u know i can do my own research (and i try never to read an analyst report of stock but always read industry reports)...but its nice to have the tech guru backing PAGE and GEMS
Special Bonus Issue/August1997
Worth magazine/Investing in Technology
The Peter Lynch of High Tech
By Michael Peltz
Roger Mcnamee's own brand of down-to-earth research has earned him a reputation as one of the sharpest investors on sand hill road
The sun is just beginning to rise over Silicon Valley, but Roger McNamee is already at his office at 2750 Sand Hill Road, poring over the dozens of electronic messages that have arrived on his computer. On this day, May 27, the missives include the usual market updates and Wall Street research, plus an invitation to a party hosted by Netscape Communications co-founder Marc Andreessen and a note from Michael Dell, the chief executive officer of Dell Computer, who has personally configured a new 266 MHz Pentium II system for McNamee.Exchanging E-mail with high technology's highfliers is an everyday occurrence for McNamee, general partner of Integral Capital Partners, which is based in Menlo Park, California. "Roger knows everybody in the industry," says Dell, who met him almost a decade ago when McNamee was managing T. Rowe Price's Science and Technology Fund. Newly appointed Novell CEO Eric Schmidt calls McNamee "the most connected human being I know."
McNamee's close ties to industry leaders account for at least part of his exceptional performance as an investor. At T. Rowe's Science and Technology Fund, McNamee delivered a 29 percent annualized return from September 1988 through August 1991. That was a full ten percentage points better than the same-period performances of both the Standard & Poor's 500 Stock Index (up 18.9 percent) and technology funds in general (up 18.5 percent), according to Morningstar. He has continued to record stellar numbers at Integral, which he founded with partner John Powell in 1991. Their first two funds, structured as five-year limited partnerships, have a combined annualized return of about 29 percent (23 percent after a 20 percent performance fee is taken out). A third partnership was launched in March 1996.
"Roger is probably the most astute investor in the business," says Silicon Valley veteran Bernie Vonderschmitt, co-founder of chip maker Xilinx and an investor in all three Integral funds.
McNamee's funds have a $1 million minimum and are currently closed to new investors. But his approach to investing is certainly worth studying. In many ways, his style resembles that of former Fidelity Magellan manager Peter Lynch--whom McNamee calls "the greatest professor of investment fundamentals." Just as Lynch likes to visit shopping malls to scout investment themes, McNamee goes to trade shows and electronics stores to check out the latest gadgets. The focus is on understanding companies' products and positioning, not just their numbers. "Real people can develop real insights into real products," says McNamee, "because they are surrounded by them."
McNamee believes Wall Street's approach to investing in technology is fundamentally flawed. Traditional analysts and money managers tend to view the world too much through the lens of a spreadsheet, he says; they often confuse product cycles with positioning and focus excessively on profit estimates. "Earnings are not the most important issue for technology companies," McNamee explains. "Investors need to have a better understanding of product cycles. If a product is going to be really hot, the earnings estimates will always be too low. If a product is going to be cold, the estimates will be too high."
Like Lynch, McNamee has become much better known than many of the companies he follows. "There are a few people in the investment business that everybody knows by their first name," says Ed Mathias, who recruited McNamee out of Dartmouth College's Amos Tuck business school in 1982 to join T. Rowe Price. "If you say Barton, you think Biggs; if you say Peter, you think Lynch; and if you say Roger, you think McNamee."
7:30 AM: McNamee is in his 1993 Toyota Camry, driving north on Highway 280 to a small studio in San Francisco to tape his regular weekly television appearance on CNNfn's Digital Jam. It's been a slow news weekend for technology stocks, McNamee informs the show's producer from his ever present cell phone. They decide to kick off his spot with a discussion of the rumored merger talks between AT&T and SBC Communications.
McNamee decided early in his career that the classic Wall Street investment model--working from a desk, with a computer, a quote machine, and data feeds--was a "loser's game" for most investors when it came to trying to keep up with the roughly 1,000 technology-related companies. "There's no way to keep track of the constant flow of information unless you're at Fidelity and can overwhelm the problem with huge teams of analysts," he says.
At T. Rowe Price, McNamee developed an approach based on techniques used by Silicon Valley's most successful technology investors--venture capitalists--to identify promising private companies and new products: "They hang out at industry events to get informal insights into the technology and to develop a network of people they think are really smart." His VC role models: Kleiner Perkins Caufield & Byers partner John Doerr, a former Intel salesman and one of the initial sponsors of Sun Microsystems, and Ben Rosen of Sevin Rosen, who helped found Compaq Computer and still serves as its chairman.
9:05 AM: McNamee returns to Sand Hill Road just as a meeting of top Silicon Valley executives, organized by Kleiner Perkins's Doerr, is letting out. In the next 15 minutes, McNamee will get the latest from Macromedia chairman Bud Colligan, CNET CEO Halsey Minor, and U.S. Robotics' Palm Computing chief Donna Dubinsky before he even gets inside Integral's offices, which are around the back from Kleiner's main entrance.
In the fall of 1990, McNamee was approached by Doerr at a computer conference and asked if he would be interested in running a new venture. "It was like reading about a million-dollar lottery and then having someone hand you the winning ticket," McNamee remembers. Within 24 hours, McNamee was back in Baltimore enlisting Powell, and nine months later the two of them left
T. Rowe Price to start raising money for Integral's first limited partnership, which opened in December 1991.
11:00 AM: McNamee stands at the blackboard in a conference room, explaining his investment strategy to Lori Zager, vice president for sales at UBS Securities, who is looking to deepen her firm's relationship with Integral. "We're pre-momentum investors," he says. "We tend to buy things other people are selling."
The 41-year-old McNamee doesn't mind getting into a stock too early. Like Lynch, he tries to identify broad investment trends and then narrows his focus to find the companies most likely to succeed within them.
Take the boom in personal computers. As PC demand grows at an annual percentage rate somewhere in the high teens, CompUSA, Compaq, Intel, and Microsoft should all benefit. Yet, as McNamee notes, this doesn't mean they're all positioned equally. Computer retailer CompUSA faces heavy competition; its margins are low, and its inventory risk is high. Meanwhile, computer maker Compaq has brand identity, which adds value, but there are still many substitutes for its products, and it also has a lot of inventory exposure. Chip maker Intel has a monopoly on the microprocessors that power PCs, but its enormous capital investments make it risky, too. At the top of
the positioning food chain is Microsoft, which has a monopoly on computer operating systems, giving it the same benefits as Intel but without the large capital commitment.
"Profitability is good, capital intensity is bad," says McNamee, who also concentrates on a company's ability to adhere to its business model. Does it have the intellectual property and market share to make it work? "Optimally, you want to own a platform, a piece of intellectual property that others build on top of," he says. "That's what's made Intel, Oracle, and Microsoft so great."
The key, says McNamee, is not to confuse positioning with product cycles. When a company gets ready to introduce a new product--either to replace or update an existing one--there's typically a slowdown in revenue growth for at least a quarter or two, because customers tend to be hesitant about making the switch to the new product. Even companies like Microsoft and Intel suffer from the uncertainty surrounding product transitions, he says. Intel, for example, has seen sales of its older Pentium chips slacken since it brought out its new Pentium II microprocessor this spring; this could cause near-term quarterly revenue to fall 5 to 10 percent.
Product transitions create great buying opportunities for long-term investors like McNamee, because the short-term slowdown in revenue growth often causes momentum investors on Wall Street to run for the sidelines. This past April, for instance, McNamee snapped up more shares of networking companies after the networking sector foundered, losing half its value after disappointing earnings from Cascade Communications and 3Com. The one caveat: "You have to buy them before they bottom out," McNamee says, because when beaten-up tech stocks finally change directions, they tend to move quickly.
11:45 AM: McNamee is back in his Camry, heading south on 280 to San Jose to visit Calico Technology, one of Integral's two dozen private holdings. The company has "cutting-edge" configuration software, he tells partner Pam Hagenah, and it hopes to raise more money to ramp up its marketing.
McNamee's Toyota looks out of place among the BMWs, Lexuses, and Mercedes in the parking lot at 2750 Sand Hill Road. McNamee has never bought a house or had a mortgage. "I've never wanted to owe people money," he says. "I grew up in a large family, and my father was a big believer in never spending above your income." His efforts to avoid being swept up in the affluence that has overtaken Silicon Valley are reinforced by weekly reality trips back to the East Coast, where his wife, Ann, teaches music theory at a small private college.
It takes some probing before McNamee reveals his investment pedigree. "My father was somewhat of an entrepreneur, and in the 1950s he started a small brokerage firm," he says modestly. That firm is regional broker First Albany, which has more than 25 offices throughout the United States. It is run by McNamee's older brother, George.McNamee considers himself a "real-time anthropologist." He studies the buying patterns of modern-day consumers, trying to identify not just the next hot products but also the broad-based themes that are driving technology.
For several years, says McNamee, "the single biggest shift in computing has been the move from computationally intense applications to more communications-based ones, from number crunching to messaging." McNamee has identified three major themes: connectivity (networking, client servers, the Internet), mobility (portable computing and cellular communications), and interactivity (games and multimedia). He spends almost 90 percent of his time on connectivity because that's where he sees the greatest opportunities.
His firm's biggest bets are on the companies that provide the infrastructure--routers, switches, modems--that makes networks possible, including Ascend Communications, Cisco Systems, U.S. Robotics (since acquired by 3Com), and Cascade (merging with Ascend). Software companies Oracle and Remedy, which write applications to run on networks, are also among Integral's largest holdings, as are PC maker Dell, which supplies many of the machines that reside on corporate networks, and Sierra Semiconductor, which manufactures chips used in network hardware.
Although the network explosion has got a big boost from the Internet, McNamee avoids pure Internet stocks like search-engine companies Yahoo!, Excite, and Lycos. He prefers enterprise-software companies with "cool" applications, such as privately held Calico, which has developed software used by Cisco to help its customers configure customized orders they can buy directly over the Net.
Netscape, however, is a unique case. It appears to violate one of McNamee's basic investment rules: "Never invest in a company whose success depends on Microsoft's failure." Yet he thinks things may be looking up for Netscape. He's very impressed with its new Communicator program for corporate intranets, which is designed to replace and extend its Navigator browser. The big test for Communicator now is how well Netscape can sell its customers on it. The jury is still out on that.
3:00 PM: McNamee explains the Integral story once again, this time to Michael Thomas, CEO of Tenera. Thomas, who was sent to him by the CFO of Ascend, one of his favorite companies, says that he has already transformed Tenera from "a confused conglomerate" into an applications-software company and that he's looking for strategy advice from "smart investors."
McNamee believes that investors should diversify within his three big themes, not outside them, because even the best technology doesn't always prevail. (Of course, "you're toast if you get the themes wrong," says McNamee.) In the networking sector, Integral owns Ascend, Cascade, Cisco, and U.S. Robotics and has avoided laggards Bay Networks and Cabletron.
Integral's model is designed for long-term investors who don't follow the markets very closely, because the firm spends most of its time trying to identify companies that have winning products. That's good, because technology stocks can be very volatile, even for smart investors like McNamee and Powell. In the first quarter of this year, when the networking sector collapsed, their portfolio dropped 16.3 percent, only to make it back in May when technology stocks rebounded.
7:30 PM: Integral's portfolio was up another 2 percent today (led by big jumps in U.S. Robotics and Ascend), extending what will turn out to be one of the firm's best-performing months ever.
To Roger McNamee, it's an exciting time for investors to be looking at technology. Not only is it the fastest-growing sector of the economy, but that growth has itself engendered a World Wide Web of tools that enables individuals to compete with their institutional counterparts. Thanks to the Internet, McNamee says, the five or six hours a day it took him to keep up with the markets when he was at T. Rowe has been reduced to maybe an hour and a half.
Many of the technology conferences and trade shows that McNamee frequents can also be visited online. Perhaps the best resources are the company Web sites themselves, through which investors can get everything from annual reports to news releases to detailed product descriptions to job listings for employment opportunities. For example, says McNamee, it was clear that rumors of job cuts at Cisco earlier this year were unfounded just from visiting Cisco's Web site.
Ten years ago, McNamee had little choice but to go to the trade shows if he actually wanted to play with the products he was investing in. Sometimes he would even buy some of the gadgets--cell phones, pagers, game systems, laptops--so he could get to know them on a more regular basis. Today, however, it's hard to get away from the technology. "As this stuff gets more pervasive in society," explains McNamee, "it gets even easier for people to do what we're doing."
Michael Peltz is the senior writer for Worth.
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Copyright 1997 Capital Publishing Limited Partnership. All rights reserved. |
