August 11, 1998
TMF Interview With Tom Kippola, Part 2
Fool: So it's all just tied up in the Technology Adoption Life Cycle?
Kippola: I think the gorilla game gets boiled down to two things. Number one, the Technology Adoption Life Cycle. And number two, the concepts regarding competitive advantage in chapter three: proprietary architecture and high switching costs. When you get a market with these advantages that's going to go into a tornado, and that tornado is going to be a long, generous tornado, there will be a company in that space that will throw off enormous profits.
Part of the reason I wanted to write this book is that I think a lot of people are buying stocks by looking too closely at these numbers. And I think that's like driving your car by looking through the rear view mirror... Looking at things like return on invested capital doesn't help me think through whether a company is going to generate enormous returns in three years. It tells me what they're doing today.
Fool: So you think the metrics that most people are using to value these stocks are largely irrelevant?
Kippola: They're relevant in helping them determine what the value of the company is today, but they don't help them determine what the value of that company will be worth tomorrow if the gorilla game dynamic pans out. That's why a company like Microsoft or Cisco often if not always beats analyst estimates because the analysts estimate by extrapolating this nice straight line, but the law of increasing returns says that over time, the numbers that they're going to throw off are going to be substantially greater than that nice straight line. So when they beat analyst estimates, the stock's going to continue to rise.
Now, your other question of when everyone adopts this, isn't that going to cause the market to recalibrate itself.... You know, we thought about that when we wrote the book. But the fact of the matter is, we've sold 40,000 books, which is extremely good for a business book. It's been on the top ten list of the business bestsellers list ever since it came out. But it's only 40,000 books.... I think it's going to have some effect, but there's still going to be a large percentage of the marketplace that won't know the vocabulary, that won't understand it.
Fool: So you don't really think that the marginal buyer determines fair value for a stock?
Kippola: What I'm saying is that I think people that understand these dynamics are going to have an edge over people who don't. And I think there are still going to be plenty of people who will not know the dynamics of how a gorilla game pans out.
Fool: Let me bring in the numbers from the portfolio mentioned in the book. The Internet portfolio as of last night was up 12.6% versus the Nasdaq's 17.4% gain over the same period. Also, I think that an investor ignorant of the gorilla game who wanted to put together a more consumer-oriented portfolio of tech stocks or Internet-related stocks -- say America Online, Yahoo, Amazon, or similar issues -- might have turned in a triple-digit gain over this same period.
Obviously we've been in a crazy market since you set up this portfolio, but it's interesting to me that a portfolio of transaction services stocks that you think aren't gorilla game material would have probably done considerably better than the gorilla portfolio you all put together. So the first question is the one mentioned in the book: Is there a need to rethink how the gorilla game plays out in the Internet space, say the role of brand or of community-related switching costs when thinking about competitive advantage for the portals or e-commerce companies?
Kippola: There are four answers to your question. Let me first comment on the portfolio. Had you looked at the portfolio two weeks ago, you would have seen it was up 27%. And if you took out Netscape [Kippola had objected to its inclusion from the start], the portfolio was up over 30%. So it really depends on when you pull it up.
Number two, we just haven't maintained the portfolio. We just haven't had time to do it. We would have sold some of those stocks. We really want discussion groups like yours to carry on some of the ideas and other people to suggest stocks to buy or sell rather than us maintaining it. There are a number of stocks that I would have sold in the portfolio, I just didn't have time to get together with my co-authors and agree to those things. Had we done that, I think the portfolio would be up, I don't know, 40%.
Number three, the portals and other content stocks are not gorilla game stocks. It's a totally different kind of investment. It's more akin to content in publishing than it is technology. Those stocks are being misclassified as technology. I think what's happening is that people are valuing them as if they're the next Microsoft or the next Cisco, as if they have the power that lock-in gives you, even though they may not have lock-in and their power comes from brand. It's going to be interesting to see what happens three or four years down the road to see if Amazon.com is still going to be worth $8 or $9 billion and whether all the search engines are going to be valued as they are now.
I was in a room in Vale, Colorado a week ago today for a venture capital firm whose advisory board I sit on. And the president of the firm stood up in front of the crowd [of high-tech luminaries and showed the one-year price gains for about 25 portal and e-commerce stocks]. He said, "Obviously, you guys are very smart and obviously everybody in this room has participated in these stocks. Let me ask you a question: How many of you have invested in the portal stocks in the last 12 months?" Not one hand went up.
And there's a reason for that. The people in that room, myself included, believe this is a tulip bulb craze. That's not to say that we might not be proven wrong two or three years from now, but at this point, what's happening I think is the consumer is coming into the market and buying stocks that they understand. You can understand Yahoo! because you use Yahoo! But SAP? That's hard to understand. The consumer is driving up the price of these stocks and not just because they're buying them themselves. The mutual funds that they're buying into have to have these in their portfolios, otherwise they get asked questions like the question you just asked me. And it makes them look dumb. So at some point, the tulip bulb craze will implode and many of these stocks will have their valuations reset.
Fool: So you're saying that these stocks are essentially being given valuations reserved for gorillas even though these aren't stocks with gorilla-type competitive advantages.
Kippola: Well, yes, but with the caveat that brand is an advantage that is investable. If it weren't, then Coke and McDonald's never would have been great investments. It is a different game, and it remains to be seen whether the brands that some of these companies have generated are going to allow them sustainable competitive advantages.
Fool: So at this point, there's not a single one of these companies that you would say, maybe we need to reevaluate? Say AOL?
Kippola: Well, I feel stronger about AOL than the others even though AOL is inching up close to $30 billion. But I'll tell you, the one I'm most concerned about is Amazon.com because I just don't see where [it has a sustainable competitive advantage]. The company is not earning any money, which is fine. As I said earlier, P/E ratios in early markets are nonsensical because E is often times zero. But when we get a number of different booksellers online (and some of these others like Borders <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: BGP)") else Response.Write("(NYSE: BGP)") end if %> have a brand as traditional booksellers and seemingly at some point can translate that brand onto the Web), what's going to keep the consumer who hasn't yet purchased books from Amazon from loading their information into Borders website and using them? Amazon.com is valued as if they're going to be able to maintain some advantage going forward, and I just don't see that.
Fool: What about a company like Yahoo!? Or even the revamped Netscape, which has a great deal of traffic basically built into their site?
Kippola: My guess is that when we look at the search engines several years from now, we're going to find that some of them will have faltered and some of them will continue to grow. So perhaps this category plays out kind of like a gorilla game where you get a number of gorilla candidates and one eventual gorilla. My sense is that's what's going to happen. Although because we don't have precedent for this space except to look at traditional publishing, we can't make the claim that the content space will play out like a traditional gorilla game. Yahoo! is clearly the best positioned. Whether or not it's going to be able to increase its valuation at the rate it's been able to is suspect.
Fool: Okay, then let me go to my second question about the portfolio performance. And this relates to the question mentioned in the book, which was: If an investment rule keeps you out of a lot of hot investments, what good is it? Your response was essentially that gorilla game investing isn't just about making money but about doing so in a way that diminishes the risks of losing it. Gorilla investing is presented as offering greater safety than other approaches. But looking at the specific picks for the ongoing gorilla games in Internet security software, supply chain management software, and front office software, all of these portfolios are down, a couple by quite a bit. And that's in a rising market. What are your comments on this?
Kippola: Number one, if you go back two weeks, the [Internet] portfolio was up better than 27%. If you compare that to almost any mutual fund, any index for that same period of time, we're in about the 80th percentile range. And it compares very favorably even if you narrow it down to high tech.
Number two, as far as the individual gorilla games, the supply chain management gorilla game only went negative in the last week. Prior to that, it was hugely positive. What happened in the last couple of weeks is that i2 has taken a big hit. Manugistics had taken a big hit about two or three months ago, but the strength of i2 had significantly outweighed the shortfall in Manugistics. So that basket was still up pretty significantly, 50% or so.