Chapter 9: The Fall, April 1, 2000 - June 30, 2000 - Episode 2Listen to podcast
BIG ROUTER WARNING TANKS MARKET
By PETER SCOTTSON
THE broad STREET JOURNAL ONLINE
April 3, 2000 5:01 p.m.
The NASDAQ fell nearly 400 points today and closed just over 4200. The selling started before the open and just after an announcement by Big Router that it expects to report “disappointing” earnings for the first quarter and will not meet analyst’s expectations. Big Router stock fell 42 points to close at 99 1/8. The company is scheduled to report its earnings on April 15.
Almost every sector was lower. Energy stocks and some consumer durables – both usually considered defensive holdings – were the only exception. Technology and e-commerce stocks were the hardest hit. Router maker PacketWarp was down almost 40% during the trading day and closed at 84, down 27%. EverFast lost 35 to close at 115.
Some market analysts are now taking the recent market weakness seriously. John Braxton of Barcourt & Brotherson says that this may be the start of the long awaited “serious” correction after the market’s long runup. He says that it’s possible that the market is “significantly” ahead of itself and will not recover until much later in the year. However, other analysts suggest buying stocks on weakness. They point to the alarming dip in March, which was quickly reversed and the trading profits made by those who bought the dip.
One venture capitalist who declined to be identified says that he believes router sales are a leading indicator for the e-commerce sector. According to him, a decline in router sales is a sure sign that growth is slowing.
Big Router attributed the weakness in the quarter to stiff price competition and some credit problems with existing and prospective customers. The company did not specify whether shipment volumes were down.
Donna Langhorne has spent most of the day on the phone with several brokers who would like to manage her personal wealth. She has given each of them a trial by allocating each a million dollars with which to buy her stock in their hottest IPOs. Some have demurred that the IPO schedule is somewhat lighter than it had been. These she has given latitude to invest no more than half in other hot issues.
Donna has also been talking to Fractional Jet. She and her husband Francis have decided to buy an eighth interest in one of their new planes.
“After the roadshows,” says Donna, “I really don’t want to go back to waiting in lines at airports and sitting next to people that fart.”
It isn’t hard to convince Francis who has also enjoyed every private jet he’s been on.
“By the way,” Francis says to Donna on the phone at the end of the day, “we filed suit against Big Router today. Thanks to our ‘timely information’, Grant & Gilding was the first firm to get its licks in. There’ll be others, of course, but being first gives us a very good chance of being appointed lead counsel for the shareholder class action. And this has really helped me at the firm. Thank you.”
“You’re very welcome,” says Donna. “Come home.”
“Send the jet for me,” says Francis.
“I’ll do that,” says Donna. “I’ll do just that.” And she does.
On April 4 the NASDAQ is down below 3700 during the day, before rallying to finish down just over 100 points. Hackoff, however, doesn’t do badly and closes up at 102 3/16. Larry is in a good mood for the beginning of his call with Barcourt Chief Trader Sam Gutfreund. Donna Langhorne and Harvey Maklin are also on the call.
“Pretty brutal day, I’ll bet,” says Larry.
“Seen worse,” says Sam. “Busy though.”
“Hackoff traded well,” Larry observes.
“Up is better than down,” says Sam.
“Learn anything from our trading?” asks Larry.
“More buyers than sellers,” says Sam.
“Tell me something I don’t know.”
“I thought you knew everything.”
“How does the shoe look?”
“We sold that Friday. We almost always sell the shoe along with the initial allotment.”
“Great,” says Larry. “That’s great. But how come I didn’t see the money in my account along with the rest?”
“Larry,” says Donna, “Sam says they SOLD the shoe. He didn’t say they BOUGHT it.”
”What do you mean?” Larry looks confused.
“Perhaps I can explain,” says Harvey when no one else answers. “We sell the shoe short as close to placing the initial allocation as we can. Then we have thirty days to buy it from the selling stockholders.”
“You sell the shares BEFORE you buy them from us?” asks Larry.
“Of course,” says Donna with malice. “Of course they do. Why should they buy them before they have to?”
“Oh, I see,” says Larry. “It’s a use-of-money thing. You get the money for the shares and you don’t have to buy them from us for thirty days. Okay, just one more way for bankers to make money on the transaction. But now we know you’ll be buying them. Still good news.”
There’s a silence.
“What’s the matter?” asks Larry. “Now that the shoe’s been sold, you’ve got to eventually buy the shares from us, right?”
More silence. This time it is Sam who breaks it: “Larry, we only buy the shoe if the stock is higher at the end of thirty days or we’ve got too much demand to go short any further like we did in the IPO.”
“I don’t get it,” says Larry. “Shit, yes I do. If the stock is lower in thirty days, you buy in the open market to cover your short because that’s cheaper than buying from us. You fuckers just can’t lose. Stock goes up and you buy it from us at below-market price and you aren’t taking any risk because you already sold it. Stock goes down and you buy it at market and have a short sale profit.”
“Uh…” says Harvey, “that’s basically it. Of course, if hackoff stock keeps acting like it did today we’ll all be very happy campers. We’ll exercise the over‑allotment option just like we did in the IPO and you’ll have your money.”
“I sure hope so,” says Larry. “I hope so for all our sakes.”
“That sucks,” Larry says to Donna as they sit alone at the conference table in his office after the call. “That really sucks. Fucking bankers get us coming and going.”
“What do you mean ‘us’, white man?” says Donna.
“What do you mean?”
“I don’t have any part of the shoe, thank you very much. The company isn’t selling any more shares in the shoe. What I’m worried about is our numbers.”
You know, your whining about the shoe is obnoxious? I got you to be able to sell all your shares up front. I have to wait for the shoe to sell some of mine and now it looks like that may never happen. Why don’t you drop it? And what numbers are you worried about? We’re going to have an operating profit this quarter, aren’t we?”
“You got greedy and you got caught,” says Donna. “I don’t have any sympathy for you. And, yes, we are going to have an operating profit — a small one — for this quarter. But what about next quarter? That’s what I’m really worried about.”
“What do you mean? The quarter’s hardly begun. How can you be worried already?”
“Did you look at how we made our number for this quarter?”
“Sure, I know how we did. We cut some prices to make some deals. We gave some extra comp to sales. So, this quarter we should have our natural growth and all that shouldn’t be necessary.”
“Don’t get me started on extra comp for sales,” says Donna. “I can’t believe you gave them that. Why are you such a wimp when it comes to managing sales? Frank Folger is the only one of your staff you’re not tough on.”
“You’re probably right,” says Larry. “Sales is the one job in the company that I know I couldn’t do. I couldn’t take being told ‘no’ time after time and still going back to knock on the same doors. I don’t understand sales guys; I don’t know what makes them tick. They’re weird; they’re obnoxious; they lie. They always cheat on their wives. But we need them, and I can’t manage them as well as I can the other parts of the company. I know enough about accounting and investor relations and all to know that you do a good job — most of the time. I know I could do a better job than Dom at managing development, but he’s much better than most people would be. I think I could’ve been a lawyer if I wanted to, so I have no problem second guessing Aaron when he’s being an asshole. But I don’t understand sales.”
“We’re going to have a big problem if you don’t START managing sales,” says Donna. “Because Frank’s not doing it — unless you call getting more commission for less sales managing. And, of course, we just dug a big hole for ourselves.”
“What big hole?”
“All those sales we got in the last few days of June…”
“Yeah. What about them? They’re real, right? We didn’t book anything that wasn’t really closed did we?”
“No. They’re real,” says Donna. “Frank would have booked anything that breathed but I only let him book real sales — not counting the wannabes, of course. But that’s not the problem.”
“Donna, what IS the problem? Stop playing games with me.”
“The problem is that we used low prices to close sales that would’ve closed anyway. Those are sales that we would have closed this quarter. Most of them.”
“No shit. So?”
“So the sales funnel is EMPTY; that’s what I think. Have you had Frank give you a report on the funnel?”
“I’ve been on a roadshow, remember?” says Larry. “I think you were there. ...No, I haven’t had Frank give me a report on the funnel. Have you? What makes you say it’s empty? Just because you don’t like Frank?”
“No,” says Donna. “Okay, I DON’T like Frank. And I don’t like watching you wimp out instead of managing him. And I haven’t had a report on the funnel. But I can still think. And it makes sense to me that we pulled sales out of THIS quarter to make the numbers for LAST quarter, so now we start in the hole. And even deeper in the hole because Frank signaled to customers and salespeople that we have quarter-end sales and now they’ll expect that. And the sales people’ll wait to do their selling until we offer them extra comp.”
“The fun never stops, does it?” says Larry. “I’ll schedule a funnel review, Shouldn’t be as bad as you think but it’s worth looking at. Meanwhile, it would help if you’d get some more analysts to cover our stock. We need to get some new interest and some new buyers. Stock’s gotta be sold, too, you know.”
“You’re still worried about your goddamned shoe. You make sure Frank — or someone else — sells software. I’ll work on the analysts but I gotta tell you, I’m nervous about getting more coverage if we’re gonna have bad numbers.”
“We’re not gonna have bad numbers,” says Larry. “Trust me.” He takes the gun off his coffee table, puts it to his head, pulls the trigger — click. “I bet my life on it.”
“We’re in this together, Lar,” says Donna. “I don’t like it but I’m a realist and that’s the way it is. Don’t fuck it up!”
Just as Larry feared, Barcourt & Brotherson does not exercise its right to buy the over-allotment or “shoe” from the selling stockholders. By the time the thirty day option on the over-allotment has expired, hackoff is trading at around seventy-four dollars per share. So, if Barcourt wants to cover the short sale of 450 thousand shares that it made on the day after the secondary priced, it can buy shares on the open market at around seventy-four. Obviously, this would be preferable to buying from the selling shareholders at the secondary price of 99 3/8. However, Barcourt does not want to cover its short sale. In fact, Barcourt has continued to sell short — to borrow shares of hackoff that it doesn’t own and sell them. The continued selling by Barcourt is just one of the factors that has continued to push the hackoff stock price down.
The NASDAQ itself is continuing to weaken. By mid-April it is trading just above 3200 after a somber earnings announcement from Big Router. Not only were sales of routers weaker than anticipated during the first quarter, but Big Router had a significant problem getting paid by its dotcom customers. Big Router’s earnings for the quarter are almost wiped out by the write-off of dubious receivables the company has chosen to take. Moreover, Big Router’s CEO, a fabled salesman given to accenting the positive, says he does not see signs of recovery in the second quarter. Big Router itself is trading at just half its all time high.