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MARKET COMMENT
By
Liverpool -- Internet venture capitalist Durlacher (LSE: DUC) has fallen on hard times. From a profit of £12.2m last year, Durlacher's strategy of investing venture capital in Internet start-ups has resulted in a loss of £44.9m for this year. The share price was pushed to the dizzying heights of over £4 at the peak of the madness, and now stands at just 3.5p. Why was it such a bad investment, and was the evidence there at the time? It always was an obviously bad investment, and the reason was there for all to see. It's a thing called gearing. Back in the days when Internet companies were leading grown men to leave pubs and go buy shares that they knew nothing about, Durlacher hatched its "internet incubator" strategy of assisting new fledgling companies in their bid to become the next Amazon (Nasdaq: AMZN). If people want to buy shares in the new technology but are held back by ignorance, what better way to go about it than buying shares in a company that is clearly an expert in choosing the best candidates? That's the theory, and up to a point it's a good one. What investors failed to take account of (and it's probably the biggest single failing of private investors) was valuation. Many of the companies that Durlacher invested in were very highly valued indeed. These were the companies that many Internet bulls thought were part of some new economy, and their prices were rich. That's risky enough on its own. But shares in Durlacher itself, and other such "incubators", were also part of the same boom. The value placed by investors on Durlacher ended up many times higher than the value of those already very highly priced Internet shares it owned. Here's how it works: Suppose an Internet company that has a fair valuation of, say, £1 per share is pushed by investors to £10 per share. Now suppose a company that owns some of them has its own value pushed to 10 times the market value of what it owns. That means the original £1 of genuine value becomes priced at £10 in the company itself, and £100 in the company that owns some. Would you want a piece of that? Many did.