The dot-com swindle: a how-to guide from Spain

Jose G. Perez jgperez at
Sat Nov 20 00:15:03 MST 1999

    The rapacious Spanish Telephone monopoly has just carried out an almost
textbook example of how to inflate your  stock price through a dot com
swindle, in the initial public offering (IPO) of Telefonica's Internet
Subsidiary, Terra Networks (notice the English language name and then think
about the old saw: No one ever went broke underestimating the intelligence
of the American public).

    First, the background: Telefónica is not only the blood-sucking parasite
that has strangled the development of online communications in Spain through
outrageous per-minute local call charges; it also bought (at fire-sale
prices) telephone monopolies in various Latin American countries (Brazil,
Argentina, Chile and Peru, if memory serves). It has greatly expanded the
number of lines (i.e., paying subscribers) at the expense of service and
also looted the local phone companies AND their shareholder partners through
outrageous "management fees" and the transfer of assets (like the local
Internet operations of these phone companies) to Madrid-based Telefonica
subsidiaries at below-market prices. Thus Telefonica got Chile's leading ISP
(with about a half million subscribers) for 40 million dollars.

    Now the Hype: Not only due to socio-economic factors but also to
abominable service and extortionate fees, Telefonica has succeeded in
virtually nipping the development of the Internet in Spanish both in the
mother country as well as in several large Latin American markets. Thus it
is fairly easy to show that the development of the Internet is WAY BEHIND in
these places. Simply leave out the fact that the reason it's way behind is
you, and project catching up in a year or two, and voila, you get figures
like an increase in e-commerce in Spain of 7000% or so by 2001. Promise the
suckers that sort of growth not only in Spain, but in Chile, Argentina,
Brazil and God Knows where else, and every speculator on the planet is going
to beat a path to your door.

    The mechanics/payoffs:  Now,to get away with a swindle on this sort of
scale, you need accomplices. No sense having the local Chilean company spoil
all the fun by saying, for example, that most people who can afford a
computer have one and are already online, or the Bolivians or Peruvians
spilling their guts about the dirty little secret that something like half
the population doesn't use Spanish as their main language anyways. Sure,
they're pissed off about how you raped the little telephone monopoly they
had invested in with you (this is the secret story of the decline of the
Latin American bolsas in the 90s: everyone who got in bed with these foreign
telephone monopolies got screwed, and they're the biggest issue in most
markets), but now call them "strategic partners" and offer them part of the
"float" of the new Internet company at insider prices to buy their

    In theory, telefónica just floated some 66 million shares of Terra,
about 23% of the company's stock. But more than 90% --61 million shares--
went to insider "strategic partners" and "institutional investors" at about
$12 or $13 a share. The only part that actually made in into the stock
market were a measely 5 million shares. AND just to make sure these would be
MONSTROUSLY over-subscribed, the stock was floated in Spain and on the
American NASDAQ, the Golden Nuggets casino of the stock-jobbing trade,

    So that's the real story. Telefonica actually put on the market less
than 2% of Terra's shares. The result was, needless to say, that for a
couple of hours Terra couldn't even OPEN in Madrid, there were no sellers.
When it finally DID start trading, it did so at about three or four times
its issue price of twelve or thirteen dollars. Now 5 million shares may
sound like a lot, but you've got to remember shares are normally sold in
blocks of 100 minimum, so really you're dealing with 50,000 blocs of stock.
And no significant INSTITUTIONAL investor (the HUGE majority of the trading)
is going to mess with anything less than 50,000 or 100,000 shares or so, a
few million dollars worth.  Because if you're the manager of, say, a two
billion dollar fund, you simply don't have the time to look into how to
invest each tenth or hundredth of a percent of your fund. You find a
reasonable bet and you plunk down 10, 20 or 50 million dollars on it, say,
100,000 shares or so. What Telefonica actually put on the market was 50 or
so of these super-blocs of 100 thousand shares, split between Spain and the
U.S. There were, let's say, in the U.S. 30 or so of these blocs initially
available and THOUSANDS of mutual funds, pension funds, insurance investment
pools, investment banks, investment companies, as well as hundreds of
thousands of individual investors.

The result is, of course, that Terra, on the basis that 5 million of its
shares that are bouncing around like crazy for 30 or 50 bucks a piece, i.e.,
a grand total of $200 million dollars or so, it said to be "worth" (market
cap) some 10 or 11 BILLION dollars.

The newspapers say it is worth many times more than any other European
Internet company, and I would not be surprised if it was as much as ALL the
other European Internet companies altogether.

Here's the kicker:  Terra "bought" the Chilean ISP --now a half-million
subscribers-- for $40 million. That's less than $100 per account. Assuming
the Chilean industry's cost structure is similar to the American one for
argument's sake, $100 isn't an irrational figure. The cost of providing
Internet connectivity in the US is maybe $10/month. Adding a couple of
dollars a month for servicing the account, that still leaves about $100 a
year per user to put in more modems, buy new subscribers (either through
acquisitions or advertising), and pay back your investment over a few years.
But how many subscribers does Terra have, all told? Last we heard, less than
a million. This means that Terra is being valued at $12,000 or so PER
SUBSCRIBER, and that, in  many cases, for subscribers in countries where
percapita GDP is half or less that amount. They figure in a few years
they'll have 10 million subscribers (fat chance), but let's say they had
them today, that's still $1,000 per subscriber to a service which, in the
countries furthest along the digital revolution, is more and more being
given away for free. Anyone with an ounce of sense can see the math doesn't
work. It's going to take you a decade or so to recoup what you've paid for
you clear per subscriber a year you invest $50, recouping the $1000 is going
to take 20 years! Compare that to getting 6% a year PLUS guaranteed all your
money back at the end from absolutely risk-free U.S. treasuries, and the
only possible conclusion is that no one is making a rational investment in
Terra, every last share has been bought for purely short-term speculative

Now, there's nothing unusual about the utter, complete economic
irrationality for Terra's valuation. It's the tiniest baby of a bubble
compared to, say, the Dutch Tulip craze. Then again, there's a reason the
brits beat out the dutch in the world colonial sweepstakes.

For serious people, however, the most worrisome part of the Terra/Telefonica
operation is that Telefonica quite consciously structured the deal to create
a huge bubble of fictitious capital which would be inextricably combined
with its own capital. Telefónica, after all, owns more than 75% of Terra. As
a result, Telefonica's shares jumped 25% over the past month or so, 5% more
with the IPO, an analysts figure it should go up 10 or 15% more, what with
Terra being "worth" so much.

    But telefónica is, by far, the largest company in the Spanish stock
market. (Terra itself is now the 10th largest.) In writing about the IPO
dot-com funny money fictitious capital in the States, I've pointed out that
the danger here is limited precisely because no one believes that, say, a
billion dollars worth of Yahoo really is the same as a billion dollars worth
of AT and T, and that if the owners of, say, sucker-dot-com tried to
actually sell five or ten billion dollars worth of stock, they'd never in a
million years get the money, instead, the artificially inflated paper of
sucker-dot-com would collapse. For that same reason you can't really use
sucker-dot-com stock to acquire a "regular" company: again, bringing that
mass of stock onto the market would just collapse the price, prick the

THAT IS NOT TRUE OF TELEFONICA. Its stock is fungible. And to the extent it
incorporates this huge amount of fictitious capital, it is going to drain
surplus value from the companies and sectors that really produce it. You do
that enough, and pretty soon the actual value-producing sector of the
economy cannot reproduce itself, and you get a catastrophic crash-and-burn
depression that goes on until every last dollar of fictitious capital -- and
a very high percentage of the REAL capital -- has been destroyed.

Moreover, as the Vodafone offer shows, the whole European Telecom sector is
tending to get bid up in a mad speculative binge. Telefonica has just shown
the really big sharks how to print tens of billions of dollars to use in
their takeover wars, and if the bigger players follow Telefonica's example,
sooner or later all of Euroland is going to crash and burn. If it does, a
very likely scenario is that it will pull the entire world economy down the
crapper with it.


P.S. Don't believe for a second that the dot-com "breakout" is going to be
limited to Spain or Europe. Disney seems to be trying something similar by
floating its (underwhelming) web sites as "" (The truth of how much
FAITH Eisner & Co. have in "go" is that they're not letting it fly the
Disney flag: THAT brand is way to valuable to risk tarnishing in a flaky
operation like this. And judging by my kids reaction to Go, I'd say someone
at the top of Disney also has school age kids.)

It may be, however, that the days of the American dot-com bubble are
numbered: there's been more and more grumbling in the financial press about
when Amazon and the rest are going to offer their shareholders some real
profits. And with every new issue that comes along, the same basic pool of
betting money gets spread thinner and thinner (That's the reason for the
tiny floats: if Telefonica seriously thought they could've gotten even $10 a
share, they would have certainly sold the bulk of Terra in the Bolsa and
especially on the NASDAQ, with Telefonica keeping a controlling minority
stake but offloading the majority of the risk. And since Telefonica still
controls the wires, they probably could have siphoned back to the main
company the bulk of the profits through equipment, access and maintenance
charges and such for use of the network).


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