A Veteran’s View of the Young Tech Economy
The California Technology Stock Letter--established in 1982--offers a rare point of longevity in the fast-moving high-tech investment world. Editor Michael Murphy, a 30-year veteran investor and analyst, has an unusually long view of the changes that have built the “new economy.” He and his staff of four track more than 2,500 stocks in electronic and biological technologies.
The Times caught up with Murphy at his unlikely outpost--perched over the Cowboy Surf Shop in this sleepy beach town midway between Silicon Valley and San Francisco. Murphy espoused some strong views on the hubris and potential in today’s technology markets.
*
Question: Are there predictable cycles in the tech economy?
Answer: There used to be, but they may be changing. In technology, the customers used to be basically other tech companies, the Department of Defense or the Fortune 500. . . . This time around, the customer is the worldwide consumer. For the first time ever, we’ve got consumer products driving Silicon Valley.
*
Q: Is that because of demand from Asia and elsewhere that had virtually no consumer market until recently?
A: That is a huge part of it. The products themselves have gotten cheap enough to become Christmas presents. . . . Then with the fall of communism, you basically added about over 2 billion consumers to the world.
[In the next period] the impact of these new technologies on the “old economy” will be the big story.
*
Q: How have your ideas evolved for assessing the value of technology stocks?
A: When we started, tech companies were a very small percentage of the economy and basically competed with all the other investments. You looked at book value. You looked at price-to-earnings ratios. You paid a premium for growth. . . . There was a big argument in what is called “quality of earnings” because the accounting rules were quite loose then. A dollar of earnings from Burroughs was not the same as a dollar of earnings from IBM.
I spent a fair amount of time trying to adjust earnings to be comparable across companies--figuring out what real growth rates were and then figuring out relative valuation. . . . It involved revenue recognition policies even back then. Was it sold when you shipped it? When they accepted it? When the board signed off on it? These are the same issues [“dot-coms” have been in trouble for] today.
By 1989, technology was up to close to 10% of the whole economy. Today it is over 20%. We needed a really different way to value these companies because we had just been through the leveraged-buyout mania in the mid- and late ‘80s and the worst companies were getting the highest valuations because everybody thought they were going to get bought out.
This is where the Michael Douglas “greed-is-good” speech [from the movie “Wall Street”] came from. Tech stocks were rather ignored for quite a while. There was a bad bear market in tech in ’83 and ‘84, kind of the original PC shakeout of companies that weren’t making IBM-compatible PCs.
*
Q: That was also a period when venture capitalists lost their shirts in high tech?
A: Absolutely. 1984 was a horrible year for venture capitalists. . . . That was the second [downturn] for them. I remember in 1970 and early ‘71, [the investment banker] Hambrecht & Quist went 15 months without doing a single IPO. That is pretty rough, considering that their model was “we support ourselves by doing IPOs.” It took until the early ‘90s before [venture capital] opened up again in a big way.
*
Q: Given today’s impending shakeout among dot-coms and Microsoft’s legal problems, which companies are best positioned to exploit the confusion?
A: Dominant companies, [such as] Applied Materials, Cisco, Intel, Microsoft and Oracle, also Hewlett-Packard, National Semiconductor. . . . If you buy Intel wrong this year, you will still have a profit two years from now.
*
Q: Database giant Oracle has become a superstar. Is that because Oracle positioned itself as an Internet infrastructure company that can help old-economy industries?
A: [At last year’s analyst meeting, Oracle Chief Executive Larry Ellison said], “We are going to apply [Internet database] tools to ourselves internally. We can save a billion dollars a year.” I don’t think anybody in the room believed him, including probably most of his management team. . . . [At] this year’s annual meeting, [Oracle showed that it was] not only ahead of schedule saving the billion, they have upped the number to $2 billion.
Oracle traditionally [operates at] 20% operating income. If they can save a billion dollars, they get to 30%, and if they can save $2 billion, they get to 40%. They double their profit margins. They can then take that story out to their customers. This is very compelling stuff.
*
Q: Do you agree that just as shareholder value increased following the AT&T; breakup, a divided Microsoft could benefit shareholders?
A: If you break them in two, the two pieces will be worth at least what they are now. Probably a little bit more. I don’t see the huge opportunity for breaking them in two that you got with AT&T;, because AT&T; always treated the regional companies just like children. Once the regional companies were cut loose, they were able to go out and do lots of things that the parent never used to let them do. I don’t think that is true at Microsoft.
*
Q: Web-based software vendors are looking to replace traditional software sales. Do those “application service providers” represent a good long-term buy? Do they threaten Microsoft?
A: Oh, yes.
*
Q: Microsoft is also moving into such services. Is it cannibalizing its own business?
A: I don’t think they have a choice. It is the old story of technology: Eat your children before somebody else does. I am not a big fan of the ethics of Microsoft, [but] they have MSNBC, they are buying cable companies, they are buying wireless companies. They are moving themselves as fast as they can toward content and distribution, which looks like where the money is going to be. I think application service providing . . . is sort of a rear-guard action as the sales of [Microsoft’s] Office [business software suite] deteriorate.
*
Q: So you are still bullish on Microsoft?
A: We bought a half a million dollars of it [three weeks ago].
*
Q: For the average investor, what’s the impact of the recent dive in dot-com stocks?
A: It is painful in the short run because the purpose of all of our efforts supposedly is to have an efficient capital market. And for a while there . . . a lot of money got put in the hands of people who had no demonstrated ability to earn a profit on it. That is not good in the larger sense, but, in terms of individual investors, having these bubbles break is good because it shifts people’s attention back to real companies and back to important things like earnings.
*
Charles Piller can be reached at charles.piller@latimes.com.
