The Deipnosophist

Where the science of investing becomes an art of living

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Location: Summerlin, Nevada, United States

A private investor for 20+ years, I manage private portfolios and write about investing. You can read my market musings on three different sites: 1) The Deipnosophist, dedicated to teaching the market's processes and mechanics; 2) Investment Poetry, a subscription site dedicated to real time investment recommendations; and 3) Seeking Alpha, a combination of the other two sites with a mix of reprints from this site and all-original content. See you here, there, or the other site!

07 February 2008

Crème de la crème

No doubts about it, the current market environment is difficult. No strategy works, as every opportunity is taken behind the woodshed, where it is bludgeoned, shot, and then decapitated. But the cream always rises to the top, and stocks are no different. As ugly as the markets appear now, this decline merely creates the opportunities from which investors will profit.

And no doubt about this either, my Core Opportunities are getting creamed. Apple/AAPL, Google/GOOG, Intuitive Surgical/ISRG are each caught in individual bear markets, and now Chipotle/CMG nears its breakdown. Does this recent share price weakness somehow equal that their businesses suffer from a sudden turn for the worse? Or do their share prices decline because that is what stocks, and markets, do on occasion?

Despite the ferocity of this decline, and the increasing ugliness of the charts, I believe the markets near a major low, especially when coupled with increasingly compelling valuations (PEs, PEGs, etc) due to the share price drops and still increasing earnings. Google/GOOG certainly ranks as an especially compelling purchase; the opportunity to purchase shares of a company that grows as fast as it does -- a PE of 30 for a company that grows in excess of 30% per year?! Hmm. A reader forwarded the following article (minus its provenance, alas)...
Microsoft's Yahoo Gambit
February 5, 2008; Page A17

Sunnyvale, Calif.

Yahoo, be coy, but take the Microsoft deal.

Microsoft's interest in buying Yahoo had been rumored for so long that when the bid -- $44.6 billion -- was finally made last week, it managed to surprise just about everyone in the high-tech world. With merger rumors fading and Yahoo slumping, it was generally assumed that cofounder and CEO Jerry Yang and his team were hunkering down to cut their losses with layoffs and then embark on a major re-organization.

Microsoft's offer has changed everything. Within minutes after the news broke, the mainstream media and the blogosphere were on fire with speculation on what it all meant. Here in Silicon Valley, and other high-tech enclaves around the world, the debate was a welcome respite from the increasingly depressing news that always accompanies the industry'squadrennial slide into recession.

The announcement also brought to the surface a lot of old emotions,
including Silicon Valley versus Seattle, corporate capitalism versus
entrepreneurship -- but most of all, the fear of Microsoft as an unstoppable force crushing all competitors before it. Pundits instantly started asking if the feds would even allow such a merger. Meanwhile, at Yahoo's photo-sharing subsidiary Flickr, members are throwing a collective (and characteristically clever) tantrum about being handed over to their new overlords.

The low point came on Sunday when David Drummond, Google's senior vice president and chief legal officer, darkly summoned the ghost of Microsoft past. "Could Microsoft," he asked ominously on the company's Web site, "now attempt to exert the same sort of inappropriate and illegal influence over the Internet that it did with the PC?" He was dangling the bait in front of the Federal Trade Commission to see if it would nibble -- all while conveniently ignoring the fact that if there is any monopoly at work in the digital world these days, it is Google's absolute dominance of Internet searches. Its market share surely equals IBM in computers, Intel in microprocessors and, yes, Microsoft in PC operating systems at their peaks.

Still, you can understand Google's paranoia. Company CEO Eric Schmidt has twice fought Microsoft in the past -- at Sun and Novell -- and been crushed both times. At Google he has triumphed at last by forcing Microsoft to play to his strategy, only now to see Microsoft try to change the rules. That's got to make you sleepless and edgy.

The rest of us don't have the same excuse. Years ago on a Sunday morning news show, Bill Gates made perhaps his most prescient comment ever. If you look at the history of technology companies, he said, none have ever been able to stay at the top for long. This is Microsoft's moment, he continued, but it won't last forever.

He was right. If you look at Microsoft with an objective eye, it becomes apparent that it is a giant company past its prime. It is big and rich, but increasingly toothless. It is able to use its money to put on a great show at the Consumer Electronics Show, underwrite an interesting market initiative -- or buy another big company -- but it no longer has the fire of ambition or the addiction to risk to ruthlessly execute on those desires any more. As has been noted before, once you look past all of the high profile moves (such as MSN, MSNBC, Zune and XBox), Microsoft has only really been as successful as it reputation would suggest in just two businesses: Windows and Office. Most everything else is flash.

Even Microsoft's full-out assault on Netscape (which, ironically, will officially die on March 1) for control of the Internet browser industry -- justly earning it the sobriquet "Evil Empire" -- in retrospect was less a brilliant maneuver by Gates & Co. to capture a hot new industry and more a desperate (and questionable) scramble by a market leader caught napping.

That corporate somnolence, rather than its more-remembered ruthlessness, has far better characterized Microsoft over the past decade. Even the Vista operating system, the most recent upgrade of Microsoft's core product line, managed to be so late that it almost crippled the personal computer industry. It finally arrived to a chorus of boos, most of them undeserved (it's a pretty good operating system), but some dead-on (it's a technological hop when it should have been a leap). Microsoft lost its killer instinct a long time ago. On the rare occasions when the mood resurfaces, the company doesn't have the chops anymore to execute on its desires.

And that brings us to the Microsoft-Yahoo deal. For all of the excitement, this is just big, rich, but slow-moving giant looking to buy another slow-moving giant, the latter having stuck to an obsolete business plan too long and lost its way. The scheme is less predation than it is desperation: In the world of search, Google owns these two lumbering monsters.

Microsoft understandably covets the sheer size of Yahoo's subscriber rolls, believing it can accomplish what Yahoo has failed to do: convert more of those 130 million monthly visitors into real, paying customers. But Microsoft has hardly shown it can do that at MSN. So, can it really find a solution to Yahoo's structural problems?

That remains to be seen -- and Microsoft's one genius is as a late adopter. The real problem Yahoo -- and perhaps soon Microsoft -- faces is that those legions of Yahoo users don't want to be stuck inside a small corner of the Web, not getting all of the experiences and services (like live TV and first-run movies) they were promised. Especially not when they can run around and find all of those things, in abundance, elsewhere on the Web. Microsoft is even less prepared to solve that problem than Yahoo.

That leaves search, which is probably the real reason Microsoft wants Yahoo. Combining the two search engines would, in terms of sheer numbers, represent the biggest challenge to Google to date. But the sum of two also-rans is almost never a winner -- unless the newly merged is very, very lucky in its competitors. That's what happened with HP and Compaq: Who'd have guessed that Dell would suddenly fall on its face?

Incredibly, the same may happen with a Microsoft-Yahoo deal if it happens. If you look at the stock market, peruse the industry gossip blogs, follow the departure of key employees, or read about the various new initiatives (energy?) the company is pursuing, it becomes increasingly apparent that Google is a company about to have an early midlife crisis. Microsoft-Yahoo may turn out to be a pedestrian idea with absolutely brilliant timing.

If that is the case, and the merger proves successful, it will have more to do with Google than Microsoft and Yahoo. Which is why the Feds should stay out of it.

So, Yahoo: Take the deal (unless a better one comes along). Microsoft: Let this be the first of many high-risk moves. Treat Yahoo as a heart transplant, not a skin graft. And Google: This new competition should be a warning to stop fooling around and get back to business.
"If you look at Microsoft with an objective eye, it becomes apparent that it is a giant company past its prime. It is big and rich, but increasingly toothless..." Does that statement not sum up the truth of the situation? I argued this point re VMWare and virtualization, but to no avail; the markets trembled.

I am an investor, so share price declines afford my portfolio the opportunity to invest in favorite long term investment opportunities at compelling prices and valuations. It happens that I like Google/GOOG, a lot. (What a surprise, David!) Thus, I seek an opportune moment (a lower share price?) to purchase more shares.

The cream does not get any more yummy than this.

Full Disclosure: Long Google/GOOG.
-- David M Gordon / The Deipnosophist

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