Do the rules of the old financial world affect the new economy? The answer appears to be increasingly yes.
Lastminute.com is not the only internet stock to have come down to earth with a bump. Lycos Europe began trading on Wednesday on the Neuer Markt and immediately slipped below its issue prices of euro 24, closing at euro 22.85.
Previous fallers included the Dutch internet company World Online International, down more than 20% in its first three days on the market.
A new paper by Chris Higson and John Briginshaw of London Business School offers a possible explanation.
Published in the next issue of Business Strategy Review, it argues that while some of the high-priced internet stocks will survive and justify their valuations most will not.
The reason is simple: they will never generate enough cash. Like most analysts, Higson and Briginshaw dismiss traditional stock evaluation methods.
Because most internet companies are start-ups, it is pointless looking at price/revenue or price/earnings multiples because they do not have any revenues or earnings. The key issue is whether stock prices reflect reasonable expectations about the growth and profitability of internet businesses.
The only way to test that is to model the company's ability to generate cash in the future.
Predicting the market for internet businesses is difficult enough, given the range of alternatives. But expectations about the future competitive environment in which they operate are just as important.
A common mistake is to assume the competitive environment will be the same as it has been in the past and that new economy companies will earn fat, old economy margins.
In reality, Higson and Briginshaw argue, the internet will become much more competitive, making the new econ omy a difficult place in which to earn profits.
"In such a world, the market allows companies survival rations, no better," they say.
To illustrate their point that most internet valuations are stretched, Higson and Briginshaw examine two high-profile internet companies - Amazon.com, which in February, had a market capitalisation of $1.6bn, and Freeserve, which was worth £7bn.
After studying a range of revenue growth patterns, structures of costs and attainable profit margins, they conclude that on only the most optimistic assumptions is Amazon's value justified. Even more aggressive assumptions for Freeserve's profit margins and sales growth are required to justify the stock's price.
Higson and Briginshaw suggest that a lot of internet investors could lose their shirts. But it is not only individuals that stand to suffer. If the bub ble bursts, falling stock prices could hit economic growth. But even the bubble is doing damage to the real economy.
"In a bubble, companies which own successful internet operations may be tempted to spin them off to give shareholders the benefit of bubble valuations, at risk of compromising their ability to capture the synergies from a clicks and mortar strategy.
"On the other hand, high observed valuations may tempt corporate managers to build internet activities even though they possess no competency or advantage in this area. New economy companies with bubble valuations may use overvalued paper to facilitate acquisitions of businesses which they have little ability to manage."
