A not-so-tiny bubble Reality bytes

In late January, about a hundred mining professionals gathered in a room in Toronto’s Sheraton Hotel to hear what Bay Street analysts and fund managers had to say about their industry’s future. Suffice it to say, seldom was heard an encouraging word and the sky remained cloudy all day.

Future? Mining has a future? Some of us throw a few dollars at the top companies for old time’s sake, but our younger peers don’t follow the sector at all, because of its poor returns and even poorer growth prospects. And why should they? All those bad investments and undisciplined capital decisions have caused little wealth to be created in decades. The action is elsewhere now, so get with the consolidation program before your combined market capitalization slips below the gross domestic product of Albania. If you ain’t in the top five, we ain’t interested. If your project ain’t in a league all its own, you’re out of the game.

Taking lumps is nothing new for the mining industry. It has been dodging bricks to the head since, well, 1997, when the gold-mining bubble ended with an ugly bang in the steamy jungles of Borneo. The entire mining industry was hauled on the carpet and told to first, clean up its act, and second, improve its returns to shareholders. While they were busy doing exactly that, the Teflon investment community turned its attention elsewhere. When the “new economy” train came chugging down the track, they were the first to climb aboard. And they hit paydirt, week after week, month after month, which only reinforced the wisdom of their “major shift in investment strategy.”

The giant returns caused even cautious investors to climb aboard, which eventually became so overloaded that people were hanging on to the side-rails. The multiples attached to technology companies became, well, absurd, given their intrinsic value. And reading a balance sheet became a surreal exercise, given the proliferation of new accounting terminology, and the discrepancies in meaning between such terms as “earnings from operations applicable to common shares” and “operating income.” But as long as the shares kept appreciating in value, few worried about housekeeping matter.

Against this backdrop, it’s small wonder mining companies became viewed as “irrelevant,” and even quaint. Small wonder that high-tech industries were praised for having “better business characteristics, and/or better decision-makers at the helm” than old economy businesses. The mining industry became as small as some of its executives must have felt.

Fast forward to mid-February of this year, and the post-Valentine’s Day massacre triggered when telecommunications giant Nortel Networks told the world it wouldn’t be growing at a rate of 30% this year after all — more like 15%, and oh yes, we expect a loss, rather than a profit, in the first quarter. Nortel’s shares plunged 33% to $30 in frantic trading the following day, continuing a downtrend that began last fall. The company has lost $289 billion in market capitalization since its shares reached a peak of $124 last summer.

Nortel’s woes spread to its suppliers and rivals, and many tumbled to new lows. Lucent Technologies (now the subject of a regulatory probe for its innovative accounting practices) trades at about $12, well below the $70 price it enjoyed a year ago. And these are the big companies — the cornerstones of the new economy.

Smaller internet companies had their comeuppance last year, when investors realized that keeping young people in Porsches was an expensive and unrewarding proposition. E-commerce companies collapsed by the droves. As Editor Tony Keller noted in the February issue of National Post Business, “the first reality to hit the technology sector was that nobody any longer thinks the future of the world economy, let alone the future of the Internet, is primarily about selling hard goods on-line to consumers in units of one.”

This sobering realization triggered an exodus to business-to-business ventures, which offered units of many. But B2B took a beating last year too, mostly because traditional businesses weren’t all that eager to give up their, well, traditional ways of doing business.

The new-economy carnage isn’t over. Recent press reports suggest that the entire telecom sector is facing a massive shake-out because of over-supply and falling prices. According to The Economist, European and North America banks were warned last year that their exposure to telecoms was perhaps a tad excessive in light of market saturation, among other things. Perhaps the downdraft that clipped the share prices of Nortel and its competitors during the past six months or so reflects an exodus of smart money. If so, the smart money can’t be blamed for bailing out of Nortel, which was once valued at something like 120 times earnings. And perhaps the smart money also realized that in the new economy, the term “earnings” had been s-t-r-e-t-c-h-e-d to accommodate a variety of creative ways and means to pretty-up the bottom line.

Add to that the business of getting a reward today for potential growth tomorrow, which, in the new economy, became far more important than managing the core business. Before long, market capitalizations were propelled into the stratosphere by every potential piece of good news the company and its cheerleaders could throw into the public domain. The battles to capture “growth” became so fierce that Nortel and its rivals tripped over each other to lend their customers billions of dollars to make their purchases. Some of those customers are going under, presumably because of the same “unexpected downturn in the U.S. economy” that bushwhacked Nortel.

Now add to that dumb deals by the dozens. The mining industry has taken plenty of flak for its undisciplined acquisitons, but if recent newspaper accounts are any indication, these pale in comparison to the flurry of transactions that made technology companies front-page news, day-in and day-out. Nortel, like many of its competitors, paid billions (in inflated stock, of course) to buy dozens of companies, including those with no earnings and no imminent sales. Had they waited a mere six months, some of these companies could have bought for ten cents on a million dollars.

The meltdown of the new economy is bound to result in increased scrutiny of disclosure, accounting and valuation practices, not just of companies, but their auditors and financial advisors too. Disgruntled investors are already questioning why technology companies, once valued in the billions, have been reduced to the bargain-basement bin. Class-action lawyers will offer to help them seek retribution. Shareholders are already questioning why so few analysts issued sell recommendations for technology companies during the past year, even when some were trading at higher market capitalizations than the major banks (five major banks, in the case of Nortel).

Another burst bubble. So many questions. So few answers. We predict that a Technology Standards Task Force is not long in coming.