Running Money, page 19
So what did Barksdale do? He bought a small company in the Valley named Collabra that made groupware software. In one fell swoop, Netscape was now competing with IBM. Within a month or so, IBM switched allegiance to Microsoft Internet Explorer, and it was the beginning of the end for Netscape. Revenues stopped growing at the huge, spectacular rates they once had. The stock collapsed to new lows. It wasn’t until America Online stepped up and bought Netscape that their saga ended. Fortunately for Netscape shareholders, AOL stock kept climbing and climbing, much to the short Dave Rocker’s chagrin, and Netscape eventually was worth $10 billion.
Jim Barksdale went on to set up a venture capital partnership, the Barksdale Group, to invest in start-ups. I’ve heard it nastily referred to as a not-for-profit organization.
Over the years, I would look at venture capital deals, some good, some bad, some great. The great ones were hard to get into, and I was often left out, stuck on the sidelines again. I would always say to the CEO (under my breath, of course), “Listen, asshole, I’ve been thrown out of much better deals than this.”
Music Play It Again
PALO ALTO, CALIFORNIA—EARLY-1999
As routers scaled, the waterfall started, allowing Metcalfe’s exponential value of the network—the n × (n – 1) formula—to kick in. Then all sorts of funny stuff started happening.
“Get anything?” I asked the Robertson trader.
“I just got most of Springsteen’s early albums.”
“What?”
“Oh, sorry, it’s been slow, so I’ve been downloading music.”
“Let me guess, you’re using Napster?” I asked.
“Yup, just about everyone on the trading desk is. I think it’s clogged most of our Internet lines.”
“Yeah, I’ve been pretty busy around here doing the same thing.”
“It’s quite amazing. I can’t do much with it besides listen to it on my PC. I gotta get me one of those CD writers.”
“Well, what I meant before is, did you get us any Elantec today?”
“Oh, sorry, a little. I can’t seem to buy it off the box—someone else is hitting all the bids—but I did find a few accounts that are selling, so you are complete on 10 and we are still working another 10. Same limit?”
“Great, thanks. Yeah, don’t pay more than four and a half.” I had already bought 20,000 on Instinet. We owned 200,000 shares and growing. The stock was moving and ticking up every day. Some days it would hit five, until I stopped buying and then it would settle back. I wasn’t sure why it was going up. Unfortunately, it was probably us. These illiquid stocks are nasty that way: you buy it and you become the market. It’s why so few funds do small cap.
Still, it had taken me four months of scraping to get this size. What a pain in the ass.
“Oh, shit,” I screamed.
“What is it?” Fred asked.
“They just halted trading in Elantec, news pending.”
“That’s never good news,” Fred said.
“Fucking assholes, what are they doing down there? It could be something good—Intel buying them?” I said hopefully.
“Keep dreaming.”
I waited while Green Day downloaded on Napster, and within a few minutes the news hit the tape: Elantec was taking a charge to write down one of their fabs—yields had been low, the process didn’t prove out and they were going to shutter it and write down all the work in progress.
“I’ll see if I can get to the company. It doesn’t sound serious. I suspect that they were carrying that fab for no good reason. It might be good news now that they are writing it down—expenses go down, margins go up,” Fred said.
“I’m not so sure,” I sighed. “The stock is down over a buck. It just punched through the wrong side of $3.”
“I’d buy more,” Fred said in a voice that was almost too calm.
“Really, they are hammering this thing.”
“Yeah, just buy it.”
I got to both Robertson and H&Q and put in orders for 50,000 shares with each of them and then started working the box, banging keys, hitting every bid I could find. I was the market. I ended up buying 50,000 on Instinet.
Within 30 minutes, we had bought 150,000 shares, which really pissed me off since it had taken me four or five months to buy our first 200,000 shares.
“Great,” Fred said. “Unless you have any objections, let’s keep going on this one.”
“I’m in.” I wasn’t so sure. If this thing didn’t work, we were stuck with all these crappy shares. It would take me a year of scratching and clawing in the other direction to get out of them.
It was like the old vaudeville gag—Niagara Falls, slowly I turned, inch by inch, step by step. Day by day, little by little, 1,000 shares here, 2,500 shares there, we built our stake. Over a few more months, we were getting close to half a million shares. This thing was becoming an important chunk of our portfolio. It better work.
The company had only a shade over 10 million shares, and we were butting up against the 5% limit. Well, it’s not a limit—it’s just that if you own more than 5% of a company, you have to file paperwork with the Securities and Exchange Commission, a 13-D filing that says you own more than 5%. The downside is that you end up tipping your hand to the market.
I was against owning so much, but mostly because it meant unnecessary paperwork. Plus if this dog didn’t hunt, we had the public embarrassment of owning all those shares, instead of an anonymous bonehead investment.
We checked in with the company every month and were due to go back in for a visit. So we agreed we would visit the company to hear the latest, then decide if we wanted to keep buying. The DVD stuff was a year or maybe two away, but we just knew that was going to be a decent business. Meanwhile, those stupid DSL chips just had to start spitting some earnings to get the stock back up to $5. Why were Pac Bell and Verizon dragging their knuckles?
“How’s business?”
“It’s OK,” David O’Brien told us.
“DSL moving?”
“A little. The telcos don’t seem in any big hurry. Cable modems are doing better, but we don’t sell into that market.”
“And the optical stuff?”
“It’s starting to move. We’re not sure why. There seems to be some stocking going on in Japan and Taiwan, but we don’t see the end demand. DVD-R/W drives are down to $500, so that’s still a luxury, but we keep an eye on it.”
“Any other fab blowups on the horizon, any other potential writedowns we should know about?” I bluntly asked.
“No, I think we’re good on that,” O’Brien answered.
“I hope so.”
“Can I ask you guys a question?”
“Sure,” Fred answered.
“Well, you seem to be the only investors coming down here. I assume you guys own the stock.”
“We do, a good chunk,” I answered.
“OK, just wanted to know. The board was getting nervous that we were wasting our time with you guys.”
“It’s not a waste of time. And do tell Don Valentine I said hello,” I said.
“I will.”
It’s like watching paint dry, waiting for this thing to work.
“So what do you think?” Fred asked.
“We own a boatload. I’m still not convinced this thing is going to work. DSL is stillborn, the laser diode is years away, management is sleepy and Toshiba could blow them out of the water tomorrow morning. Having said all that, there is something to this thing. But it’s your call. You seem to think these guys have something, I’m just not sure what.”
“Let’s keep buying it. Don’t worry about the 13-D filing. Think of it as free advertising.”
“Elantec on the tape,” Fred yelled over. Fred doesn’t yell much.
“What does it say?” I asked.
“A dime. H&Q had seven cents. I figured it would be eight. They beat the numbers, but let’s see how. The conference call is in a few minutes.”
Over the last few weeks, I had kept buying the stock. We were up to 700,000 shares, and the stock was going through $5½, so I started getting less aggressive. Still, the share count grew. We had 45 days to file the 13-D, but it looked like the company was helping us look good when we did file.
Napster was on the cover of most magazines. Despite almost every other venture capital firm turning them down because of potential legal liabilities, Hummer Winblad out in the East Bay had invested. I thought that was pretty stupid. They installed Hank Berry, a lawyer I had known at Wilson Sonsini years ago, as CEO of Napster. That struck me as kind of funny—you invest and put a lawyer in as CEO, almost as if you were expecting trouble. Still, Napster had tens of millions of users who were downloading billions of free MP3 files onto their PCs. The thing was an amazing success, although they barely generated any revenue. But there was a frenzy on the Internet for free music.
I was half-listening to the Elantec conference call as I downloaded every Elvis Costello and Stevie Ray Vaughan album.
Over the speakerphone, I heard, “The attach rates seem to be moving up, which helps our optical segment. We think we can grow it double digit this year.”
“Fred, what does that mean?”
“I’m not sure, but it sounds bullish. I’ll ask on the Q&A. I’m glad we are almost done buying this thing. It could start moving.”
“Ten dollars? Eleven dollars?” I kidded.
“I don’t want to jinx it by saying it could go higher than $10.50.”
“I’ll write that down. Fred says $10.50 or higher, sometime before we have all our limited partners beg us for their money back.”
The next morning, the stock popped a buck or so, but then settled back down. We kept buying it, in dribs and drabs. We never did get to one million shares, because sure enough, over the next few quarters, they kept beating the numbers and the stock went to $10.50 and higher and higher and kept going.
Napster helped millions join the Music Pirates “R” Us program. A firm named Roxio wrote a clever program to write MP3 files as analog songs onto a CD. Now you could steal music and then create your own party disks. There was a run on CD writable drives for PCs that cost around $150. And sure enough, just about every one of them contained a little $2 laser diode driver.
Soon, as these drives dropped below $100, Dell and Sony and everybody else offered PCs with CD-R drives as standard equipment. That was the attach rate that Elantec was talking about—what percent of PCs have CD-Rs as standard equipment. It went from 0% to 10% to 20% and then, six months later, hit 80%, meaning that 80 million out of the 100 million new PCs that shipped to customers had a stinky little $2 laser diode driver.
A huge barrier to digital music distribution had now burst, and there was a huge waterfall of demand. No one could quite figure out how to invest in a pure play on music piracy. Napster was an ugly failure: it really was a transfer of wealth from venture capitalists to lawyers. Meanwhile, no one else could figure out how to charge for MP3s when they were readily available for free. (Wasn’t that the point?) Sure, Intel and Microsoft benefited and disk drive companies sold more gigabyte drives, but that isn’t hypergrowth. AOL saw dial-up customers increase monthly, broadband connections grew and Internet backbones proliferated, almost all, one could argue, for the ability to steal music.
While Wall Street scrambled for pure play ideas, we had this little doggy company in the bowels of Silicon Valley barely keeping up with demand for laser diode drivers for CD burners. The waterfall didn’t even come from the writable DVD drives we were willing to so patiently wait for.
When Elantec hit somewhere between $50 and $75, it got discovered. Momentum funds, mutual funds that wait until they find stocks that consistently go up, were on it like white on rice. The company kept beating their numbers every quarter, and some analysts got wise and started touting them as a pure MP3 play.
Despite thinking it would be tough to go above $10, at $100 we started trickling the stock out for sale. On Instinet, of course. We also started using another stock matching service, called the Island, which was Web based. You didn’t need a private line to your office or a special box, just any old PC. I could trade from home at 6:30 a.m., or from a hotel room, or, shhh, off a laptop from a hot tub.
I sold every single share of Elantec through Instinet and the Island. In fact, I was now doing 90% of my trades through these matching systems (who needed Wall Street?). We did our last trade of Elantec shares somewhere over $200. If you buy a stock at $70 and it goes to $200, it’s tough to sell, figuring it might go to $300. If you bought it at $3, it’s a lot easier to sell.
I sometimes wish I were smart enough to have seen this one coming. We had it only about half right. It was an accidental waterfall, but as a 50-bagger, a huge waterfall nonetheless, which made up for lots of disasters. Why can’t they all be like this?
Why not? Alteon lived on the edge of data networks and was selling their switches like hotcakes, a direct beneficiary of that 80-20 barrier coming down. It went public at $18 and ran to over $100. Crazy.
We had a chip company, MMC, that sold parts to Cisco and was running hot. Another little chip company, Exar, was running. Remember the company Cybersource, with “just a bunch of nobodies” as investors? They spun off a software retailer named Beyond. com. It didn’t look like a great business, but after cutting a marketing and promotion deal with America Online, even it went public.
Less than a year after meeting with Mr. Shim of Ssangyong, CS First Boston (or Worst Boston, as Nick Moore would probably say) took our little chip company public at $18. The stock soon traded over $100. The Koreans had a little currency problem? To our benefit.
Our performance was almost unreal. We were up 32% in the first quarter of 1999 and then another 52% in the second quarter, and we were already up another 20% in the third quarter. When it rains it pours. We now had almost a billion dollars in assets. A long way from the $10 million we barely scraped together back in the fall of 1996.
The market was flying but I needed some grounding. How did all this really work? How did money flow around the world? Why was I so lucky as to pick off some hapless, sweating Korean who was stuck on the wrong end of a trade now worth 40 times what he sold it to me for? There is always something sane to craziness.
You Turned Down What?
PALO ALTO, CALIFORNIA—SUMMER 1999
“I can’t believe we just turned down a billion dollars. It seems to be only a couple of months ago that we were begging people for a million bucks.” I sighed.
At two breakfasts a week apart at Il Fornaio in Palo Alto, we had been offered, and turned down $500 million each, from two different Middle Eastern groups.
“It’s probably the best investment decision we ever made,” Fred calmly noted.
“Someone is going to take that billion. It’s going to find its way into the Valley.”
“Not through us.”
“I know, I know. I didn’t feel like having money from Bahrain and Saudi Arabia either.”
“It’s not that. The billion we have is already too much.”
“I thought you can’t be too rich or too thin.”
“I suppose. But you can be too big in this business.”
“But 1% a year on another billion is—”
“Forget that.”
“What then?”
“When I was at JP Morgan, they burdened me with assets until I broke.”
“What do you mean?”
“You start chasing lousy businesses just to put the money to work.”
“How?” I asked.
“Because there are only so many good investments out there. Five-or ten-baggers are not supposed to be easy to find. This bubble we’re in the middle of is silly. Everything is a five-bagger—the worse the company, the more it goes up.”
“I agree that we’re not in some new funky utopian era. This thing will shake out. But it’s not like we’re chasing Pet Food ‘R’ Us.com.”
“It doesn’t matter. Who do you think is buying all that fiber and switches, General Motors?”
“So we ought to be giving money back to our investors?”
“Maybe.”
“But I kinda like it. It was so goddamn hard to raise. I can’t bear the thought of just shipping it back out.”
“I know. But I’ll bet that no one is going to want it back.”
“Which is probably why we should force it back—the perfect contrary indicator,” I said, realizing that, as usual, Fred was right.
“We can still find some great stocks. We just need to be smaller before this all blows up. If not, we’re going to have a lot of blood on our hands.”
“So we need to start selling stuff so we have cash for redemptions?”
“Not overnight, but we should think about doing this over the next year or so. In the meantime, this market is still flying. It’s probably not a bad discipline to put on ourselves,” Fred said.
“Actually, this might be fun. There are a few investors I’ve always wanted to throw out of the fund. I’m going to start calling them and toss them out. Can I start with your friend James Duck?”
“Start with that guy in Laguna who calls once a week asking for stock tips—or anyone who bothers us. We can work our way to the whiny investors next.”
“And what do we sell?”
“Probably 20% of everything,” Fred figured.
“But there are some great names in there—they could go higher.”
“Isn’t that the point?”
“I suppose you’re right. No better way to rip those babies from our tight clutches.”
