Bussiness Analysis and Valuation

Case Study 1
The Role of the capital market intermediaries in the Dot Com Crash of 2000

1) Objectives of the Case
This case presents to us the situation surrounding the initial growth of Tech
companies and their impact on the wall street during the hay days of the
internet boom and the eventual downfall and the circumstances leading up to
the dot com bust of 2000. One of the major objectives of this case study is to
present facts and realities about every major component in a successful business
endeavor i.e. right from the entrepreneurs who nurture the idea to the various
intermediaries who cast and mold it into a successful and well-functioning
business to the investors who gain from letting go their investments.

2) Observations from the case


3) Need for Intermediaries
Capital Markets primarily function to link institutions with need for funds to the
individual with need to invest but these markets can be huge for an individual
investor to meet the right kind of investment which matches his own
sensibilities. The absence of a right navigator to connect the individual and the
institution led to the evolution of intermediaries. They are of two type financial
intermediaries and information intermediaries. With these intermediaries
interests aligned with the profits of their customers a perfect stream of
information and financial services is created.

4) Consequence of intermediaries
In this particular case intermediaries played an important role as to how the
markets behaved during the time leading up to the bust. An in-depth analysis of
the case will show us how each intermediary influenced the market. Every
intermediary was involved in the expansion of the bubble knowingly and
unknowingly and paid heavily when the market corrected itself .

5) Who are the intermediaries stated in this case ?
Financial Intermediaries
a. Venture Capitalists
b. Investment bank underwriters
c. Sell- Side analyst
d. Buy side analyst and Portfolio Managers
Information Intermediaries
e. Accounting
f. FASB Regulator


6) The intended function of each
a. Venture Capitalist: These were the people who selected ideas which best could
be made into a profitable business franchise. They provide seed funding to kick
start a company. They help in establishing a dependable and high performance
management team. They guide and nurture these companies till they can stand
on their own two feet i.e. showing profits and ultimately going public. Being a VC
is a high risk high reward job which requires skimming through huge number of
ideas and be able to select the right one which could eventually pull of huge
profits for the VCs
b. Investment bank underwriters: When a company goes public these investment
banks act as financial consultants taking care of every job related to the IPO and
in turn take a cut from the total money raised. Hen huge investment banks back
these companies they find buyers for the IPOs from individuals and institution
alike. So in a way Investment banks buy the shares of a company for a short
while with a promise to sell it off to the open market at a predefined price.
c. Sell Side analyst: Sell Side analyst work with investment banks. They are tasked
with researching companies and providing with their recommendation. A high
profile and well respected analyst could single handedly decide the swing of the
market. They help during the IPO buy providing research and key information to
the buy side. This helps in creating public confidence in the IPO.
d. Buy Side analyst and Portfolio Managers: Portfolio managers work in huge
Mutual funds, Hedge funds and other such institution which manage a huge
amount of wealth. They make decisions about investments with the help of the
research and recommendation form the buy side analyst. A wrong decision by
these managers and analysts generally leads to huge losses for the investors.
e. Accounting: The accountants are the information intermediaries who provide to
the general public the current financial standing and health of the firm. Any
manipulation in the accounting practices leads to a conclusion which might be in
the favor of the company but may not be in favor of the investors. Incorrect
accounting practices could mean a wrongful portrayal of the company which
means cheating the investors.
f. FASB Regulators: To regulate the accounting practices we have the Financial
Accounting Standards Board (FASB) . The FASB pitches in during an accounting
dilemma and sets a general rule that is to be followed by all the auditors. FASB
reprimands inappropriate accounting practices and sets guidelines for future
auditing standards.

7) How each player is rewarded?
a. Venture Capitalist: They invest in the companies in nascent stage and in turn
own a percentage. If the company turns out to be profitable and goes public the
Venture Capitalists sell their ownership and move on to nurture the next big
idea.
b. Investment Bank Underwriters: After a successful IPO the investment banks take
a certain amount of the money raised (usually 7%) as fee.
c. Sell Side analyst: Sell side analyst are employed by the investment banks and are
paid according to the profitability of their recommendation and performance of
their selected stock.
d. Buy Side analyst and Portfolio Managers : Just like sell side analyst the buy side
analyst are paid according to the profitability of their recommendation and the
performance of their selected stock and the Managers rewards are tied up to the
actual performance of the fund

what consequences of the compensation function are?

The compensation for all the intermediaries depended upon how good the stock
performed. A positive response from the investors meant an influx of money for
the entrepreneurs, Venture capitalists, Investment bankers and every other
intermediary involved. A positive response shown by the market in the time
leading up to the bust was due to the high performance nature of the tech
stocks. Anybody who could not deliver a promising tech stock to the investors
was missing out on some serious chunk of cash flow for their clients. With the
intermediaries compensations tied down by the market they did everything to
yield positive results even if it meant venturing in the grey area of legality. Many
experts believe that this compensation relationship between the intermediaries
and the markets was the main reason for the dot com bubble crash of 2000

why is it that the high-priced intermediaries were so powerless to correct the behavior of the
individual investors

Most of intermediaries involved introducing the tech companies to the market
had a responsibility to see the long term repercussions along with the short term profits . The
high flying VCs chose to invest in companies with no proper management team and the
investment bankers backed companies without any revenue stream . The analyst both buy side
and sell side made recommendation based on the positive growths in their past without looking
at the current financial standings. Portfolio managers and Accountants presented a rosy picture
to the clients to yield immediate results and the regulators where not capable enough to
forecast the debacle caused by these intermediaries .
By the time the stock started trading at the exchange they were significantly above the par
value which attracted anybody with a little cash a lot of time to spare . This led to the advent of
the day traders . They lacked knowledge of the analysts and funds of an investment banker or a
portfolio manager. They traded based on market sentiments and gut feeling. As the number of
day traders increased the market swung in the direction of the sentiments of these uninformed
investors and huge intermediaries could only sit and watch. With major indices soaring at all
time high anybody pointing out at a possibility of a bubble was termed as a pessimist and
disregarded. In the dot com crash along with the intermediaries the investors were to be
equally blamed .