Something Ventured:
February 16th, 2001
By Brent
Holliday
Greenstone
Venture Partners
"What's
the use in tryin',
All you get is pain.
When I wanted sunshine,
All I got was rain...
Disappointment haunted all my dreams..."
- The Monkees, I'm
A Believer
It's
always darkest before daylight. I have repeatedly stated
here in this very column that we are not about to crash,
economically speaking. The stock market has done a
remarkable swoon, reducing some sectors to "drill
bit" stocks (you know... 3/8, 1/2, 3/4) and it
would appear (if you read, watch or listen to much of
the media reports) that we are in for even more
troubling times. In the short term, yes. Ugly. Turn of
My Yahoo until April. Throw your monthly RRSP reports in
the recycling bin unopened. Ignore it. Get on with
making real money at your job. Set your alarm for April
15th and then look out at the bright sunny world of
stock market investing once again.
In
the meantime, do not equate the movements of the stock
market to the economy. The two are connected but not
related. I will give you my reasoning in a second. Just
remember that my perspective as a venture capitalist is
to go long. I'm thinking five years out because a) I get
great comfort in shaping a world that I essentially make
up and b) If I invest in what's hot today, due to the
early stage of my investment, I would never make money.
I
have been to a few conferences in the past three months
in the US, where many of the smartest minds in
technology have been busy trying to explain away today's
market ills and expound on the future of the technology
industry. The most recent trip was this week to
Robertson Stephens investor conference where I had the
pleasure of listening to many CEOs of top technology
companies, fellow VCs like Vinod Khosla of Kleiner
Perkins and analysts like Arun Veerappan, uber analyst
covering the Optical Components space. Let me synthesize
the current thinking of these brighter than bright minds
for you:
The
Market Today Explained - A stock is priced by the
market at a level that takes into account the
expectation of future growth of the profits of the
company. The faster the expected growth rate, the larger
the premium placed on the price relative to earnings. So
after the silly season of "irrational
exuberance" where the market placed unrealistic
expectations of growth on the market, things have come
back to earth. Well, duh. That's why we have drill bit
stocks today. The real fear cycle in the market today is
not related to the dot.combustion, but to the warnings
of the giants, the profitable companies that were
untouchable before October 24th.
Zeroing
in on the optical/internet infrastructure meltdown,
October 24th was a key day. As Arun put it, the first
shoe dropped. Nortel gave guidance to the market that it
would not meet its 4th quarter numbers and stated that
demand was slowing. They were the first to admit it and
they were punished. Along with everyone else. Salt into
the open wound, or the "other shoe" dropping
was three weeks later in mid November, when Cisco
reported slowing demand and enormous inventories. Just
in time for winter, we had a big downward slope to all
technology stocks. Good for sledding.
Every
year for the past decade, the major "box"
makers (Cisco, Lucent, Nortel etc.) showed a decline in
inventories over a calendar year (Q1 highest, Q4
lowest). Like clockwork. Except in 2000. For the first
year in a long time, inventories went up every quarter
and were massive by Q4. Cisco's were 8.5 times what they
were just 9 months before. For those that don't do
financial statement analysis, this means that Cisco
overbought from its suppliers so that they would not be
short of parts only to see demand from the carriers
(Bell, AT&T, Qwest, etc.) evaporate. The ripple
effect, or the third shoe was that the suppliers to
Cisco and Nortel would get it in the shorts the
following quarter because Cisco et al would stop buying
parts and try and sell the inventory. Right on cue, PMC-Sierra
and JDS Uniphase said Q4 was great, but Q1 2001 would be
bloody awful. Ouch. Down we go again.
Now
Nortel gets hammered again for even lower guidance and
job cuts (they have announced 13,000 job cuts, which
coincidentally is the exact number that they hired in
2000. People, like inventory, must be cut when demand
slows. Wall Street says so.)
Essentially
2000 was a watershed year. The biggest guns in the
massive buildout of the Internet all got ahead of
themselves. Ask anyone that runs a large business,
"What is the hardest part of your business?"
Answer: predicting demand.
So
the market is in a fear cycle. Fear of demand going away
for a long, long time. When will it end? I'll come back
to that.
The
Really, Really Big Picture - Leave it to Vinod
Khosla, all over the covers of the latest
business magazines and owner of the most enviable
track record in VC investment history (since 1997:
Cerent, zero to $8B in 18 months, sold to Cisco...
Juniper, zero to $55B in 3 years... Extreme Networks,
zero to $9B in 3 years... Corvis, zero to $25B in 2
years) to give us some comfort as to where we are
headed. He did caution that he is not God and that he
was just lucky.
All
through history, technology innovation has accelerated.
And it scares the crap out of people. In 1885, a group
of Yale students whacked down a lightpost because it was
too light at night and "more light than they
relished". In 1885, there were only a few hundred
lightposts. By 1899, there were millions, an astonishing
growth rate of a new technology that could not have been
predicted by anyone watching the Yale students with
their axe fourteen years earlier.
If
the pattern of increasing pace of innovation holds,
imagine what we will be looking like in 2010. Taking
Moore's law as our pace setter, we will see the
equivalent amount of innovation and change in the next 9
years as that which occurred from 1970 to today. Think
about that for a second. How many recessions since 1970?
Four? The Dow was at 1000 back then. The NASDAQ did not
exist. Bill Gates was high school dweeb. The point is
that if we map that to the next 9 years, we have to
expect lulls in the cycle, but we are trending up.
Vinod
had another good point about change. In the 70's there
were 6 dominant computer companies (IBM, Data General,
Sperry, Univac, Wang, HP). In the late 90's, the
dominant 6 are Sun, Compaq, Dell, IBM and HP. In a
little more than 2 decades a lot changed. Look forward.
Assuming that the next big thing is not computer
systems, but network systems, today there is Cisco,
Nortel, Lucent, Alcatel, AT&T, Sprint, Worldcom. Who
will be there in 2010? Lucent is looking downright Wang-ish
already. Nortel may not be the big gun in 9 years
either.
Look
at the world in an old economy way for a minute. IT
spending (computers, software, networking, services) has
been proven to increase productivity (finally!) in most
businesses. Average IT spending is at 3% of revenue
today, up from 1% only 5 years ago. As CEOs and managers
get a hold of e-business and its inherent efficiencies,
it's safe to assume that IT spending will increase over
the next 9 years. If it increased to 10% of revenue
(which is possible if increasing IT spending reduces the
need for some G&A and some sales and marketing
expenses) by 2010, we would see trillions of dollars in
spending every year. Wanna bet that we will see a
trillion dollar market cap company by then? Vinod goes
one step further and suggests that the trillion dollar
company in 2010 may not even exist yet. That gets a VC's
heart thumping.
So
back to today. When will the current cycle end? The last
two downturns in the tech market were in 1998 and 1996.
In each case, the bearish market lasted for 3 to 4
quarters. In each case, the market started going down
exactly one quarter before the companies admitted
problems (which is what happened here if you look back
to the late summer and Nortel and Cisco coming off their
peaks). In each of the previous cases, the market
anticipated the end of the pain by 2 full quarters. In
other words, the bottom of the cycle was 6 months before
the companies started announcing good results again. If
Oct 24th was D-day and this downturn is a full year (big
assumption, but not without merit considering the really
big picture and pace of innovation), then Buy day starts
April 24th or thereabouts. But no earlier.
Your
confidence in that date depends on whether you listen to
today's noise or think about tomorrow's inevitabilities.
I'm sure those Yale students did not invest in light
bulb manufacturers at the time. Would you?
Random
Thoughts -
-
Drill Bit Stock Of The Week - Onvia is at 7/8
today, one full year after going public and trading at
$65 on the first day. They are in danger of being
de-listed on the anniversary of Glenn and Rob pushing
the button to open the NASDAQ on their first day. As
they say, what a difference a year makes.
-
Drill Bit Stock Of The Week - Book4Golf.com is at
$0.63, which is 3/8 in US funds for those keeping score
with your Black and Decker at home. They lost $28
million dollars of investor's hard earned money
(remember that during the exuberance, Yorkton coaxed
money out of investors at $15 per share) in the year
2000. Revenue? $0.685 million, which I find hard to
believe is even that much.
What Do You Think? Talk
Back To Brent Holliday
Something Ventured is a bi-weekly column designed
to supplement the T-Net British Columbia web site with
some timely, relevant and possibly irreverent insight
into the industry. I hope to share some of the
perspective and trends that I see in my role as a VC.
The column is always followed by feedback (if its
positive or constructive. I'll keep the flames to
myself, thanks).
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