Air
date: August 20, 2004
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FORTUNE roundtable
GEOFF COLVIN: Well hallelujah, at last we can stop reading
about Google's stock offering -- it finally happened, and the story reads
like a script for The Three Stooges Do an IPO. But how much really
went wrong -- and at $100 a share, who gets the last laugh? Nobody's laughing
about oil hitting new highs near $50 a barrel. It's hammering the economy.
And it's back to school time, a critical period for retailers. What's
hot, what's cool, what's neither? Two of my FORTUNE magazine colleagues,
David Kirkpatrick and Julie Schlosser, have been looking into these and
other issues in the news.
David, Google -- the most hyped IPO in years. They were going to revolutionize
the process by using this auction, online auction. Then at the last minute,
they radically reduced the estimated price, causing the Wall Street Journal
to say the whole thing had fizzled, in their words. Add a complication
caused by an interview that the founders gave to Playboy magazine;
this whole thing feels like it was snake-bit from the beginning. Was it
a fiasco?
DAVID KIRKPATRICK: It was not even close to a fiasco.
In fact, I would say it was a huge success, an unprecedented success,
and the most successful IPO in history in fact.
COLVIN: How so?
KIRKPATRICK: Well, for all of the stumbles that Google
experienced, and they made mistakes, no question about it, there is no
IPO in any industry in the history of the planet that has ever come close
to the success of this one. Just look at the key data, which is the market
cap of the resulting company. Investors said this company is worth $23
billion going out of the gate. That's what the auction determined, $23
billion. No tech company, no company in any other industry that's a new
company going public has ever had a valuation anything close to that.
COLVIN: And so the problems, if they were problems, came from expectations set by the company, right? Because they had said originally, well, maybe it's going to be $30 or $33 billion.
KIRKPATRICK: Well, the company and the underwriters were very, very aggressive in what they projected, and that did confuse the market. I think it was a very difficult process to participate in, and that scared off a lot of investors as well.
JULIE SCHLOSSER: Yeah, I think the modified Dutch auction
threw people off and they just didn't know how to deal with the…
COLVIN: Well, you know, that's a good point, because you had to register online ahead of time. Only certain people could register. But this is critical for individual investors, because part of the deal here is that in a normal IPO, the small guy gets frozen out, right? Only the insiders get the stock at the offering price. Then it goes way up on the first day, and that's where most individual investors have to buy. The auction was going to get rid of that. In fact, though, they set an offering price of $85. It opened and then closed at $100 on the first day. So it didn't really work the way it was supposed to.
KIRKPATRICK: It ended up becoming much more like a conventional IPO than they had anticipated I think.
COLVIN: David, like most IPOs, the Google IPO involved venture capitalists who had backed the company years ago. How did they do?
KIRKPATRICK: Better than any ever in history. The two
venture capitalists, Sequoia and Kleiner Perkins, both invested $9 or
$10 million in I think '98, that never had any other venture money, which
is unusual in itself. Google was so profitable and successful they funded
it through operations. Each of those companies, Sequoia and Kleiner, invested
9 or 10. Those investments are each worth about $3 billion as of this
week.
COLVIN: Incredible.
KIRKPATRICK: Unbelievable.
COLVIN: And they've held on to them.
KIRKPATRICK: Three billion from a $10 million investment.
COLVIN: Yeah, not bad.
KIRKPATRICK: Not bad at all.
COLVIN: That could fund a lot of losers and you'd still do okay.
KIRKPATRICK: Probably the most successful venture investment in history.
COLVIN: There's another question. We now have a company that people have to decide whether they want to invest in. $23 billion is a high valuation for a search engine, right? I mean…
KIRKPATRICK: For anything.
COLVIN: For anything. And, you know, we can remember when AltaVista was everybody's favorite search engine. Google came along, better product, superior, took away the market, but who's to say the same thing won't happen to them?
SCHLOSSER: Well, they are creative guys, though. I mean I have a lot of faith that they'll come up with some new ideas down the road that we'll be able to watch for years to come.
COLVIN: What do you think, David? Is this valuation justified?
KIRKPATRICK: Well, I would never say that. I think any kind of valuation at this sort of level is very, very hopeful about future opportunity. On the other hand, Google has not only incredible technology and truly brilliant leadership, but they have a brand that is one of the best brands in any industry. It tests up at a level, you know, close to Coca-Cola in certain market segments. So I think they will find plenty of ways to continue staying very, very competitive, if not on top. So I'm not worried about them.
SCHLOSSER: And they were already profitable going into this. They didn't do this just …
COLVIN: It is a good point.
KIRKPATRICK: Well, that's another thing unusual about this IPO. Here's a company, unlike most tech IPOs, this is a company that has, that's growing at 100 percent a year, that's making hundreds of millions of dollars of profit. None of the IPOs during the bubble were profitable at all.
COLVIN: At the time of the IPO.
KIRKPATRICK: None of them were profitable, or if any like two.
COLVIN: That's a good point, and you know it brings
up another related point having to do with eBay. Now last month FORTUNE
put on this remarkable conference called Brainstorm which involved CEOs,
scientists, artists, government leaders, all coming together in Aspen,
Colorado, and among the distinguished attendees of course were all three
of us. One of the things that came up a lot, unplanned, through this conference,
was eBay as the ultimate business model. Julie, what were they talking
about?
SCHLOSSER: I mean everyone wants to be eBay, but the question that it kept coming back to was can they and which models would it work for? You know, can you customize things, make the consumer empowered, and does that work for other businesses?
COLVIN: David, what's so great about eBay's model that makes everybody else want to emulate it?
KIRKPATRICK: Well, everybody loves the fact that basically eBay does nothing aside from facilitate the transactions of others. They're essentially just a platform, and all they do is make it easy for their buyers and sellers to do their thing, and they get a little cut and take it to the bank, which has given them opportunity to basically create a quasi-bank and PayPal or buy it and operate it very successfully. It is the ultimate example, in my opinion, of empowerment of the customer, though, and that's the part that, as Julie says, is extremely hard for anybody else to emulate because it's just the nature of the business they're in. You know, the flea market business is unlike what most other companies are engaged in.
COLVIN: Right.
SCHLOSSER: And I think you'll see other companies try to bits and pieces of what they do, but I think it's going to be hard to emulate the whole company.
KIRKPATRICK: Right, but the key thing for other companies it seems to me is to always be thinking about what would be the potential advantages to your company of further empowering the customer. Because eBay took it to the ultimate extent, and I think there's plenty of ways that you can do it in other industries.
COLVIN: Here's another topic that was big at the Brainstorm conference, and that was China. Everybody wanted to talk about China. Now we've known forever that this was a huge market. A lot of companies have been in it for a long time, but just recently we seem to be getting this critical mass of interest, right? Just in the last few days or weeks we've seen Home Depot going in there, Staples going in there. FedEx just announced they're going to serve 100 new cities in China. Amazon just this week bought China's biggest Internet retailer. Why now? What's going on?
SCHLOSSER: I think they have the proper infrastructure. One of the discussions led by Goldman Sachs Ken Curtis at the conference in Aspen was about is it better to invest in India or China, and it kept coming back to China because they have the stronger infrastructure that was welcoming to foreign direct investment.
COLVIN: And, David, I gather that if we really think
about it, as I know you have, this issue of China can be related to the
issue of oil and oil prices and oil consumption. What's the story?
KIRKPATRICK: China has so many, the growth of China and the explosion of the consumer economy in China has so many implications and so many industries, but one of the more interesting ones I think is that the Chinese recognize that their people want to have a consumer society. They also recognize that if those billions of hundreds of millions of consumers consume energy at the rate that we do in the developed world today, they will choke on their own smoke and they'll probably run out of oil pretty quick and it will be too expensive. So they will, they are almost certain to adopt stricter environmental regulations, for example, than most of the developed countries. But because their market is so big, companies that want to sell in China, things like automobiles, very well may end up building all of their models globally to the Chinese standard, which would ironically render essentially irrelevant the U.S. environmental regulations for auto emissions.
COLVIN: It's a remarkable and very unexpected thing, because of course traditionally developing countries and Communist, or ostensibly Communist, countries have had the worst environmental standards. You're expecting exactly the opposite.
KIRKPATRICK: Well, the Chinese have not just a planned economy but a pretty brilliantly managed economy, and they still have plenty of room for error, but they are not making a lot of the mistakes that the, not even close, that the Eastern Europe dictatorships made when they were ostensibly Communist. China's just doing so many things right in terms of developing its economy.
COLVIN: Julie, it's back to school time, critical time for a lot of companies, retailers and other companies. You've looked into it. What's hot? What's cool? What's changed?
SCHLOSSER: Well, we've had a lot of impressive earnings coming out this week with the retailers, whether they be specialty apparels to the Home Depots to the Target and Wal-Marts of the world. And the analysts foresee increased spending of 7 percent…
COLVIN: On back to school?
SCHLOSSER: On back to school. Up from $450 last year, the average household is going to spend about $480.
COLVIN: That's a lot of money.
SCHLOSSER: A lot of it's going to be going into the preppy collegiate look, which I think American Eagle might be one to benefit, J.Crew will probably benefit. And you'll even see a lot of jeans going from Target to Wal-Mart.
COLVIN: Those of us who are parents of teenagers would like to believe, but are skeptical, that the preppy collegiate look is actually going to catch on. Does it seem that it is?
SCHLOSSER: It seems to be. I think we've kind of, we topped off with the Hot Topics, which were pushing kind of the grunge or the gothic look, the low-riding jeans, and that's supposedly on its way out, so more preppy, collars turned up, bright colors again.
COLVIN: The Fifties are back.
SCHLOSSER: We'll see.
COLVIN: Mod dress can't be far away, right?
SCHLOSSER: Hopefully we'll wait for spring till that.
COLVIN: But now what about other back to school merchandise? Electronics hot?
SCHLOSSER: Yeah, one of the things that we're going to see this fall which is different from other years past is an increase in spending on electronics and gadgets. I don't know how kids are justifying this to their parents, but iPods, the mini iPods are going to be hot.
COLVIN: Mom and dad, I need an iPod for school?
SCHLOSSER: I need a ring tone. I mean I don't know how they're doing it, but I'm sure they're making their cases.
KIRKPATRICK: I just heard of a school in New York that's going to require all of its students to have an iPod for their language and other instruction. It's at a high-end private school. All the kids are going to have iPods.
COLVIN: And they really believe that the kids are going to use them to listen to a foreign language?
KIRKPATRICK: Well, that's what I asked. If they're walking around school with an iPod on, what makes them think they're going to be listening to course materials?
COLVIN: Right.
COLVIN: There's one other thing I wanted to ask you about, which is you have spent a lot of time with this Brainstorm conference and all the people who come, and it seems to me that you've observed a change in the attitudes of CEOs towards global topics, terrorism, understanding Islam, the environment, things like that. Is that right, and what do you think is behind it?
KIRKPATRICK: Well, I think what we were talking about before regarding China and environmental standards in other countries is a good example of why the CEOs of global companies recognize that they have to think about big issues of policy and regulation and just social change in a way they never had to before. They recognize that environmental change, demographic change, energy issues, issues of political risk are going to affect their companies because they are, so many companies get the vast majority of their revenues and profits outside the U.S. now. You can't just look around the corner. You've got to really take a global view, and that's part of what Brainstorm is all about is looking at business in the context of these giant global tectonic shifts that are happening in so many fields.
COLVIN: People have been arguing in favor of that for a long time, CEOs taking that view. They didn't, and now it seems maybe it's finally happening.
KIRKPATRICK: A lot of smart ones really are, no question.
COLVIN: So much going on in the news. Julie Schlosser, David Kirkpatrick, thank you.
KIRKPATRICK: Thanks, Geoff.
SCHLOSSER: Thank you.
Schaeffer interview
KAREN GIBBS: As oil prices near 50 bucks a barrel, the
Dow surprisingly is also on the rise, once again flirting with the 10,000
level. The blue chips closing at 10,000 plus for a 285 point weekly gain,
the Nasdaq better by 62 points, and the S&P picked up 26. Analysts and
CEOS keep cheering positive results like this, but there are concrete
signs that the economic recovery is on shaky ground. Yet investors are
once again pouring money into stock mutual funds. Bernie Schaeffer, CEO
of Schaeffer Investment Research, says this has all the signs of another
big investor fall. So, Bernie, if Main Street is buying, who's selling?
BERNIE SCHAEFFER: Well, I fear that the smart money
is selling, and the public has now gotten to the point, the investing
public has gotten to the point where they feel it's safe to get back in
the water. As you just mentioned, we've had 15 consecutive months of inflows
into equity mutual funds, and the picture that's being painted for the
investing public by Wall Street, by CEOs, and by the Fed I would say as
well, has been a very rosy one.
There have been some glitches, so to speak, recently in terms of higher energy prices, in terms of GDP numbers and employment numbers that have been less than stellar, so to speak, but those are kind of being dismissed as temporary problems. But we have risk out there, and to the extent risk is not recognized and to the extent risk is real and to the extent investors are being complacent and throwing money at the market without thinking too much about it because they're being given all kinds of rosy scenarios, that sets up what I call an environment of vulnerability. And particularly if the market can't get out of its own way, as has been the case so far this year, and the technicals are starting to look a little bit dicey, as they have been over the past few months, that kind of environment, weak technicals, complacent sentiment, real risks that are perhaps being shunted aside, is the kind of environment that makes for market tops and in many cases historically major declines.
GIBBS: Well, I know that you follow the market on a technical basis, but what's wrong with the rosy economic picture being painted?
SCHAEFFER: There's nothing wrong with the rosy economic picture being painted if we understand that that's just one scenario. I can name other scenarios. I mean we're in a situation. We've got some dicey economic data. The Fed is now in a situation where they have to continue raising rates, as they've reiterated recently. So rising interest rates, perhaps a slowing of an economic recovery, inflation out there coming into the picture through crude oil prices and through other price increases, that's kind of a pretty scary witch's brew when you look at it from the negative potential for the economy.
So I guess what I'm saying is we have a continuum here. The best case is what the Fed is telling us and what Wall Street is telling us and what CEOs are telling us. The worst case, I just kind of outlined a worse case, and I didn't include war, terrorism, etc, because we don't particularly like to talk about that. So it's a continuum.
I think investors are being herded, so to speak, towards the best case, and that's why they're so willing to throw money at this market, and I don't know that they're being given a fair shake by those who they have a lot of confidence in to guide them in terms of what their investing decisions should be. And I think the John Q. Investor right now is thinking it's safe to go into the blue chips, it's safe to be 100 percent invested, and I'm saying, wait a minute now. There is a lot of risk, the technicals are weakening, there's a lot of complacency out there. That is a dangerous environment to be 100 percent invested.
GIBBS: Talking about safe, a lot of the blue chips are seen, or conventional wisdom says that they are safe havens in any type of storm. Aren't these Microsofts and big names like that safe havens?
SCHAEFFER: Microsoft, Pfizer, GE, Wal-Mart, I mean these are what I call the usual suspect names. I mean these names have been thrown at investors for the past few years as the safe havens, the way to be. Money managers have thrown money at these stocks. Wall Street analysts are almost unanimously bullish on these stocks. Well, that is another way of describing an environment of vulnerability. When everybody's got buy recommendations on a sector of the market, when money has flowed to that sector to the point that there's very little more that can be thrown at it, what is the path of least resistance? The path of least resistance is not higher. The path of least resistance is lower. It doesn't mean they have to go lower, but there is again an atmosphere of vulnerability that creates downside risk that I don't think people are giving sufficient credit to.
GIBBS: Do you think we could be facing another bubble?
SCHAEFFER: I think it could be worse than facing another bubble in the sense that people feel, the investment world kind of feels like we've been through the bubble and now it's a question of recovering from the bubble. If in fact we were to see another leg down in the market, after the environment has been declared by everyone from the biggest CEOs to the Fed to all the Wall Street firms as safe, and now let's say we saw another 15 to 20 percent drop, I fear for the psychology of the individual investor. I fear for the resilience of the individual investor to come back again like they have come back over the past couple of years.
Now I'll put a footnote to that, and I'll say the Fed, by keeping interest rates down at emergency low levels, by throwing, growing the money supply by leaps and bounds, the Fed used to have weapons in its arsenal if the market would take a big tumble that it doesn't have anymore, simply because it's used those weapons over the past few years to kind of prop up the economy. So I also fear that if the market were to decline significantly, I don't know if the Fed is going to be able to step up on its white horse and come to the rescue of the market as it has in the past.
GIBBS: Well, what are the four key pieces of advice you'd give investors and your clients right now?
SCHAEFFER: Maintain an aggressive cash level I would
say, and by aggressive I mean 25 to 30 percent, or if you don't have that
much of a risk tolerance, and only you know that as an investor, perhaps
even more than that. I would avoid what is referred to as the safe blue
chip names. I would invest in certain sectors of the market that I feel
either have a lot of opportunity associated with them, energy, energy
services, gold, or sectors that pay nice dividends that might have a little
bit less downside risk associated with them, like the utility sector.
GIBBS: Let's get some picks of stocks in the energy sector. Start with that.
SCHAEFFER: Okay, energy sector, my favorite is ChevronTexaco
in that sector.
GIBBS: Why?
SCHAEFFER: Huge earnings growth, and they just beat the Street by about 40 percent, record earnings, increased their dividend by 10 percent, have a nice dividend yield of about 3.5 percent, and the Wall Street analyst community has still not gotten on board. There's actually more sell and hold recommendations out there than there are buy recommendations, so a lot of room for upgrades, and of course we have oil setting record prices every day almost.
GIBBS: Energy services, what's your pick there?
SCHAEFFER: Energy services, this is a sector that even
though it's performed extremely well in recent, a couple, three years,
it has lagged the S&P by so much since the early 1980s, since we had the
huge energy boom in the early 1980s. There's a tremendous amount of room
for that sector to add to its gains. Oil prices stay at these levels or
even a little bit lower, there's going to be an exploration boom, and
that still has not hit.
Smith International has been an outstanding performer within the energy
services sector, and again, another one of those situations. Eleven analysts
have holds and sells on that stock, and only seven have buys, so room
for upgrades to help power the stock higher, and a big short interest.
Ten percent of the share float is shorted, and again room for short covering
rallies should the stock continue to perform.
GIBBS: How about the utilities area? Generally thought as stodgy for widows and orphans.
SCHAEFFER: Stodgy, it's actually been slightly outperforming
the overall market. Individual names are kind of difficult to pick in
that sector. There are some company-specific risks in that sector, so
I like to buy the whole package and I like the exchange-traded funds,
particularly the Utility Holders Trust that has a nice 3.5 percent dividend
yield and you're able to diversify across the whole spectrum of the sector.
GIBBS: How about the technology sector? Are you sour on it entirely or are there some picks there that look attractive to you?
SCHAEFFER: I'm sour on the big-caps, the Ciscos, the
Microsofts, the Intels. Some special situations I think are pretty interesting.
PalmOne, which of course has been a tremendous outperformer so to speak,
but here's a company that's growing by leaps and bounds, and Wall Street
is still quite skeptical of. The short sellers are all over it, and good
upside potential from my perspective.
XM Satellite Radio, the satellite radio stocks these days remind me of
the Internet stocks, not at the peak of the bubble, but in the mid-1990s.
Because in the mid-1990s, everybody loved to hate the AOLs and the Yahoos.
They had not reached that level of acceptance on Wall Street yet. Satellite
radio is generating that kind of skepticism. Huge growth, nobody argues
with the growth. XM Satellite has had a quadrupling of their subscriber
base over the past couple of years. But the same old concerns about valuation
and price/earnings ratios that used to dog the Internet stocks in the
mid-'90s are kind of dogging the satellite radio stocks, so a good way
to enter a high-growth sector that before it peaks I think Wall Street
is actually going to be quite bullish on it.
GIBBS: Bernie Schaeffer, always a pleasure. Thanks for joining us.
SCHAEFFER: Thank you, Karen. Enjoyed it.
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