In Today's Daily Reckoning:
*** Tough times in the New Economy...Caribbean cruise
canceled...MicroStrategy fires employees...
*** Spending rising twice as fast as earnings
*** $36 Billion of IPOs in the pipeline...who's going to
buy them? Henry and Edward, back to school... and more
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*** Remember Michael Saylor, CEO of MicroStrategy? He was
back in the news yesterday, announcing a layoff of 234
employees - 10% of his workforce. Not only that, the
company cancelled its annual Caribbean cruise for
employees and their families. Things must be tough in the
New Economy.
*** But even in adversity, Saylor took care of the
workers (at capitalists' expense, of course). Each laid-
off employee will get accelerated options and $10,000
worth of Saylor's own stock.
*** Saylor's business has been unprofitable from the get-
go. The stock traded as high as $333, but in March, he
was forced to restate earnings. Then, down it came -
reaching its latest resting point at $27 yesterday.
*** There are a lot of no-account New Economy companies,
but Saylor attracted attention by the evangelical way in
which he shilled for the New Era. "Information should be
as cheap and free-flowing as water," he remarked. He
maintained at an on-line university would revolutionize
education, and that free information would move economic
growth ahead at warp speed.
*** But the rocket fuel of the New Era is not
information. It's cash and credit - both of which are
still rising. MZM (cash) is going up at about a 6.3%
annual rate. And personal spending for July rose at about
a 7% annual rate. Both of these numbers are about twice
as big as the number for personal income growth.
*** Meanwhile, in Japan, the personal spending numbers
came out and showed that the average Japanese person is,
true to recent stereotype, not spending more, but
spending less. Personal spending on the island of
perpetual darkness fell by 3.6% in July.
*** What the numbers tell us is not, I believe, something
fundamental about the difference between the Japanese
character and the American one. Spending is not, at least
I don't think, directly correlated with, say, height...or
inversely correlated to the desire to eat uncooked
seafood.
*** Instead, the numbers reflect an episodic shift in
confidence. Reuters reports that U.S. investors are
enjoying a "growing confidence" - which is in itself
remarkable, inasmuch as confidence and self-esteem were
already at the highest levels ever recorded. Americans
seem to have cornered the market on self-esteem...and
maybe there is some subterranean Smoot-Hawley Act
prohibiting the exportation of it - particularly to
Japan, where confidence hasn't been seen in more than a
decade.
*** Yahoo fell almost 10% yesterday after an alert
analyst noticed that Internet advertising revenue, which
is Yahoo's income source, may be softening.
*** But it was a good day for most stocks. The Dow rose
60 points. The Nasdaq stumbled upwards by 27 points -
putting the index in barely-positive territory for the
year.
*** The dollar fell against the yen...and rose against
the euro. Nothing important.
*** Oil rose 77 cents.
*** The German economy rose at a rate of 3.1%. This is a
slower pace than the U.S. figure - but the number is more
reliable. German number crunchers are not (at least yet)
teasing up their calculations with 'hedonic' measures.
*** And here in France, things are looking up too.
Laurent Fabius, the finance minister, said he would soon
announce the biggest tax cuts since WWII. He said he
recognized that high taxes in France were a structural
impediment to growth and aimed to do something about it.
*** Gold fell 10 cents...but platinum rose $5.90. "The
world is running out of gold reserves, and faster than
you think." This is a quote from Chris Thompson, CEO of
the world's second largest gold producer, recorded by
Harry Schultz in a recent newsletter (www.Hschultz.com)
"Central banks will soon realize it's not smart to either
sell gold or lend gold they may have trouble getting back
in a gold-scarce market."
*** There are still a lot of IPOs in the pipeline. A NY
Times piece says that about 280 companies are waiting to
go public this year - hoping to raise about $36 billion.
That's about as much as for the whole of 1998.
*** In addition to the IPOs there is also a huge supply
of insider stock that is coming out of 'lock-up'
restrictions. Typically, insiders can't sell their shares
until at least 6 mo. after an IPO. Millions of shares
from IPOs of last year and early this year are now coming
on the market. The sale of these shares, as well as new
supply from IPOs, seems directly related to the Nasdaq.
The NY Times piece: "In May, according to IPOlockup.com.,
insiders at 63 companies were free to sell 2.7 billion
shares. Nasdaq fell 12 percent that month. In June, the
shares available for sale dwindled to 1.3 billion shares,
and the Nasdaq rose 17 percent."
*** "Now, however," the Times piece continues, "the lull
is over. By the end of the month, some 1.7 billion
shares issued by 53 companies will have been unlocked.
And in September, 1.8 billion shares in 45 companies will
be free to trade for the first time."
*** Henry and Edward head back to school in Paris today.
Poor things. The summer went by so quickly. And we were
all so busy. I don't remember spending any time with
them. Could I rerun the tape, please, in slow motion?
Ah...but that's the problem. The Internet may have
destroyed many of the limitations of space. But time has
become even more precious.
*** I'm still down here in the country - with Jules,
Maria and Sophia. The older kids don't start school until
next week, so we're enjoying one last week of vacation.
Jules is fishing. Maria is swimming. And Sophia is on the
Internet trying to figure out where to go to college next
year. (I've been discouraging her...but more about that
another time.)
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The Great Debate I refer to in today's letter has nothing
to do with the two candidates for America's highest
office. Instead, I am talking about the debate between
digital and analog. Analog or Digital? Which are we?
Could we be both? And the future...is it completely
digital? Or purely analog?
"Like many people," writes Jim Davidson, moved by the
spirit of democracy, "I have a cell phone which mainly
operated on digital signals. But it also serves as an
analog device when a digital signal is not available. In
that sense, I feel that our thinking should be both
"digital" and "analog." We should pick up the strongest
and most useful signal that comes available."
On one hand, some people say that the Internet changes
everything. On the other, there are people who say it
changes nothing. I'm going to go out on a limb here...but
I firmly believe both are right.
Let, me try to tidy up around the edges of the discussion
to see if I can reconcile this paradox.
Many people, fascinated and impressed by the Internet,
routers, optic fiber, chips and the other paraphernalia
of the New Era, are quite sure that these advances must
lead to good new businesses...and must also undermine old
ones.
In this, they are certainly right. We already have a
great number of very good businesses of the New Economy
persuasion. Intel, Microsoft, Cisco - these are all
fairly new companies, and very profitable. (For whom they
are profitable - the workers or investors - is another
story.)
These companies - and many others - benefit from the
tremendous economies of scale in the new information
economy.
Rick Ackerman sent me this explanation: "The
technological leap forward made possible by our brand-new
computer and communications technologies creates a large
host of winner-take-all markets. If you are producing an
information good-a computer program, a piece of online
entertainment, or a source of information-the work only
needs to be done once and then it can be distributed to a
potentially unlimited number of consumers for pennies:
producing at twice the scale gains you nearly a 50% cost
advantage."
Specialization produces better goods and services at
lower costs. The Internet makes it easier to select the
best deal - giving the best company a huge advantage.
Plus, in all markets where Metcalfe's Law applies - that
is, where the more widely used a particular product is,
the more useful it is to each user (like the telephone) -
economies of scale give the largest-scale producer an
added advantage. Who wants to own a computer that is not
compatible with the most common software?
So, the companies - such as Microsoft, Cisco and Intel -
that enjoy these huge economies of scale, can be expected
to become very good businesses. You only have to make it
once - and you can sell it everywhere at very low extra
production cost. In that sense, these products are like
the Daily Reckoning. It costs no more to send it to
100,000 people than it does to send it to 10 people.
By contrast, there are a lot of companies that operate on
the Internet but fail to benefit from specialization
and/or economies of scale.
The most familiar example is our old favorite river-of-
no-returns, Amazon.com. Ackerman continues: "Here the
logic of reduced frictions takes over: for without a
large scale economy-driven cost advantage, the effect of
the new economy is not to increase but to reduce
margins..."
Selling books is not a high margin business, anyway. In a
world where the customer can click on a search engine
(www.isbn.nu) to find the best price, margins nearly
disappear. Amazon sees the problem too. Its solution is
to try to be something else - a place where you come to
shop...like the parking lot of a suburban mall. Amazon
hopes to make its money by getting a little piece of a
great number of transactions. Will it work? Who knows.
VitaminShoppe.com, an example cited by James Cramer in
today's column, is a similar case. It was described as a
'category killer' and was backed by a parent with 60
stores and $132 million in sales. It came out in October
at $11 and promptly fell to $9.75. But then, it was named
the #1 Top (a little redundancy helps get the point
across) E-commerce site. And its daily unique visitor
traffic increased by 337% according to Media Metrix.
The stock roared up to $16.
But was it a good business? Well, no. The company could
bring in a lot of visitors, but it had no way of taking
advantage of the Internet's economies of scale. Vitamins
are not an information product. Like books, and unlike
software, they're tangibles that cannot be replicated at
negligible marginal cost. The only way VitaminShoppe
could bring in and retain customers was by competing on
price...which meant squeezing the margins.
Soon, no one cared what Media Metrix said. Investors
realized that the whole B2C - business to consumer - e-
tail industry was a loser. Amazon continues to struggle
to hold its stock above $30...as investors hope the
company will figure out how to realize some economies out
of its enormous scale. VitaminShoppe.com has fallen down
to just $1.16 - with negative $2.60 of earnings for each
share.
Microsoft, Cisco and Intel, however, are recognized as
good businesses. Not only are the recognized as such,
they are practically canonized.
But a good business is not necessarily a good investment.
It depends on what price you have to pay to acquire it.
No matter what kind of business you buy, you're paying
for a stream of income. In the end, that's all there is.
A digitally-oriented man could do the arithmetic. Simply
make reasonable assumptions and discount the expected
stream of income from any of the Big Techs to present
value and see what you get. You will get a number much
lower than the current selling price.
The typical man may think digitally when he writes
software code, or builds a computer switch. But when he
calls his broker, he reverts to more analog behavior. He
is gripped by fear, greed, confidence or anxiety -
depending up the temper of the times and his own mood. A
stock may shout BARGAIN to him one day and whisper "sell"
to him the next. Going along with the great mass of other
investors, he responds to these suggestions with the
enthusiasm of a Republican with a defense contract.
Cisco is a good business now. It will probably be a good
business 5 years from now. But it will only be a good
investment when most investors no longer think so.
Your correspondent...
Bill Bonner
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Last modified: April 01, 2001
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