Back To Basics: What Now After The Year 2000 Techstock Quake?
It's time to re-evaluate the technology investing landscape, a major overhaul. The year 2000 was like a leap year for Wall Street and venture capitalists, where technology stocks and startups were hit hard by the
risk side of the equation. We felt the pain here too. To paraphrase, "risk happens."
NASDAQ is as volatile as a Florida ballot in the hands of Tipper Gore, Internet stocks suffer from the on-again, off-again love affair with the industry. Everyday the headlines declare a new dot-com has closed its doors while at the same time other sectors of the Internet and tech
industries heat up, pop and drop with every wave of momentum investor, real investor and those merely there for the adrenaline.
I believe we are in a time of technology industry upheaval never before seen in this magnitude. In the past it was possible to have major changes in isolated sectors of the technology universe, say an update in storage or better PC chip speeds, with each sector moving at its own speed with its own metrics. Chip stocks or storage stocks could run on
isolated advancements that didn't affect directly or directly any other tech sector to much degree.
Some of you may be familiar with the one way of gauging chip sales with the 'book to bill' ratio. Chips were at the center of the technology
universe for decades yet I seldom hear much about chips as the barometer
of choice for technology or tech stocks anymore.
In 1994-95 I recall Intel's Pentium was a catalyst for stocks and the
market. From July 1998 through March/April 2000 the "Internet" was the catalyst. But it wasn't the Internet based on underlying business profits, it was the Internet as 'blue-sky magic sauce' to make all
businesses better. Just dip it in Internet Magic Sauce and the business will be fine. Doesn't work that way.
While uncomfortable for the present time, the volatility and uncertainty
that rocks tech stocks, and Internet especially, may in the long run
sort out the underlying business models. And that's something that's
never really been done with much effort on Wall Street.
The IPO market is all but dried up, venture investors are getting very
selective, dot-coms are going belly up. We are in the opposite market
extreme than last November, the pendulum swung back, taking with it an
array of companies, good, bad or just plain ugly.
If good companies can get hammered by market mad cow disease, then to me the bigger need is creating a dialogue of understanding that empowers
investors to comprehend the new foundation being laid in the technology world. Understanding this emerging foundation is the focus of this report since the principles may help you become a better overall investor to evaluate the sectors and companies in any technology sector.
But before we embark on the boat, the year 2000 the weather pattern on Wall Street was high winds, strong gales and the fishing was further out
than before. For the first time millions of speculators participated in the stock market, and the highly-emotional style of investing they
brought with them basically ruined the market.
What factors combined for this 'perfect storm' that sent NASDAQ skipping, closed the IPO market for all but a handful of ultra-stellar companies (or those in the latest fad)?
 Daytrading
 Thin floats of Internet stocks (too few shares available and
too many buyers)
 Lack of patience on the part of the investing public, people
not willing to wait for businesses to grow at a "normal" pace but
looking for "overnight" hypergrowth.
 Too many early-stage companies were taken public, diluting the
overall universe of Internet stocks and tech stocks
 Ridiculous ads on TV by some of the online stock brokerages
that touted the easy money to be made trading stocks online (one
featured a truck driver who had just bought an island thanks to trading
stocks). These are comical and have little to do with investing for the
long-term.
 Strong overall economic growth which raised interest-rate fears
 Comments from Alan Greenspan about "irrational exuberance" in
the stock market
 Endless babble about the New Economy replacing the Old Economy
or vice versa, depending on which day it was
Greenspan was right. The irrational exuberance was out of hand. Now
we're just in the "irrational" part, where investors don't have a gauge
to use to figure out "fair" valuation of Internet or many technology
stocks. Nobody can support a 500x price-to-earnings or 500x revenue. And
yet we still see some sectors with such high multiples. Haven't
investors learned?!
Those are a few of the many reasons - any one of which on its own
impacts tech stocks - that the year 2000 had a storm hit the tech stock
beach head with tremendous force. I don't believe the storm clouds have
passed 100%.
But I also think that the silver lining of these volatile elements is
the fact that the Internet is indeed changing business and consumer
living. That basic premise is something I've believed since 1994 when I
first started covering this nascent field as an investment research
analyst at Paul Kagan Associates.
We're returning to more rational ways of evaluating, the daytraders,
dabblers and others are not as active as they were. It's beginning to
feel like 1997-98 again. I remember those days well, when true
entrepreneurs wanted to build businesses and not build IPOs, when only
the true investor owned a company's stock and didn't expect it to double
overnight.
Late 1999 and early 2000 was the exception and not the rule.
Like nitroglycerin the volatility can be harnessed to power ahead the
economy as it does. But occasionally we're going to see the downside to
volatility. It isn't pleasant and it hurts like hell when the market
goes against you, when the uncertainty of a new technology suddenly
becomes a real risk.
Speculators were and are the first to jump ship since they have no
understanding of what they invest in. This caused a huge pop in tech
stocks as the bubble burst in Spring and has been leaking ever since as
it had no or little support by long-term shareholders.
For speculators tech and Net stocks in particular, were lottery tickets,
market espresso for those who weren't looking for the proper nutrients
of management leadership, technology dominance, sales/earnings growth
(or losses being slashed), innovation. In late 1999 and early 2000 Net
stocks were the Cabbage Patch dolls of Wall Street.
In this sort of environment good companies can get crushed by bad
investors. And they have.
For the market right now is choppy, uncertain and full of change.
Most of, if not the entire Internet and many tech stocks on Wall Street
was tossed in this manner. The question is what does it mean for real
investors? The current outlook reminds me of a few years ago when nobody
thought the Internet would change anything, that it was a fad that would
pass.
It reminds me of 1996 when many said that "push" (sending or
broadcasting data to your PC via the Internet automatically based on
your preferences in topics, news, sports, etc.) would replace the search
engines such as Yahoo, Excite, Lycos and Infoseek. All of these stocks
traded in the doldrums, many BELOW THEIR IPO price. Nobody wanted them.
Let me share with you a story.
In December 1996 I organized and helped produce (and hosted) a live
3-hour TV forum on Bloomberg TV where I invited the heads of Yahoo,
Excite, Lycos, Infoseek, and HotBot to Bloomberg's TV studios on Park
Avenue in Manhattan. I also invited Paul Noglows (analyst at Chase H&Q)
to moderate with me and had Kleiner Perkins partner Vinod Khosla (the
founder of Sun) deliver a special keynote.
The mood was not optimistic nor exuberant. The mood was a group of
people looking to build their businesses, with an openness and humility
that the early days of the Web fostered and that we are now getting back
to. Nobody thought about stock options, IPO millions or how fast a
company could go public. Business was the focus.
At the time I kept writing in my analysis reports about the value of the
search engine group, that search wasn't dead. Popular trendy tech
magazines declared search dead and PUSH! Rules (push being the old
companies such as Pointcast and FirstFloor). While organizing the
conference the mood for search engine stocks was sour and dour,
conventional wisdom said these companies were toast, burnt toast.
Well search didn't die, despite media headlines to that effect. But it
took 3 or 4 years to reach somewhat a level of maturity or understanding
by investors. Since they focused on business and ignored the headlines
all of these companies survived. More than that they still exist today!
How many of the current crop of crap out there will say that in 3 or 4
years?
The search group as a whole exploded and went from a combined market cap
in the measly hundreds of millions to the more than $100 billion (thanks
largely to Yahoo). The point is the sector as a whole kept growing and
changing. Even the last of the litter, Infoseek, was acquired for north
of several billion.
And this leads to my next point, a point which is key at understanding
how to view investing in the Internet and technology area. This is the
point at which I believe today many investors don't see clearly or
understand clearly the landscape. In fact, many people who bought
Internet stocks were never investors, they were there for the ride. So
the first real step for them has never been taken: to become an
investor. To understand the difference between TCP/IP and HTTP. To
understand DSL vs. cable, twisted pair vs. coax. OC48 vs. OC192. UNIX
vs. Linux.
Ignorance and greed killed the NASDAQ in 2000 and largely because a core
divide in the markets that has nothing to do with 'Old' vs. 'New'
Economy. It has to do with assets and business models. Here it is:
We're at the juncture where 'digital' and 'non-digital' or
'digital-enhanced' companies are being mistaken for each other. This to
me is the primary reason for the dot-com backlash, the mixing of sheep
and goats. This is the reason that the general public regards Internet
to some extent now as a confusing industry with questionable businesses.
Because companies, venture capitalists and Wall Street rushed to
'dot-comize' the planet, put a domain name on anything and take it
public, without a logic to the truly digital from the merely
digitally-enabled, which I'll explain further in a minute. Let's look at
the table:
Steve Harmon's Digital Divider
DIGITAL DIGITAL-ENHANCED
Ebay Amazon
AOL Time Warner
Napster CDNow
Yahoo Disney
Microsoft.NET Microsoft
future Intel Intel today
With Internet stocks on Wall Street for we have the equivalent of a
kid's toy box where the kid throws everything into the box without
separation of which is what. Similarly, investors and speculators alike
threw digital and non-digital companies into the same sectors of
'Internet.'
Darwin would have a field day with the lack of genus/species going on
here. Companies with little or no Internet business in terms of
percentage of operations and overhead hyped themselves to be defined
"Internet' to take advantage of the lack of a zoo keeper separating them
into groups. The "Internet" moniker boosted valuations, at least for a
time.
In the table above the companies under the Digital-Enhanced banner are
good companies. But they are not 100% digital companies (operations
running in bits and not atoms). Of the six shown, two are etailers,
Amazon (NASDAQ:AMZN) and CDNow (acquired by Bertelsmann).
Etail is not a digital business. Let me give you an example: Dominos
Pizza makes pizzas and delivers them. It requires a phone to order a
pizza from Dominos, no other way to order one really. Walking into a
store and ordering in person is a rarity. Dominos delivers pizza. So we
can say Dominos makes and delivers pizza. Part dough, part sauce, part
logistics and part delivery company. But the one thing Dominos is NOT is
a phone company. Agree?
The phone is merely the ordering device, the front door so to speak, to
Dominos. It's an 'audio' front door. Ditto for Amazon and every etailer.
The Web is simply a 'visual' ordering system while most of their
business is about putting books, music, videos (and now patio supplies)
into a box and sending it to you. Shipping, warehousing hard goods is
what Amazon does everyday.
Yes, it gains some efficiencies from using the 'visual ordering system
(the Web)' to create affinity groups, list recommendations, etc. It's a
beautiful interface. But that's the front door. The guts of Amazon if
you visit Seattle or one of its warehouses is storing and selling hard
goods, stuff. That is not a 100% digital business - and that's why
Amazon posted such huge losses all these years, it's building a
traditional retailer with an Internet ordering system.
The Internet (digital part) enables the rest but the rest is there, like
an iceberg underwater. The cost of running warehouses, shipping and
returns is high. There aren't very many economies of scale there. In
contrast, eBay (NASDAQ:EBAY) is 100% digital and it has been profitable
as a company since its first few weeks being in business several years
ago. eBay had profits, in fact, BEFORE IT RAISED A DIME OF VENTURE
CAPITAL.
It wasn't because eBay founder Pierre Omidyar's first auction items, Pez
candy containers, were so popular. It was the fact that eBay was a
digital company, not involved in the handling of hard goods. eBay is the
software/service - the bits - behind the process of buying and selling
hard goods. Beyond eBay this model has been copied heavily by those
trying to create online marketplaces but the one thing they lack is
critical mass of users. Just being digital isn't enough, being digital
with enough customers matters. That's why even AOL or Yahoo cannot beat
eBay at the auction game.
Pure digital companies, and we don't have to look at just 'Internet' to
get them, provide a prototype for the economics that create hyper
profits and not just hyper revenue. The new hurdle for all digital
companies is creating hyper revenue and hyper profits.
It's not all Internet. The 'Net is a part of the larger 'digital'
industry.
Microsoft (NASDAQ:MSFT) is a digital company founded 23 years ago. All
software. Soft goods. Digital. Bill Gates and company develop software
code, one master file and then copy it 100 million times or whatever and
distribute it.
In the pre-Internet days the boxing and traditional shipping of software
on floppy disk and CD jewel cases did compromise the net margin and it
still makes up part of the distribution today. But the reason Microsoft
has had 42% NET MARGIN is owed in large part to it being digital.
Above I cite Microsoft and Microsoft.NET. The latter to me -
Microsoft.NET - describes Microsoft's moves to migrate the distribution
chain from offline to online, as software becomes the invisible service
and the functionality of the software takes precedence over the
packaging of it. Consider that Yahoo is powered largely by software yet
we don't call Yahoo a 'software' company. It's a media company, a
digital media company. In the old days Yahoo would have had to put its
software on a disk and sell it to you at a PC store, the way
old-fashioned online services ran. The Web replaced that distribution
system for good.
That's why I think Microsoft.NET could replace the old Microsoft, it has
to. Microsoft's becoming a commerce and communications service company,
its software that we see today is being moved into the background, back
to the servers at Microsoft. In fact, where software is stored will
become unimportant. For example, the software that powers the broadcast
industry, is it in your TV or at the broadcast network operation center?
Does it matter? The TV has a lot of chips and logic in it but to users
the point is moot. I like MSFT at these levels, Bill Gates stepped aside
(put aside some ego), changed course for the ship in full public view,
admitted they nearly missed the Internet, and now comes out with .NET, a
strategy that may ultimately eat Windows.
Private company Napster revealed a very powerful way of consumers
sharing music files, basically what is the world's largest music network
or personal radio network. The copyright battle over sharing
professional music recordings is another topic. The technology is
powerful. Watch the peer-to-peer space but don't believe the hype.
But just because you send files a different way doesn't mean the
underlying business model is good.
Peer-to-peer is an old technology that's been around since the early
days of the Internet. It has some benefits in immediacy, more current
files being accessed, in distributed networking, load balancing and file
access.
Yet separate the technology from the business model. The tech is strong
while the business model non-existent. Don't be wowed by the technology,
be wowed by companies that make this technology pay off in profits. The
rest is hype.
Many of us know the year 2000 more changed more than anybody could
imagine. The speed of the change caught everyone by surprise, I don't
care who it was or what kind of hat they wore, whether on Wall Street or
a futurist think tank.
It used to be thought of that the Internet accelerates time by a factor
of 7. For every passing year there's 7 years of "Internet time," 7 years
of innovation and development. I know the pace well. Until this year
that ratio, 7-to-1, felt right.
Beginning this year I think the ratio and speed are greater than that.
We're more like 14-to-1 now. It's a function of how many new users of
'digital' stuff (all networked) and how many new innovations appear.
As the network moves to fiber optics and broadband the pace of data and
service has increased (or will). It's like going from drinking from a
straw to drinking from a fire hose, and the experience won't initially
be pleasant for those with weak stomachs or bad dental work. Broadband
is creating a lot of volatility in the pre-broadband technology and
Internet sectors. Mostly it's eating value as capital is re-allocated to
the future platforms that are broadband. Broadband now sponges up
venture and public capital, which overall is good since the platform
(network backbone infrastructure) is weak and not at critical mass (in
business or consumer users).
In times like these patience is key but also realizing when volatility
may have triggered a loss and eat the risk. It's like living in
California. One minute you're in Malibu and then a big earthquake hits
and the new beach front is Arizona.
One thing I used to say and am reviving here is if you cannot afford to
invest in high risk areas and take the loss then don't invest in
high-risk areas. Unless you deploy market neutral long-short positions
and have the reflexes of a flea. But that's 'trading' and not
'investing' (which I think implies long-term and research).
The risk and reward go hand in hand. Technology investors have years
when the rewards dominate. And they also have years when risk rules and
losses occur. It comes with the territory. If you want to go to the moon
prepare for motion sickness, dehydrated steak and unfiltered Sun rays.
There will be Apollo 13s and floating detritus (Mur) to counter those
years when people jump on the moon, leap over Mars and everyone drinks
Tang and high fives Neil Armstrong.
Absorbing the year 2000 then as a technology quake, what are the steps
at seeing the new landscape, where old and emerging trends fit?
For tech investors it's time to look for these attributes: no hard
assets (keep it digital), viral (network enabled), velocity (can grow
without huge sales force), economies of scale, able to shift strategies
quickly (and recognize mistakes as MSFT and INTC did), service-based
revenue and earnings, steadier and more lucrative than upgrade model,
better lock in of customers.
For valuations we have to look at price-to-earnings growth (PEG),
discounted cash flow (DCF), peers and market segment more closely. PEG
and DCF may be the two titans of analysis metrics now for all tech
companies, Internet included. More on them next time.
Disclaimer:
Steve Harmon does not make specific trading recommendations or give
individualized market advice. Information contained in this report is
provided as an information service only. Steve Harmon recommends that
you get personal advice from an investment professional before buying
or selling stocks or other securities. The securities markets and
especially Internet stocks are highly speculative areas for
investments and only you can determine what level of risk is
appropriate for you. Also, users should be aware that Steve Harmon
and affiliates may own securities that are the subject of reports,
reviews or analysis in this report. Although Steve Harmon obtains
the information reported herein from what it deems reliable
sources, no warranty can be given as to the accuracy or completeness
of any of the information provided or as to the results obtained by
individuals using such information. Each user shall be responsible
for the risks of their own investment activities and, in no event,
shall Steve Harmon, affiliates, agents, partners, or any other
affiliated entity be liable for any direct, indirect, actual,
special or consequential damages resulting from the use of the
information provided.
1. CDMA & W-CDMA: WHAT THEY MEAN TO QUALCOMM AND NOKIA
If all the world's acronyms could be thrown into the trash heap, the
world would be a better place. If you agree with that statement, and
are really averse to acronyms, maybe you should stay away from
wireless investing. Any discussion of the wireless world is bound
to be chock full of acronyms. Which brings us first to CDMA.
CDMA stands for "Code Division Multiple Access." It is a wireless
standard of "multiplexing," which means the transmitting of signals
over a single channel from two or more devices. If Qualcomm
(QCOM, $83) has its way, CDMA will become as essential to 3G
(high-speed third-generation wireless services) as apples are to
apple pie. Everyone will be hungry for CDMA because it is simply
superior to the other three standards of multiplexing in the U.S.
today, namely: GSM, TDMA, and iDEN. How is it superior? It offers
unsurpassed voice quality and capacity, and it is more efficient,
more secure, and operates at lower power. It is also important to
note that the different standards are not compatible. If you have
a GSM phone you cannot use it on a CDMA network.
Qualcomm is the pioneer of CDMA, and is its champion. When you say
"Qualcomm," you think "CDMA." The company has licensed the technology to over 80 leading communications manufacturers worldwide, and this will translate into big royalty payments. Qualcomm wants to bring in royalties from every CDMA product sold. It is also worth noting that Verizon Wireless has adopted the CDMA standard, as has Sprint PCS (PCS, $25).
When you say "Nokia," you think "handsets." In 1999, Nokia (NOK, $42)
built 81 million phones for 31% of the global market. The company is
intent on grabbing global market share, and on being the best
2G-handset provider and controlling GPRS (General Packet Radio Service)
. Nokia is also a licensee of Qualcomm's CDMA rights; so for this
and several other reasons, it cannot be viewed as anti-CDMA.
Nevertheless, for several years Nokia, along with others like
NTT DoCoMo, have challenged the validity of Qualcomm's many CDMA
patents and have repeatedly lost. You can imagine that it would
be downright painful for Nokia to pay royalties to Qualcomm for
every phone sold.
Along comes W-CDMA, or Wideband CDMA. W-CDMA offers a progression
to 3G W-CDMA networks from 2G GSM (Global Standard for Mobile
Communications) networks, which are today's wireless leaders with
nearly 70% of the global market. What's more, W-CDMA offers
competitors a way around Qualcomm's grip on the future of wireless
technology. Nokia and Motorola (MOT, $21) both hold GSM intellectual
property rights to W-CDMA, so both companies would benefit from royalty
payments for W-CDMA. The W-CDMA alternative also offers a great potential alternative when compared to the billions in infrastructure spending that would be needed to convert GSM networks in Asia Pacific and Europe to CDMA networks.
No one disputes Qualcomm's bright future in wireless, but it is
not the company that it once was. CDMA grew 118% last year, and
there is still tremendous growth ahead for the technology. But,
with the advent of W-CDMA, Qualcomm no longer has a stranglehold
on the future of wireless. The company has changed in other ways.
It has sold off its handset division and its infrastructure division. It is planning to spin off its chipset division, referred to as "Spinco." These changes make it more difficult to compare present results with historical earnings. Investors should also consider the possibility that 3G might get delayed. In that scenario, Qualcomm's royalty payments could be delayed and the stock could get hurt.
NTT DOCOMO SET TO BREAK INTO U.S. WIRELESS MARKET
An alliance between AT&T Wireless (AWE, $19) and Japan's NTT DoCoMo
could be set for an announcement as early as this week. NTT DoCoMo
is a subsidiary of Nippon Telegraph and Telephone (NTT, $42).
Although the deal has yet to be announced, it appears as though
DoCoMo is interested in purchasing a roughly 16% stake in AT&T
Wireless for about $9 billion.
COMMENT: NTT DoCoMo has one of the world's most popular services
in their I-Mode Internet service. Basically, it includes always-on
Internet access along with e-mail capabilities for two-way messaging.
This service is geared specifically for the business card sized screen,
and many of Japan's content providers are taking the time to gear their
information to NTT DoCoMo's screen size limitations.
The service has become very popular and has led to great increases in
NTT DoCoMo's subscriber base. The company's subscriber base was 6
million in January of this year, increased to 14 million by October,
and is projected to escalate to over 20 million by March. Now that
is growth! We like that, and we like the possible ramifications it
could have on AT&T Wireless's offerings.
With the rest of the world struggling for the best way to present
the wireless Internet, NTT DoCoMo has just steamrolled their I-Mode
service across the globe. Here is a rundown of the company's most
recent talks and/or deals:
AT&T Wireless-NTT DoCoMo rumored to be buying a 16% stake
(valued at $9 billion) of the third-largest wireless service
provider in the U.S.
KG Telecom-NTT DoCoMo is reportedly close to inking a deal
(valued at $540 million) with privately held KG Telecom that would
give the company a 20% stake in Taiwan's third-largest mobile carrier.
Analysts see this as the logical next step in the company's Asian
expansion strategy.
America Online (AOL, $41) -- NTT DoCoMo will invest $93 million to
receive a 42% stake in AOL's Japanese unit, naturally called AOL Japan.
The two are hooking up with the goal to put Internet messaging and
e-mailing into the palms of mobile phone users worldwide.
Hutchison Whampoa-At a price of $410 million, NTT DoCoMo took a
19% stake in Hutchison Telecom, a subsidiary of one of the largest
companies listed on the Hong Kong stock exchange. This was the first
in a string of global investments for the company.
KPN Mobile (subsidiary of KPN, $14) -- This 43% Dutch government-owned
communications firm sold NTT DoCoMo a 15% stake in their mobile unit
for $4.3 billion. This was back in May of this year, and it marked
the company's expansion into the European wireless market.
TIW (TIWI, $8) -- NTT DoCoMo (through the company's DoCoMo Hutchison
venture) is rumored to have taken a 15% stake in Canada's Telesystem
International Wireless, Inc. for $1.8 billion. This deal was aimed
at giving them an entry into Britain's wireless market.
SK Telecom (SKM, $24) -- Japanese media has reported that NTT DoCoMo
plans to take a 15-20% stake in South Korea's largest mobile phone
carrier. This may take place late in 2001. The two companies may
cross-connect earlier than that in an effort to allow NTT DoCoMo
subscribers the opportunity to use their cell phones in South Korea.
Telekom Malaysia-NTT DoCoMo and Malaysia's largest listed firm were
in talks for NTT to acquire as much as a 40% stake in the company.
Obviously, NTT DoCoMo continues to strive to increase the coverage
area for their I-Mode service. However, what does this mean for AT&T
Wireless? For one, the company will have the extra cash to make a
serious run at the upcoming 2001 U.S. spectrum auctions. With
wireless companies needing to acquire licenses that allow them to
provide wireless service in an area, these upcoming next-generation
auctions might be the key to the potential success/failure of these
large wireless players.
Another standout to this alliance would be the future possibility
that AT&T Wireless could begin to offer one of the most sought after
wireless services (I-Mode) in the U.S. market. NTT DoCoMo has proven
that this service can grow a company's subscriber base, and the
success of this alliance may bring AT&T's soon-to-be-independent
wireless division to the top of the heap. |
