have failed miserably in their efforts at interactive entertainment. But letting some techies — and especially a tech head still in the MTV demographic — give it a try sounded like just the thing. DEN, which launched in May, promised streaming video over the Net, on demand, and with tiny production costs to boot. But the “content” plays in tiny windows, no more than 2-by-2 inches on a typical computer screen. A bit of a tight fit for Gen-Yers used to 25-inch television sets.

DEN is the ultimate “concept play.” Its revenues for the first half of 1999 weren’t just small; they were zero. But for a concept play — a stock in which investors put their money not because they’re impressed by the financials but by the idea — that’s not necessarily a bad thing. After all, when you start at zero, it’s easy to show growth, and the upside is unlimited.

Buried deeper in the financials, however, are some numbers that make more seasoned tech investors blanch. David Neuman, the president and a onetime senior Disney exec, gets a salary of $1.5 million a year, plus a $1 million signing bonus.

In the Net world, megabucks option grants are routine, but million-dollar salaries are almost unheard of. (The historical role model is Netscape, whose CEO Jim Barksdale was so well sated on stock that he forewent his salary.)

Neuman wasn’t the only one with a seven-figure salary, either. Marketing head Edward Winter takes home a $1 million annual paycheck — not bad for marketing a company with no revenue.

If all this sounds bad, about a month ago it got even worse. At the end of October, Collins-Rector resigned after settling an ugly lawsuit that BusinessWeek reported involved allegations that he had sexual relations with a 13-year-old boy. Shackley resigned also.

Collins-Rector and Shackley reportedly lived extravagantly in a mansion once owned by jailed rap impresario Suge Knight. Some observers saw their departure from DEN as a welcome sign that the company’s profligacy was at an end. But remember: Neuman and Winter got the seven-figure salaries, and they are still on board. Now DEN has lost its key founders, but it still has enough highly paid Hollywood execs. Surely that’s a recipe for success, right?

IPO first, business later

Imagine that someone comes up to you and asks you for money to buy two bicycles. He is nicely dressed, in an expensive suit. Perhaps he is a professional financier. He tells you that if only you give him enough money for the two bicycles, you’ll get to own one of them.

Great deal, huh? Well, that, more or less is what Espernet is proposing to do.

Espernet is an Internet service provider, a fairly straightforward and — unless you’re America Online — money-losing commodity business. Well, that’s not quite right, Espernet is going to be an Internet service provider. As soon as investors give it the money.

Here’s how it works: Espernet plans to buy 43 smaller ISPs, with a total of 274,000 subscribers. To buy the ISPs, it will spend about $173 million in cash and stock. Where will all that money come from? You guessed it: an initial public offering for a company that for all practical purposes doesn’t exist.

Espernet is the ultimate evolution of what in the financial world is known as “roll-up” strategy. A company pursuing a roll-up strategy grows by buying smaller companies, usually paying for the acquisitions in stock. The idea is that the whole is worth more than the sum of its parts.

In this case, Espernet is planning to raise up to $172.5 million to pay for its acquisitions. It sounds good — after all, the end result will be a company that owns 43 ISPs, for which it will pay $173 million. But the important thing to remember is that investors in the public offering won’t own the whole company. They put in $172.5 million for only a piece of it. The rest would be held by current investors and management.

Espernet has yet to disclose the exact percentage of the company investors will get for their $172.5 million — that will come in later revisions of the company’s SEC documents. But the prospectus does say, in boilerplate legalese, that investors in the public offering will “suffer immediate and substantial dilution.” That’s the legal way of saying that Espernet will use the investor’s money to buy two bicycles and the investors will get to own one. Of course, what’s involved here isn’t two bicycles but 43 ISPs, and the fraction that new investors will own won’t be exactly half — it could be a whole lot more, or a whole lot less, but the principle is the same.

Even if it were certain that the whole would be worth more than the sum of the parts, this would be a very iffy proposition. But even that is by no means certain. Other Internet service providers, such as Onemain, have found that hooking up a bunch of disparate ISPs just gets them a lot of incompatible equipment and mismatched systems. And running small Internet service providers is a very expensive proposition indeed. Onemain lost over $45 million in the six-month period that ended in September 1999. (Onemain.com’s stock rocketed to $46 a share and now languishes below $20.)

Taken together, the 43 ISPs that Espernet plans to buy lost $33 million in the first half of this year alone. So in some ways it’s a good thing that Espernet will have plenty of money in the bank.

In the IPO game, no one is wholly innocent. Even some avid dot-com investors figure that when the music stops playing, someone will be left holding a bag full of stock in failing companies. They just hope it won’t be them.

So who really benefits? Most of all, the management and early backers in the truly doggy dot-coms. Sure, the stock is going to drop sometime in the future, but by that time, in many cases, top management will have sold part of their holdings and made an easy fortune. The worst dot-coms will go public with a bang — but eventually some of them will go broke with hardly a whimper.