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TSC: It sounds like you think there's something
materially different between this swoon and the past
seven, whereas other people say that the bubble has
burst.
Jeff Applegate: Certainly you've had a different
phenomenon this go around with a lot of dot-coms. You had
a lot of companies that typically operated in
private-equity land now operating in public-equity land.
Some people were fairly happy to go out and buy a bunch
of companies that were losing money on an accelerating
basis. So in that sense was there something different?
Yeah, no question. But to me that's a stock-selection
issue, choosing where you want to be.
In this virtual economy portfolio, since it's a riskier
portfolio, you can see that about a fifth of the names
are still losing money. We think they have business
models that will get them to profitability. So, when we
put this portfolio together, another decision was,
"OK, if we're going to start playing the game of
buying companies that are losing money, let's put in
place some decision rules around that."
We're not going to spend a moment on any company that's
losing money unless it's passing three screens: 200%
year-over-year revenue growth, 70% gross margins, and
a globally scaleable business model, click, not brick --
so Yahoo! (YHOO:Nasdaq - news - boards), not AOL
(AOL:NYSE - news - boards). Most dot-coms can't pass one
of those screens. My hope with that is at least we'll
start out with a very robust business model. And then you
do your fundamental research -- do you like the
management, do you like the product, do you like the
space they're in? Which doesn't mean we won't make
mistakes -- of course we will -- but hopefully we'll make
fewer mistakes.
If you think about where we are with the virtual economy
at the moment, it's still only 2% of retail sales,
and it's about 3.5% of wholesale sales. First one
looks like it's growing at 100% year over year; the
other one looks like it's growing 150%. If you think
about where we are with the Internet at the moment on a
company basis, Cisco and Dell (DELL:Nasdaq - news -
boards) are the preeminent examples of B2B and B2C. Every
company on the planet wants to look as much like Cisco
and Dell as it possibly can. It's the most efficient way
to do business, reduce cost of goods sold, improve
productivity, etc. And everyone will get there to a
degree, depending on what kind of business they're
ultimately in. The economics there are exceedingly
compelling on the B2B side. Then you've got the B2C side.
We go to the Internet for convenience, for fulfillment,
for price. If you think about the Internet for consumers,
it's cumbersome, it's a pain to use. It's still very
crude. It's also not a mass market -- but it will be. And
when it becomes a mass market, that's going to demand a
lot more routers, switches, servers, bandwidth, storage.
TSC: What companies that we don't consider technology
companies right now do you think might really benefit
from the advent of the Internet?
Jeff Applegate: Oh, I think everybody will.
TSC: As an investor, are there areas you can look at
outside of technology and say, wow, these guys, they're
smart management, they understand technology, and here's
a company or an area where the Internet or new technology
is going to do incredible things to the bottom line?
Jeff Applegate: In an absolute sense, what you're talking
about is going to improve the profitability and the
margins of Phelps Dodge (PD:NYSE - news - boards) and
Alcoa (AA:NYSE - news - boards) and Ford (F:NYSE - news -
boards) and Wal-Mart (WMT:NYSE - news - boards). It's a
whole bunch of Old Economy companies.
The real question is: Is that the security that is going
to beat the market? And when I look at a lot of those
companies, and the final demand characteristics they face
as compared to the final demand characteristics of a
Cisco or a JDS (JDSU:Nasdaq - news - boards), or an EMC
(EMC:NYSE - news - boards), I don't think it's much of a
horse race. While we would make the argument that all
this IT is going to have a significant impact on
profitability for the market, we still argue about [where
the] most robust growth is. And that, to me, is not going
to be Ford.
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"We couldn't have sat here five years ago and figured
out that there would be such demand for people who could
create and maintain cool Web sites."
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TSC: Are there any areas in the New Economy that you
think are going to be pretty exciting?
Jeff Applegate: The way I think about your question is,
we couldn't have sat here five years ago and figured out
that there would be such demand for people who could
create and maintain cool Web sites, because we didn't
know.
Well, here we are. And now you've got folks like
Razorfish and Scient (SCNT:Nasdaq - news - boards) --
companies that didn't exist prior to this. You've got
business models like priceline, which is basically an
inventory clearance mechanism that couldn't have existed
before the Internet. Or eBay (EBAY:Nasdaq - news -
boards), which is kind of like a global garage sale,
which couldn't have existed before the Internet.
Whenever you get rapid technological change like we're
seeing, you'll get a substitution effect. Without trying
to predict precisely how this will evolve, particularly
on the service side, what we try to focus in on is who's
going to be involved in improving the sensory
capabilities of cyberspace. That's what the name of the
game is: to make the thing easier to use. Accessing
cyberspace ought to be as easy as turning on your
toaster, but it's not. Who are the companies that are
going to get us there?
Now, what businesses is Cisco going to be in five years
from now versus where they are today, when they weren't
even in photonics and fiber optics 18 months ago and now
it's 20% of their revenues? I don't know, but I'm
betting that management is going to be able to figure out
where they want to go.
TSC: What about biotech and genomics? It doesn't seem
like you have much of a focus on those.
Jeff Applegate: We don't and that's really lack of
knowledge to be frank. We did a fair amount of work in
the second half of last year, and then they had these
parabolic price moves. We have been doing more work, and
we're looking to add some of those names to the
traditional portfolio in the health care sector. We just
haven't done anything as yet.
If you look at the traditional portfolio, where for all
intents and purposes we've got three-quarters of this
portfolio in tech or tech-related. ... On traditional
metrics people would argue that this is a hugely
concentrated portfolio. My response to that would be
certainly, on traditional methods. But we're living in a
fairly atraditional world where the advent of the virtual
economy is going to have an enormous impact on a lot of
physical economy business models. The challenge for a lot
of these guys is going to be to move their brand, their
valuation, and their profitability increasingly to
cyberspace. And we'll see who makes it and who doesn't.
I find it fascinating to think about the next generation
of shopping bots as we move to handheld wireless. These
guys are working on devices and software that in the
future will allow you to be in whatever store and you'll
see whatever it is you want, and you're going to be able
to input an SKU or brand name and what's going to come
back to you is the cheapest price online or off-line.
What's that going to do to the pricing power of Wal-Mart,
Target (TGT:NYSE - news - boards) or Amazon (AMZN:Nasdaq
- news - boards)? So we've decided we don't own any of
those stocks.
We used to own Wal-Mart. We don't anymore, which has been
a mistake because it's done pretty well. Wal-Mart, to me,
is a great company -- probably the best of the breed
globally. They've got a very sensible e-commerce strategy
in their joint venture with AOL. Most of their customers
are not on the Internet, and they're going to get them
there, but I'm hugely concerned about their pricing
power. And I'd apply that to any retailer I can think of.
Though we've still got Home Depot (HD:NYSE - news -
boards) and Tiffany (TIF:NYSE - news - boards).
TSC: They're more high-end.
Jeff Applegate: Well, certainly Tiffany is. They're not a
price sensitive kind of thing. And Home Depot is not
Wal-Mart, it's not Gap (GPS:NYSE - news - boards), it's
got a different product line where people want to kick
the tires.
But if the Internet is the most deflationary event of our
lifetime -- which I think it is, and it's barely begun --
it ought to have a huge impact on a lot of companies'
pricing power. |
