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Bubble market story { November 13 2002 } Original Source Link: (May no longer be active)
http://www.washingtonpost.com/wp-dyn/articles/A46087-2002Nov12.htmlhttp://www.washingtonpost.com/wp-dyn/articles/A46087-2002Nov12.html
'Johnny Appleseed' for a Risky Field
Doerr's Ambition Paid Off -- at First
By Ariana Eunjung Cha
Washington Post Staff Writer
Wednesday, November 13, 2002; Page A01
Fourth of six articles
REDWOOD CITY, Calif.
The company was born, as were so many in Silicon Valley in the 1990s, with a single conversation.
"I have an idea for you," John Doerr said to a group of cable television executives he wanted as partners for a company he envisioned marrying cable and the Internet to bring more and as yet unimagined sorts of programming to consumers. As perhaps the most famous of the venture capitalists, the financiers who seeded the Internet boom, Doerr had the money at his disposal to make his ideas reality. In this case, he even had a name for his new venture: At Home.
Over the next three years, Doerr, through his firm Kleiner Perkins Caufield & Byers and its co-investors, pumped several hundred millions of dollars into At Home Corp. The company prospered, quickly attracting nearly 300,000 customers who paid a monthly fee to get super-fast Internet access from their houses and apartments, and banking several million dollars in revenue each quarter.
But Doerr was not satisfied.
By late 1998, nearly the middle of the boom, Doerr told some company executives that he feared At Home wasn't moving fast enough. He, along with the management team and other directors, wanted At Home to ally itself with a company that could provide the content -- the stories, sound clips and video -- it needed to become a media venture. And the time to do that was while At Home's stock was flying high.
The target: Excite Inc., a popular online search and directory site that also happened to be heavily backed by Kleiner Perkins. Excite was losing money -- lots of it -- and that made some investors skeptical: Why endanger At Home by exposing it to Excite's losses? But those concerns were swept aside. The $6.7 billion merger, the biggest ever between two Internet companies, was overwhelmingly approved by shareholders in 1999.
Kleiner Perkins, however, did not wait around for the new company, Excite At Home, to succeed. Soon after the merger, it took company shares worth more than $1 billion and distributed them privately to its investment partners for them to sell if they wished. Public investors who placed their bets on the company's long-term success and held on to their shares were not as lucky. Excite At Home went out of business this February, and their stock became worthless in one of the New Economy's most spectacular failures.
Charles Moldow, a former vice president of At Home who worked on Excite At Home's business development, believes At Home took a fatally wrong step. "If we hadn't merged with Excite, At Home would still be around today," he said.
But during the boom years, venture capitalists played God, and they largely decided which start-up companies lived and which ones died, which investment bankers and lawyers got the deals and which ones got rich. Doerr, an electrical engineer who became the premier financier of Silicon Valley, did all that and something more: He was the public face and ultimate salesman of the obsessively ambitious Internet world.
Doerr's imprimatur on a company gave it instant credibility. But any venture capital fund's investment began a familiar process, according to Wade Randlett, chief executive of San Francisco-based Dashboard Technology. First the fund would send money to a start-up. Then, as the start-up picked up steam, the fund would distribute some company shares to its investors, usually institutions or wealthy individuals. Those private investors would, in turn, sell their shares to the general public. If the company ran into trouble, Randlett said, "it turned out that the individual investor was the last sucker at the table."
To fledgling Internet entrepreneurs, venture capitalists held out badly needed start-up funds in one hand. With the other they pushed hard for the companies to expand quickly and jump into new areas of business. Now that many of these companies are in ruins, outsiders point to the obsession with growth and size as a major factor in the dot-com industry's undoing. And Doerr's talk of keiretsu -- a Japanese term that became his catchword for a network of ventures that led to unions like that of Excite and At Home -- has become an epitaph for a bygone era.
As the history of the boom is being rewritten, so is Doerr's.
He has gone from being known as the "Johnny Appleseed" of Silicon Valley (Time Digital 1999) to being compared to Henry Blodget (Barron's, 2002), the Wall Street analyst who hyped shaky stocks and now finds himself being questioned by government regulators.
Like many other prominent financiers of the boom, Doerr has found himself caught up in all the scandals that have beset the corporate world in the aftermath of the bubble. A few of the companies he funded and on whose boards he served are fighting off investigations by the Securities and Exchange Commission and shareholder lawsuits that allege wrongdoing including insider trading and accounting fraud. Attorneys for Doerr, who declined repeated requests to speak on the record for this story, have vigorously denied the allegations.
Doerr's failures -- Excite At Home, HomeGrocer -- are now as well known as his successes -- Amazon, Intuit, Sun, Netscape. But those failures don't necessarily mean that Doerr's insights about the future of technology were wrong. Dot-com-era businesses such as online retailing have found a loyal consumer base. People really do download music from the Web. And the number of homes paying for the use of high-speed Internet that Excite At Home promoted has been increasing steadily.
On the other hand, he helped create a climate in which people thought the potential riches were so large many made foolish investments and ended up losing lots of money. "The Internet is the greatest legal creation of wealth in the history of the planet," Doerr said on numerous occasions. "It's underhyped," he said. "It may hit 30 on a Richter scale."
Paul Kedrosky, a University of British Columbia business professor who is writing a book about venture capitalists, said venture capitalists -- and Doerr in particular -- created a romanticized vision of the world that was hard to resist.
"He was a blue-eyed believer but his proclamations were so full of hyperbole that there was no good that could come of them. . . . He made a lot of people lose a lot of money," Kedrosky said.
Doerr's defenders argue that he was sincere in his belief in the future of all the companies he financed and that it's unfair to blame him for the greed of others. They note that Doerr backed up his words with actions: He never sold a single share of his personal stakes in companies for which he served on the board of directors.
"It is in the nature of technological innovations for inventors and the people closest to them to be be excited by what they see. . . . That John Doerr's enthusiasm was infectious is not John Doerr's fault," said Paul Saffo, director of the Institute for the Future, a think tank based next door to Kleiner Perkins.
The Origins of Hype
The Internet bubble began with a relatively simple transaction, repeated hundreds of times. A fledgling Internet entrepreneur whose company often consisted of no more than a 10-page "business plan" received seed money. In return, the venture capitalists, located along fabled Sand Hill Road in Menlo Park, Calif., or some other tech hub around the country, got a stake in the company.
But the venture capitalists were more than regular investors. In contrast to investment banks that rarely got involved in the day-to-day activities of the ventures they funded, venture capitalists nurtured their companies, recruiting top management, drafting contracts and negotiating deals. It wasn't unusual for them to take jobs as executives within the businesses.
Kleiner Perkins and the companies it funded were Silicon Valley's elite ruling party during this time, Doerr their leader. In a reversal of the usual practice, investors were chosen by the firm, which often demanded an initial commitment of at least $1 million to get in, according to several limited partners. Among the groups that placed money in Kleiner were some of the nation's most prestigious universities and pension funds.
Venture capitalists were known as the long-term guys, the ones who kept their investments in companies for a decade or more, until they had a chance to grow into stable enterprises with robust earnings. But all that changed in 1995 with the initial public offering of Doerr-backed Netscape Communications Corp.
Netscape, co-founded by whiz kid Marc Andreessen, the inventor of the Web browser, and backed by Doerr, had no profit and only a vague idea of how it would make money. But its stock jumped 107 percent on its first day of trading, giving the fledgling company a market value of $2.2 billion.
Over the next five years, nearly 1,000 other companies would go public in the hopes that they could duplicate Netscape's performance in the stock market.
In the not-so-distant past, venture capitalists would often take months or years to mull over investments, doing careful market studies about competitors and even surveys of potential customers. In the go-go days of the late 1990s, however, some venture capitalists say it wasn't unusual for a company to be funded almost on the spot, on the New Economy idea that whoever got the customers first would dominate a sector.
So much money was flowing into venture capital funds so fast that often companies in the same or similar businesses began to multiply, especially in e-commerce. Pets.com, Petsmart.com, Petopia.com and Petstore.com, for instance, all offered pet food and other products for animals. DellaJames.com, WeddingChannel.com and TheKnot.com offered wedding advice and gifts. Wine.com, WineShopper.com, WineCountryGiftBaskets.com, eVineyard.com and VirtualVineyards.com, obviously enough, sold wine.
E. Floyd Kvamme, a Kleiner Perkins partner emeritus who wasn't actively investing during the dot-com years, said that as an outsider he saw this haphazard investing style as one of the biggest contributors to the shakiness of the New Economy.
"For whatever reason due diligence kind of got put aside," Kvamme said. "Looking at the amount of dollars being thrown at things, it was clearly a strange time, and the bubble shouldn't necessarily have happened."
Geoff Yang, a partner with Redpoint Ventures, who, along with Vinod Khosla, one of Doerr's partners at Kleiner, was an initial investor in Excite, believes that the emphasis venture capitalists placed on size also was a mistake. To be sure, the land-grab strategy of trying to become the ubercompany worked for some ventures, such as Amazon.com, Yahoo and eBay, but those turned out to be the exceptions.
"Clearly in retrospect if we had thought smaller -- 'I will do rational pricing, I won't worry about being the uberbrand' -- clearly, I think that would have been better," Yang said.
That, however, wasn't Doerr's style.
During the late 1990s, Doerr always seemed to be multi-tasking, simultaneously trying to manage beeps on his two cell phones, laptop and pager as he sought to carry on a conversation. He rarely drove, instead riding in a chauffeured van where he could fiddle with his electronics in the back seat, invariably dressed in a dark suit with a blue tie.
Sun Microsystems Inc. chief executive Scott G. McNealy described the rail-thin Doerr as "the Energizer Bunny on steroids."
Louis John Doerr III, the eldest of five children who grew up in a middle-class area of St. Louis, studied electrical engineering at Rice University, went to business school at Harvard and then took a marketing position at chipmaker Intel Corp. Six years later, he joined Kleiner.
Doerr was an almost instant success, funding a string of successful companies in the late 1980s and early 1990s before the general public knew what a venture capitalist was. But his real fame didn't come until the dot-com years.
Between 1991 and 1993, author Michael Lewis noted in "The New New Thing," Doerr promoted "pen" computing, a technology that would allow people to enter data with a stencil on a tablet instead of typing on a keyboard. When that didn't work out, he started talking about the future of interactive television that would allow purchasers to watch shows and do things like chat online at the same time. A few years later, he hit the right trend, promoting the riches that were sure to come from the commercialization of the Internet.
A sampling of Doerr's other predictions:
"All Silicon Valley homes will be connected at high speeds by 2001 -- and still want more."
"By 2001, I believe set-top computers will be as important as PCs, only cost about $300 to make, and may even be subsidized by the cable companies. They'll allow users to not only view programs but pay bills and purchase products as well."
"Much sooner than a PC on every kid's desk, we'll have a handheld in every kid's pocket."
Things didn't turn out exactly the way Doerr imagined. But he was so successful at making others believe in his ideas that former Netscape chairman James H. Clark once declared, "As a salesman, he's so good he can sell you just as easily on bad concepts."
Artificial Demand
No idea was more associated with Doerr, and Kleiner Perkins, than keiretsu, a Japanese term that refers to a network of interdependent ventures that help each other. Some critics now see it as a not-insignificant cause of the dot-com bubble.
During the late 1990s the Kleiner keiretsu companies, which included e-retailers, optical-networking toolmakers and software companies, would sometimes get their initial revenue from online ads, equipment and services they bought from each other.
SportsLine, for instance, had a deal with Excite At Home to provide the Web site's users with up-to-the-minute game statistics and news; Excite At Home partnered with Healtheon/WebMD to create a 24-hour 'virtual health center'; fine-jewelry retailer BlueNile had a home on the merged WeddingChannel/DellaJames site; and WeddingChannel promoted WineShopper.com's selection of chardonnay and merlot.
The result, some critics say, was an artificial demand for the companies' products that was deceptive because it wouldn't have existed without the involvement of Kleiner partners.
Eric Von der Porten, a money manager with Leeward Investments LLC in Silicon Valley, says that while there is nothing inherently wrong with the keiretsu way of doing business, there are questions about whether it was abused, producing an "illusion of prosperity without the economic substance to match."
"During the bubble, [keiretsu] partnerships were one of the most certain ways to 'get big fast.' Many partnerships created enormous amounts of temporary stock market value, but it's not clear that many created lasting economic value," Von der Porten said.
Doerr was at the center of many of these cross-promotional deals.
Managers at Kleiner-funded companies say it wasn't unusual for them to wake up to find e-mails from Doerr sent in the middle of the night making introductions between two companies and suggesting why they might make good partners.
It wasn't a demand exactly, says one entrepreneur, but it wasn't a casual invitation, either. "You knew you had better respond," said Peter Sisson, chief executive of the now-defunct WineShopper.com.
"There was pressure" to work with a keiretsu company, Sisson said, but he added that he was never overruled when he chose a non-Kleiner company as a partner over a Kleiner company. "The partners always respected the CEO's final decision to do what was best for the company."
From Merger to Meltdown
In an era defined by the spectacular implosion of one upstart after another, Excite At Home's was arguably the biggest.
Within a few months of the merger's close, the company found itself on precarious ground as it used up the last of its cash, $350 million, to purchase an online greeting-card company even as its losses were mounting. Within two years, Excite At Home filed for bankruptcy protection. Within three years, the company closed its doors, its assets sold at fire sales, its 2,500 employees left without jobs.
But when Excite and At Home merged in 1999, the $6.7 billion stock-swap deal was celebrated as marking a new era in the development of the Internet. Excite was just a portal -- an Internet directory and search engine -- at the time, but people like Doerr had grand visions that it would become an incubator for new multimedia content that would allow a computer to act as television, radio and stereo at the same time. With At Home's extensive distribution network, the combined company would be able to control what the country watched and listened to.
Doerr was far from alone in his belief that the convergence of entertainment systems would throw into upheaval the way Hollywood did business. He measured the new company's value not only by paid subscribers but by "eyeballs," the number of visitors to its Web site each day. Visitors were assumed to be a proxy for revenue, an idea that became the basic premise of the New Economy.
"John is not afraid to try to do things that are significant," said Milo Medin, a former NASA scientist who helped design the At Home network. "He likes to do things that make a difference. If it's incremental, he's not interested." At Home was a hybrid between New Economy and old-line companies -- it had a young, big-thinking management team that defined the era but had to clear many of its moves with the old-line cable companies that were its partners. Excite in many ways typified the "dot-com." The search-engine company was financed by Vinod Khosla, Doerr's partner, and founded by six Stanford University buddies. Lots of people were visiting the site, but the company hadn't quite figured out how to bring in revenue.
At some point in 1998, when their stocks were flying high, both companies separately began shopping for merger partners.
At Home began talks with Yahoo and Lycos. Excite looked at Microsoft Corp., Yahoo and others. But by early 1999, At Home's management had decided it wanted to do the deal with Excite. There were various reasons, people involved in the discussions say. They felt Excite's technology was superior to its competitors. Plus, it was close by -- its next-door neighbor, in fact -- which would make integration easier. The fact that it, too, was a Kleiner company was also a big part of their decision.
In retrospect, said Richard Gingras, a senior executive with At Home, "We didn't do as thorough of an analysis [of Excite's financials] because they were a Kleiner company. . . . They were on a downward slide."
Investors have grumbled on online message boards that Doerr and Khosla never really believed in the merits of the merger but orchestrated the deal to create enough buzz so the shares of Excite At Home would jump long enough for Kleiner Perkins to sell off its holdings.
But several insiders say that just wasn't the case.
Doerr and Khosla, who were members of the boards of directors of their respective companies, may have strongly advocated the deal, they say, but they did it on the belief that the combined company would thrive.
"Kleiner clearly wanted it to happen. There were folks there that recognized that Excite's fortunes were on the downswing. They thought At Home was so strong that any negative effect from Excite wouldn't matter. In fact, they felt that At Home could better leverage the Excite property," Gingras said.
The day the merger was announced, Doerr hired a plane to fly over the companies' Redwood City, Calif., offices with a banner that said "CONGRATULATIONS T.J. & GEORGE." T.J. was Thomas A. Jermoluk, the chief executive of At Home and now a partner at Kleiner. George was George Bell, chief executive of Excite.
Publicly, Doerr continued to promote the benefits of the merger, but privately his company quietly "distributed," or handed control, of many of its Excite At Home shares to the investors who had put their money in Kleiner's control. These limited partners could sell or hold their shares, but the fact that the venture capital firm distributed them is often taken as a signal to sell.
Kleiner did not have to disclose the distribution, experts say, because it is technically accounted for as a private transfer of ownership of stock and doesn't count as a sale under securities law.
Stanley Sporkin, a former head of enforcement for the Securities and Exchange Commission, said he believes that there should be more obvious disclosure about such moves by venture funds, especially if one or more of their partners sits on the board of directors of the company in question. That way other shareholders would be able to make better-informed decisions about what to do with their own investments.
"If insiders are selling or bailing out either directly or indirectly, they should be required to disclose that," he said.
The Excite At Home merger document states explicitly that venture capitalists who sit on boards of public companies may have dual loyalties: "When considering the recommendations of At Home's and Excite's boards of directors, you should be aware that certain At Home and Excite directors and officers have interests in the merger that are different from, or are in addition to, yours."
The paper, which was mailed out to shareholders, specifically names Kleiner Perkins, Doerr and a fellow partner who was also a board member, William Randolph Hearst III of the famous newspaper family.
Before the merger was announced, Kleiner's 1.6 million shares of At Home were worth $164.2 million; its 1.4 million shares of Excite, $94.5 million. By April 26, its At Home stake was worth $258.5 million and its Excite holdings $224.7 million.
Securities filings show that Doerr didn't sell any of his personal holdings: He had 576,000 shares that were worth around $58.7 million when the merger was announced and climbed to $92.4 million by the time the deal was completed. But Kleiner's distributions seemed to contradict what Doerr himself told everyone about the promise of the company and what he had repeatedly told people in the tech community -- that the value of good companies peaks in years five through 10.
Former employees cite many reasons for the failure of Excite At Home -- a relatively inexperienced chief executive, a series of bad acquisitions that nearly wiped out the company's cash reserves, board members who represented cable companies, specifically AT&T Corp., that sometimes had different interests. More than a few believe the idea of merging a Web portal with a cable company was flawed from the beginning.
Regardless of who is to blame, the impact on shareholders was the same: Those who believed in Doerr's optimistic view wound up losing everything.
No More Predictions
In recent months, Doerr has all but gone into hiding. Kleiner, like other surviving venture capital firms, continues to invest but does so much more conservatively. Some of Kleiner's limited partners are upset with the firm because returns are negative. The trade press has begun to write only about Kleiner's failures rather than about new companies Kleiner is funding.
Doerr, like practically every other director of a public business that has been suffering from the stock market's downturn, must now contend with corporate fraud lawsuits and government investigations into Kleiner-backed companies. He is being sued by shareholders of Amazon, Freemarkets, Drugstore.com and Martha Stewart Living Omnimedia Inc. At least three Doerr-backed firms, Martha Stewart, Homestore and AOL, are being scrutinized by regulators.
University of Wisconsin law professor D. Gordon Smith believes that most of the flurry of lawsuits against venture capitalists such as Doerr are unfounded.
"When something bad happens we wonder whether someone was evil or stupid. I think it's pretty clear that most of the VCs were not in the first camp. They were not manipulating markets," Smith said. "What they were doing was taking advantage of the situation."
Former congressman Rick White, a Republican from Washington state and a friend of Doerr's, insists that Doerr's views are essentially unchanged. "We don't talk about the New Economy anymore," White said, "but Doerr is a guy who still believes there is a physical power in tech."
The past few times Doerr spoke to a public audience, earlier this year and in 2001, he gave almost identical speeches. He started by saying he had come with "somewhat of an apology" for some of his previous comments. He then flashed slides of his famous "greatest legal creation of wealth" quote and revised it to say "greatest legal creation (and evaporation) of wealth."
But what may be more telling is what he is not saying.
Doerr has stopped trying to predict the future. There isn't, and hasn't been for some time, talk of the next new thing in technology.
Researcher Richard A. Drezen contributed to this report.
© 2002 The Washington Post Company
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