June 14, 1999
Fund of Information
Storm Warnings
Managers hunker down, seeing more trouble ahead in Internet
shares
By SANDRA WARD
Memories of last year's late-summer market collapse still linger in the minds
of many professional money managers, and the specter of a fresher hell
arriving in the near future is lending a bearish tilt to portfolios.
While bullish on the overall market, Anthony Weber of the $33 million
Alleghany Veredus Aggressive Growth fund has cash levels at 8% from a
combination of inflows and through the sale of "residual" Internet positions.
That should help Veredus weather the storm that Weber thinks could be
brewing in the Internet sector and which he thinks could hit this fall after a
summer rally.
Scoreboard | Fund Scope | Cash Track
His concern: A big boost in the supply of Internet-related shares amid
weakening demand will result in a selloff. For one thing, trading restrictions
limiting insider activity at companies that came public earlier this year are due
to be lifted this fall. Meanwhile, the IPO pipeline is still bursting with new
issues: 77 in the gate at latest count, valued at $6 billion-if they're completed
as planned. That's on top of the $360 billion in market capitalization
represented by the existing 115 Internet companies, of which America Online
accounts for $108 billion. Of those, 51 came public this year through June 4.
Consider that the market cap of the Russell 2000 Index is $1.2 trillion.
Another catalyst that could cause investors to head for the exits, as Weber sees
it, would be signs of slowing revenue growth among the commodity-like
Internet service providers, such as the Amazon.coms. Weber, a onetime
student of Fred Alger, sees the stage being set for a "great leadership change"
of the magnitude seen in 1991, when biotechnology and health-care stocks hit
the skids and capital was reallocated to a broader segment of the market.
"I'm quite bullish," says Weber. "But I think the Internet sector is where the
money will come out of."
So far this year, the universe of 127 Internet stocks tracked by Dreaderman's
Internet Research Trends, or D.I.R.T., published by David Readerman,
director of Internet strategy at Thomas Weisel Partners, is up an average of
82% year-to-date compared with gains of about 6% for the S&P 500 and 13%
for the Nasdaq. (Readerman's research shows that America Online and Yahoo
are the most widely held of Internet stocks with market capitalizations of $10
billion or more by the top 20 asset managers. The top five institutional holders
-- Fidelity, Barclays, Janus Capital, Bankers Trust and Vanguard -- own
positions in all Internet companies that fit that bill and account for 50% of
total institutional holdings in them.)
To make room in his portfolio, Weber weeded out sketchier names such as
Verio, Concentrics, Flycast Communications and National Discount
Brokerage, fully expecting the group to decline again after its snapback from
its recent 50% correction. He's not shunning all stocks related to the Internet
sector, however.
Louisville-based Veredus -- a name that means alternately "swift horse" or
"horse-hunter" in Latin -- is up 28% so far this year because Weber has
focused his attentions on what he calls "Internet enablers," companies that will
be instrumental in helping to build and enhance Internet networks. Among his
winning bets so far: Uniphase, a maker of fiber-optic parts and lasers that will
be instrumental in expanding the pipe through which information flows. He
bought it when it had a market cap of $175 million; it's now worth about $12
billion. Earnings at the company have been increasing at a 40%-50% clip a
year, but at 144 the stock is beginning to look "rich" based on expected fiscal
2000 earnings of $1.80 a share ($2.30-$2.40 on a calendar year), which gives
it a P/E ratio of about 83 based on fiscal earnings and about 62 based on the
calendar-year estimates.
He also likes Harmonic Inc., which he bought last November after the maker
of lower-margin digital and fiber-optic parts beat earnings expectations for a
couple of consecutive quarters. For added security with an investment, Weber
notes that he tends to "buy on the way up," looking for reassurance that an
earnings surprise isn't a flash-in-the-pan but a sustainable event. Other picks in
his eclectic portfolio are: Navistar International, whose engine business gets
overlooked; Ames Department Stores; shoemaker Genesco; the Italian
restaurant chain Buca di Beppo; and LaserSight, a chain specializing in laser
eye surgery.
Weber's not alone in bracing for some turbulence.
Gordon Grender, manager of Global Asset Management's Gamerica fund and
an investor in U.S. stocks since 1974, is sitting on a 30% cash position. That's
in large part because he's "concerned about a crash in Internet stocks," the
result of "dubious" business models and rampant speculation that reminds him
of the late 'Sixties, when "people were buying terribly insubstantial companies
because everybody else was buying them."
"Internet stocks have already corrected, but there's more to come," he
cautions. Though much has been made of the broadening out of the market, he
suspects much of it is related to Internet euphoria and so is somewhat
misleading.
Much of his cash position comes from unspent inflows rather than through any
active program to build a safety reserve by selling stocks, and he expects to
put about one-third of it to work "soon."
Wally Weitz, celebrated manager of the Weitz Value and Weitz Partners
Value funds has let cash drift up to more than 30% in those portfolios, the
highest level since 1987. Takeover activity, strong cash flows and a lack of
good value is behind the high cash levels. Tom Carney, head of equity trading
at Weitz, notes that while Weitz is no market timer, he is patient, and the high
level of cash suggests "there very well could be better opportunities" and
"hopefully the market would take care of that."
Lately, too, Fred Kobrick of Kobrick Capital Management has grown more
circumspect about the Internet group.
"We've been more cautious in the last five weeks," he says, particularly after a
round of visits at Internet companies in April. Amazon.com's plan to spend
heavily to build brand and market share signaled to Kobrick what he believes
will be a major shakeout in the sector, which he intends to watch from the
sidelines as he waits for buying opportunities. As a result, he's "changed the
complexion of the funds somewhat" and has let cash rise to 6%. He's pared
back positions in America Online and CMGI and sold his positions in
Amazon.com, Real Networks and Inktomi.
"I want to own them, but not at these levels," Kobrick says. "The Internet is
the most exciting, dynamic, technological change in our lifetime. I'd rather
not see it go by without trying to figure it out."
To that end, he applies Kobrick's five M's -- management, model, market
share, momentum and math -- before he determines whether he'll make an
investment. He's bullish in the long term about Amazon.com, for instance,
because he considers management "brilliant." He maintains its business model
is that of a "consumer brand" company, not a technology business, and will in
the end develop a "world-class auction site."
Kobrick thinks he'll have the opportunity to jump back into the sector soon,
fully expecting a "sharp" but normal correction to create better values in an
otherwise healthy economy with moderate inflation.
For the first time since 1990, No-Load Fund Investor's editor, Sheldon Jacobs,
added cash positions to his model portfolios: "wealth builder" and
"pre-retirement" now have 15% cash and "retirement," 10%. Insisting he's
"not that bearish," Jacobs is concerned that the market is too expensive and
that a rate increase or a shakeout in the Internet sector could make for tough
going.
"I wanted to bring down the risk level," he says. "And in the correction last
summer there were no safe havens."
The other prequel: Long, long ago in a galaxy far, far away (Jimmy Carter
was President, long Treasury rates were 7.64% and rising, and the Dow stood
at 912.99), Mario Gabelli (whose hair was probably still red) made a
rebellious case. Twentieth Century-Fox was a buy at 20 a share and deserving
of a market multiple because of the boost to earnings that a picture such as
Star Wars would provide: "The quality of deals Fox's management will make
should be a tip-off of the value of Star Wars' earnings that will accrue to
shareholders on a secular basis."
One valuation method the then 34-year-old stockpicker offered: C3 Po + R2
D2 = Profitability. He likened the impact from a movie such as Star Wars to
an oil gusher. Indeed, News Corp. bought Twentieth Century-Fox eight years
later from oil tycoon Marvin Davis in two separate transactions; News Corp.
paid a total of $550 million and allowed Davis to retain control of a real-estate
partnership. Last November, News Corp. spun out about 20% of Fox
Entertainment, which includes Twentieth Century-Fox as well as cable and
television assets, for $22.50 a share. Now the shares change hands at about 28
for a market capitalization of about $3.5 billion.
The force was with him.
Fred Kobrick's also been selling elsewhere. When he teamed up with Howard
Silverman of Cendant Corp. nearly two years ago to sell mutual funds, it
seemed a match made in heaven from a marketing standpoint. Cendant was a
leader in executive-relocation services, owned the Howard Johnson hotel and
Avis Rent-a-Car brands, was buying an insurance company and had plans to
add further to its financial-service operations. Distribution delight.
But just months into this odd-couple venture, potential quickly turned to pitfall
when accounting "irregularities" at Cendant sent that company's reputation
right into the gutter and its stock into a near-fatal swoon from which it is only
just beginning to recover. Distribution dried up and Kobrick funds were
scarred by the alliance with Cendant.
Last week the alliance ended as Kobrick sold his $200 million mutual-fund
firm to Boston-based NVest for an undisclosed sum. NVest is a holding
company for 18 investment firms and has a total of $133 billion under
management. The Kobrick funds will continue to operate with independence
and autonomy, but a revenue-sharing arrangement and strong distribution
networks should keep its interest aligned with NVest. |
