Running Money, page 14
“What do you mean?”
“Well, we break down music to its harmonic fundamentals and figure out a baseline Tact. Then you just play along on your PC keyboard, and we make sure it stays along on the pitch ’n’ tempo of the Tact. Tough to do, but it sounds real good. Lemme show ya.”
He proceeded to click on a few spots on his laptop screen. Music came out of the speakers; I think it was Cindy Lauper, although I am embarrassed to admit it.
“So you jist play along.” Danny put his hands on the laptop keyboard as if he were sitting down at a baby grand piano and then started to “play.” Computer-synthesized music came out of the speakers, on top of the Cindy Lauper song. He was playing right along.
But then he started singing, “Girls just want to have fu-u-un.”
He stopped playing and, thankfully, stopped singing. “OK, now watch this. It don’ matter how I play.” He started banging the keyboard like a child, just smacking the keys randomly. The music coming out of the speakers still played along with the song.
“Lemme do sumptin harder.” He clicked a couple of times, and the song “Achy Breaky Heart” started up. “Yup, Billy Ray Cyrus, uh-huh!”
He banged away at his laptop and started in again. He threw his head back and closed his eyes and belted out, “Don’t tell my heart, my achy breaky heart…”
“OK, I think I get it.”
“Thank you, thank you very much.” Ah, finally, the signature Elvis impersonator lounge act line. “Now you try.”
“That’s OK, just walk me through the hardware and financials and I can—”
“No, you gotta give it a whirl. Pick a song.”
“You got ‘In-A-Gadda-Da-Vida’ by Iron Butterfly?” I was hoping he wouldn’t.
“Sure, jist a second. Here ya go.”
I banged the keyboard a bit, and it sounded great. All of a sudden I was happy I had blown off those piano lessons as a kid and never practiced. I resisted the urge to belt out the chorus. I banged away, a rock star at 10:30 in the morning in an airport hotel room with Elvis’s ghost. I couldn’t tell if I was a sucker in a big, bad practical joke or being tested by Frank Bonsal on my ability to make venture investments. Maybe he was just trying to tell me that sometimes the stupidest ideas are worth listening to.
“OK, tell me about the hardware.” It was time to wrap this nonsense up.
“Well, we made our own chip to both create Tacts as well as harmonize the keyboard tempos.” Danny’s Elvis accent disappeared as he talked about the hardware. I didn’t dare interrupt him, lest he break out in song.
“Here is a photo of our chip, pretty small, doesn’t cost us more than $5 in volume. TSMC in Taiwan makes it for us. Over here is the harmonizer, the pitch control, tempo stabilizer. Here is a DSP to do Fourier transforms. There’s not much else to it.”
“What is that section at the bottom corner, labeled 780?”
“Oh, that. Well, I grew up programming DEC machines, so when I needed something to control the whole process, I just sat down and threw in a VAX.”
“An entire VAX?”
“Sure, it’s no big deal, just a little 1 MIPS VAX 11/780.”
“You’re kidding. I bought one of those 15 plus years ago for close to a million bucks.”
“Yeah, it’s pretty amazing. It fit right there in the corner, cost me about an extra 25 cents in chip cost, well worth it. Every chip has some 1 MIPS controller on it these days. It was just easier for me to stick in a VAX than to buy someone else’s.”
I suppose I shouldn’t have been shocked by all this. No, not the Elvis stuff, the fact that a VAX now cost 25 cents. I politely asked a few more questions about finances and his business model.
He hadn’t gotten that far into it when he started asking me for advice. I told him that he was really onto something and should allow kids to download his “Tacts” for a couple of bucks just to get out of taking piano lessons and he could have a hit on his hands. I told him that I was 100% sure that Frank Bonsal was very interested in investing, he told me himself, and that there probably wasn’t room for our fund because Frank Bonsal really, really wants to do the whole round himself, and I would just call Frank every day until he does invest, and with that I ran out of room 1211.
To this day, I’m still not sure whether Frank Bonsal was serious about this guy or he was just pulling my leg, really hard. I may have gotten Punk’d. But I learned something—I think. Thank you very muuuuch.
Homeless in Palo Alto
“This market is killing us,” I complained to Fred. “We were on a roll, and now all those gains are evaporating.”
Just like that, poof, our early success started unraveling. Again. Turns out the Asian currency problems that hit in the fall of 1997 never really went away. That slide of a rickety old roller coaster I showed at the Institute for Private Investors meeting was right in more ways than one.
“You just have to slog through these things. What matters is what you own coming out of these times, not what you own going in.”
“I never had time to enjoy it when it worked,” I said. “We’ve been down every goddamn day.”
“Yup. It’s that currency stuff in Asia again. Nothing we can do about it.”
“Up in the morning, down in the afternoon,” I noted.
“Don’t worry about it.”
“I think it’s that homeless woman on the bench outside.”
“What?” Fred asked.
“I swear, every morning that she’s there, we have a down day,” I said.
“C’mon.”
“Really, check it out. She’s like some demon. She’s taken possession of our fund.”
“Stranger things have happened,” Fred said.
“She’s got those bags filled with god knows what. Research from Merrill Lynch?”
“Probably.” Fred was tuning me out.
“Perhaps we can take her to that Soylent Green factory I heard about in Burlingame,” I suggested.
“That’s heartless,” Fred shot back.
“Shit, I’ll do anything to get this thing working.” I sulked.
“Only one thing works. Go back to finding some new names,” Fred scolded me.
I was trying. Our office in Palo Alto is above an art supplies store. It is basically a dump, a one-room, 600-square-foot space with some cheap desks, blue Cat 5 cable running around for our Ethernet network and a fax machine that never stopped humming out research notes. You can see why we don’t spend much time there. Every day at 10:30 in the morning, a putrid smell of burnt toast and kitty litter wafts in from an Italian restaurant next door. Suffice it to say, we never eat there.
And we consider ourselves lucky to have the place. Office space in Palo Alto is crazy. Rents are higher than on Park Avenue in New York City. It’s ridiculous. We tried to find better space, but the market was tighter than the lid of a Mott’s Apple Sauce jar. So we tough it out.
It’s just the two of us. We had a secretary early on, but we had to let her go. She was too much work. It wasn’t an ordinary business, so we couldn’t just say, “File these correspondences.” We didn’t quite know what we were doing, so it was hard to have someone help you learn on the fly. We set up our own meetings, sent out our own quarterly letters to investors, got our own coffee and took out our own garbage. Voice mail and e-mail and mail merges are just easier to manage than people.
It was just me and Fred—Fred and me. The economics were 50-50. Everything was by consensus, which meant that we each had the power of veto. I was his boss and he was mine, and I told Fred that I have a history of hating my bosses. We signed each other’s checks—when we had enough money after expenses to pay ourselves, that is. It took a while. We didn’t take a salary for the first two years. Pretty scary.
Embarrassed by our dumpy office, we try to hold all of our meetings at coffee shops in town—Café Verona, where the name for the programming language Java came from, is just down the block. It’s our conference room. We met with a company there yesterday—passing the bag lady sitting on a bench at the bus stop in front of our building.
Palo Alto is a strange town. Not much is over two stories tall, so it feels like a middle-American town: drugstore, stationery store, Chinese restaurant. Except there are subtle clues that something is different. Stanford University is next door. Sand Hill Road, home to almost every venture capital firm, is a few miles away. A typical walk down the block finds a beat-up old Volkswagen Beetle parked behind a brand-new Ferrari F355. Next to a frozen yogurt store is a bike shop with selections that start at $1,299. There is money infused in the sinews of Palo Alto, although the place is by no means glitzy.
Some prospective investors insist on seeing our space, and we begrudgingly have them come on up. The response is typical, a bout of laughter followed by the comment “You know, I really like that you guys are keeping expenses down and focusing on investing.” Then, strangely, they come into the fund, in a small way anyway. Maybe we are an experiment, like we’re some backwoods investors. Hey, whatever works.
“Fred, a few more downsticks and we’re working for free,” I warned.
“What do you mean?”
“Remember that high-watermark language we put in our fund agreement?”
“Sort of?”
“Well, we get 20% of the upside. But if we go down, we have to get back to the original amount before we can charge our 20% again.”
“So?”
“So, if we go down 50%, we have to go up 100% to get over the high watermark before we get paid another penny.”
“Well, let’s not go down 50%.”
Like it was that simple.
I just wish that bag lady would spread her bad mojo somewhere else—we’re getting killed here.
Sharp Tooth
What is with these Asians? Twice now, they have whacked our fund. Just as things started rolling, some currency gyration would give risk a bad name and we’d be back to breakeven. This was starting to annoy me.
Long ago, I figured out that I would never invest in Asia. Once a year, I used to travel to the Far East as an analyst for Morgan Stanley. Like William Kaye in Hong Kong, I don’t think the Asians ever made any money. I always figured that was their problem, but the world is interconnected, like dominoes, so in reality, it was my problem too.
OSAKA, JAPAN—DECEMBER 1991
I almost missed out on the most startling revelation of the secret to the Japanese supposed success. Across a small conference room in Osaka sat an overweight, middle-aged Japanese man, with a thinning mop of jet black hair. But his most distinguishing feature was one of his front teeth. It pointed straight at me, like a loaded gun. It was perfectly perpendicular to his face and jutted out from his gums instead of hanging down. And like Mona Lisa, it always stared directly at me. I snuck looks at it while sipping green tea, and all I could think about was how was he going to drink from his teacup without drooling it all over his shirt. I couldn’t pay attention to much else but his bayonet tooth, but luckily some of his words stuck. He spoke with a huge smile, and without realizing it, explained why Japan was doomed.
Traveling at 250 miles per hour on the bullet train from Tokyo to Osaka, I wasn’t sure whether to be scared shitless or impressed by Japanese efficiency. Instead I struck up a conversation with my colleague, Takatoshi Yamamoto. We had met at the main Japanese train station on a brisk evening in December 1991. I was always in Japan around Pearl Harbor Day, maybe because most Americans avoid it.
Like everyone else scurrying around the station, we loaded up on supplies. He bought what looked like a comic book to read and suggested we buy some food. He picked out two bento boxes from a vendor at Track 5 and then headed to a vending machine and asked if I wanted a can of Pocari Sweat (which turned out to be something like Gatorade). I wasn’t drinking anyone’s sweat, so I politely declined and scanned what else I could have. I settled for coffee in a can.
We were headed to Osaka to visit Sharp Electronics, and I was just trying to figure out how Japan works. Yamamoto-san was the electronics analyst for Morgan Stanley Tokyo, which made him the mirror image of me. We got along well. He set up several days of meetings for me with chip companies, consumer electronics companies and even Nintendo.
“So, tell me about Sharp,” I said.
“Sharp is one of my favorite stocks. They are a big player in memories and also in liquid crystal displays. I set up meetings with the president of both of these divisions.”
“Great, I look forward to meeting them.” There was a glut of memory chips on the market, and everyone was bleeding red ink. I couldn’t believe that anyone was making money at it, in Japan, Korea or the U.S.
Just the day before, we had gone to Toshiba in Tokyo and met the tall, handsome, gray-haired president of their memory division. I knew that both Texas Instruments and Micron were getting killed selling memory chips, and wondering how Toshiba was doing, I asked. A stern look crossed the president’s face as he shot a why-did-you-bring-this-American-fool-into-my-presence look to Yamamoto-san.
“Mr. Kessler, you must understand that we are big players in memory, and we must meet our commitment to MITI [Ministry of Industry and Technology] for production. It is in all of our long-term interests to sell memories.” Yamamoto-san was nodding.
“Mr. Kessler,” the man from Toshiba continued, “you must appreciate the power of the Japanese.” The word “power” was thrust at me, almost spit as “p-HOW-er.” Yamamoto-san smiled and mentioned there weren’t any markets in which Japanese couldn’t outdo American manufacturers. I got the point. But Japanese or not, this guy was also losing money hand over fist selling memory chips.
I was fascinated by LCDs, which Toshiba also made, but I didn’t get to ask anyone about them, so I was looking forward to the meetings at Sharp.
Laptop sales were booming, and someday, computer monitors would be replaced by LCDs, once they got cheap enough. I had done some homework on how LCDs were made. Basically, you take giant pieces of glass, a couple of feet on a side, and then use the same techniques as in chip making: print and deposit the transistors to turn on and off pixels right on the glass. A light behind red-, green-and blue-tinted glass is either blocked or allowed through for each of the million pixels. But dust was a killer. With chips made on six-inch-diameter wafers, 80% or 90% of the chips worked, a very high yield as they say in the industry. Dust or other defects kill the others. With LCDs, dust could kill every display on the giant piece of glass. Yields were more like 5–10%. Tough to make money, which is why no American manufacturers even tried. Shareholders hate money-losing businesses.
The coffee in a can tasted like a used kitchen sponge, and I began jonesing for Yamamoto’s can of Sweat. I learned that Sharp was originally a maker of mechanical pencils, hence the name. They ventured into other markets like TVs and VCRs just as those markets were booming in the U.S., Europe and Japan. Now they make everything from laptops to camcorders to cordless phones.
As the train pulled into Osaka, I got a sense of a city of farms and railroad lines interspersed with giant modern factories. It looked like a drab version of Atlanta.
Lots of sushi and Asahi Super Drys helped launch me into a fitful sleep.
In the morning, we took a taxi over to Sharp headquarters. The white-gloved taxi driver spoke fluent English. “You American? I get lots of Americans, I take them all over Osaka. Here are some of my American friends.” He handed me a stack of business cards. I politely shuffled through them and noted with amazement that I knew a few names, including Scott Cook, the CEO of Intuit, who I had met with a few weeks earlier. Small world.
We entered the lobby, which was filled with visitors. I was handed a five-page application to fill out to enter the building, which required that I promise not to steal any of their secrets. I noted with suspicion that Yamamoto-san had a 3 × 5 card to fill out.
We walked for what seemed like half a mile to a conference room, passing giant rooms filled with huge tables and people sitting around them, yapping away to one another or on phones. The rooms were like Wall Street trading floors, but without screens.
“This is all marketing,” I was told by our guide. I noted maybe one personal computer off to the side in these giant rooms.
We got to the end of the hike and entered a small conference room. They all look the same with furniture from the 1960s: a green couch on one side, two chairs on the other side and another facing the center. I sat in one of the chairs and got a quick “Tsk, tsk” from Yamamoto-san.
“Sorry, Japanese custom, you must sit with your back to the window, and the hosts will face you.”
In walked two gentlemen. We shook hands and exchanged cards. I got good at the two-handed grab the card and stare at it a while with interest, which always pleased. But I passed on the bowing. One gentleman ran the memory chip division and the other the LCD division.
We started with memories, and it was clear after a few minutes of listening that they were losing tons of money, probably $100 million a year. But I already knew that. We moved on to LCDs, and that’s when I almost stopped listening. Years and several children of mine later, I would sit through multiple screenings of the animation The Land Before Time. The baby Tyrannosaurus rex is named Sharp Tooth, and it would always make me chuckle.
In Osaka, my Sharp Tooth was one of the smartest, most articulate Japanese managers I had ever met. He walked me through their production plans, screens per glass substrate, costs, market prices, overhead, yields, fully loaded depreciation and anything else I asked for. It took me a while, but I figured out that he was dropping between $1.5 and $2 billion a year in operating losses.
Still shaken from the “p-HOW-er” meeting the day before at Toshiba, I was very nervous about how I asked questions. Plus, it was hard to look up from my paper. I chose my words carefully.
“So, this product line is in investment mode?” I asked.
“Yes, I see what you are asking. Of course it is in very big investment mode, but so too is it in investment mode for everybody else. No one is in profit-return mode, if you understand my choice of words.”
