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May 27, 2008

Where is the Forest?

Oil Shock - a barrel of Texas Tea sold for over $135 on Thursday.

Gas Shock - it cost me $80 to fill my 17 gallon tank this week.

Milk Shock - at $4 a gallon, it cost almost as much to put milk on my cereal as gas in my car.

Housing Shock - median home values have fallen over 10% in past year.

Bank Shock - banks don't want to lend you money, lend your company money, or even lend other banks money.

Big Daddy Bernanke, after dropping the discount rate 325 basis points since last September to 2%, said he does help out and with 4% inflation, we are going to figure it out for ourselves.

Any questions on why consumer confidence is at 28 year lows?

Stocks, which had been acting well since mid March in spite of all the negative noise, finally succumbed this week. The ThinkGrowth Index was off 4%, the worst of all U.S. Indices we track, followed by the Dow down 3.9%. The NASDAQ was off 3.3% and the S&P 500 down 3.5%.

Looking internationally, and we increasingly are seeing the greatest opportunities internationally, stocks fared equally poorly. Singapore was the worst off 6.6%, followed by India and China down, 4.5% and 4.2%, respectively. As another case study for why it's always good to challenge conventional wisdom, Chinese stocks, which the smart guys said would surge into the Beijing Olympics, are off 34% for the year.

While it's definitely a scary time in the world with all the aforementioned problems, if "it's in the papers it's in the price." Moreover, the energy problems that have EVERYBODY concerned will accelerate the development of green technology as alternative to dirty, expensive, and out of our control foreign oil - that's great long-term news.

Additionally, if we quit focusing on the trees that keep falling on our heads, the environment for innovation and growth is breathtaking. At our ThinkTomorrow~Today conference last week in Half Moon Bay, it was amazing to see what is going on in growth sectors such as green technology, education and the Internet.

In August, it will be 13 years since Netscape went public, but when you see the entrepreneurial activity that is taking place, it is maybe the second or third inning for the Web's development.

When RCA's David Sarnoff introduced television sets at the World's Fair in New York in 1939, people knew it was the beginning of something big, but the early applications were to take what was previously done on the old medium - radio - and put it on the new medium - TV. Families would sit around and watch announcers in front of a microphone (like Don Imus and Howard Stern today!).

The bridge to a new medium almost always starts by taking the old material and processes and transferring them to the new medium. Accordingly, the first phase of the internet, Web 1.0, was dominated by businesses that tried to put everything and anything on this exciting new medium and companies that created a connection to the net.

Yahoo!'s (NASDAQ: YHOO, $27.72) early days were basically putting a yellow pages online. Banner ads swarmed static websites. Then brick and mortar businesses began webifying themselves. Netscape was the "on-ramp" to the superhighway and AOL helped non-techies get online.

Like going from radio to TV, this new medium was breathtakingly exciting, almost magic, but few people had re-conceptualized the true power of the Internet and how new models would emerge to change the game.

"Web 2.0," coined by Dale Dougherty and Tim O'Reilly, is that following the dot.com crash, far from being dead, the web became even more important than before. The companies that survived the nuclear winter were thriving and creating exciting new applications like Wikipedia.

The key principle behind Web 2.0 is that the internet has emerged as the fundamental global platform for communication, commerce, information, services, and product development.

Microsoft (NASDAQ: MSFT, $28.05) illustrated the power of a platform with its pre-Web 2.0 era dominance thanks to the Windows operating system. It brilliantly (and arguably unfairly) used its dominant position to bury peripheral competing products to its application suite in order to squash the competition. Despite having a better product than any of those that Microsoft offered, Lotus 1.2.3, Word Perfect, and Netscape Navigator were all crushed by Microsoft's better business model. Aces beat Jacks and platforms beat products.

The second key concept of Web 2.0 is to tap into the collective intelligence of the web. In James Surowiecki's excellent book, The Wisdom of Crowds, he provided compelling examples of how the collective intelligence of many is much more powerful than the opinion of even the smartest individual.

Creating a network effect and leveraging the collective intelligence of the World Wide Web is at the core of many of today's most powerful business opportunities.

Google (NASDAQ: GOOG, $544.62) is unquestionably the poster boy for Web 2.0 and has established itself as the platform to beat. Search is where it all begins and Google is at "First and Main." Gmail, Google Earth, Google Docs, Froogle, Orkut, and Google News are all strategic in expanding and enhancing its leadership position.

Google's algorithm is made better by more users; ditto for eBay (NASDAQ: EBAY, $30.18) and Amazon (NASDAQ: AMZN, $78.35).

ThinkPanmure was the first Wall Street firm to have a blog (www.thinkpanmure.com/blog). Tapping into the collective intelligence of investors in a specific sector or company is extremely powerful and could radically change the way Wall Street research is coordinated.

The reason Zagats in NYC is so amazingly on-target is it has 100,000 people contributing to the opinions it publishes. Wikipedia is a wildly successful online encyclopedia written and anyone who wants to edit it. Imagine how that model can be applied to stocks.

The key principles of Web 2.0 are:
1. Web is a platform
2. Collective Intelligence
3. Database Management
4. End of Software Release Cycles

As it turns out, John Doerr was right - the web was underhyped!

Last week, at the ThinkTomorrow~Today (TTT) private company and venture capital summit, ThinkPanmure hosted presentations from 20 of the fastest-growing private Internet companies. My partner Bill Morrison who is the senior Internet analyst had a lot of observations. Some key observations are:

We continue to believe that, with the notable exceptions of Google, Bankrate, eHealth, and comScore, private companies are powering most of the growth and innovation in the Internet media market, solidifying our fundamentally bearish stance on the majority of publicly-traded Web 1.0 advertising models. A quarter of the companies that presented at TTT are generating revenue in the $50-100M range and growing 25-50% Y/Y, with several others in the $10-20M range and growing 100-200% Y/Y. (This version of the Media Industry report replaces the versions published earlier today. Page 11 now begins with EveryZing.)

We came away from the conference more convinced that Internet and digital media innovation and growth is almost the exclusive purview of private Internet companies (with notable exceptions including Google, eHealth, Bankrate, comScore and, to a lesser extent, Yahoo!, through its work in the display ad platform space). If public investors are occasionally puzzled by the disconnect between a rapidly-growing Internet ad market and anemic growth among Web 1.0 media and advertising models, the explanation can probably be found in the very strong growth rates of private Internet companies like those that participated in ThinkTomorrow~Today. It is becoming increasingly clear to us that the leading private Internet companies are capturing significant market share from their public company brethren.

The program at TTT included presentations from 80 high-growth private companies within several growth areas of the economy including GreenTech, Consumer, Business Services, Software, Networking, and Internet. Internet and digital media companies presenting last week included Boxee, BzzAgent, CelebTV, Cobalt Group, ContextWeb, Education.com, Everyzing, Friendster, Glam Media, Imeem, LinkedIn, NebuAd, OpenX, ReachLocal, Trulia, Vibrant Media, VideoEgg, and Whitepages.com. To read Bill Morrison's complete note, please click on the following link: (link) PDF

This week, price action signaled a market correction and while we don't know how long this will last, we look at it as an opportunity to purchase shares of companies with the strongest fundamentals and growth potential. Moreover, in a world where growth is scarce, companies with strong growth fundamentals should get premium investor's attention.

Posted by Michael T. Moe at 09:09 AM | Comments (0)

May 19, 2008

If I Were King

I'm not looking for sympathy, but writing a weekly market perspective piece is hard. Forget the time it takes, just coming up with fresh ideas that make sense is a cause of weekly anxiety that usually starts around Thursday. It's no wonder that one of my market strategist heroes, Barton Biggs, used to occasionally write a book report or he discussed his most recent mountain climbing expedition in his weekly market research for Morgan Stanley - he needed a break from writing what he thought was going on in the market or what stocks to buy or sell.

Given that I feel like I'm sounding like a broken record with market strategy - "BUY LEADING GROWTH STOCKS" - and I haven't compiled all my thoughts from last weeks ThinkTomorrow~Today conference, I'm going to go off the reservation a little bit and do a political forecast. I know polite people don't discuss religion or politics in public but this is a fascinating race with the consequences likely to have significant impact on both the country and the stock market.

With Barack Obama and Hilary Clinton still slogging it out for the Democratic nomination, I wanted to turn to who John McCain was going to select as his Vice Presidential Candidate. Being "one heart beat away" from the Presidency, this role has always been important but given that Senator McCain is turning 72 this August, who he selects as his running mate is even more critical.

Creating "scenarios" is the best way I know on how to develop a thesis about the future. Case Number 1, Case Number 2 and Case Number 3: Bullish, Bearish, or Neutral.

For the "if I were John McCain, who I would select as my partner" exercise, I've put my scenarios into five buckets: 1) The Southern Governor Strategy; 2) The Counter the Opposition Strategy; 3) The Northern Governor Strategy; 4) The You Only Get to Be President Once So You Might as Well Do It with Friends Strategy; and 5) The Commander in Chief Strategy;

Southern Governor Strategy: There is an argument to be made that a strong Southern Governor on the ticket could deliver a "W" from Texas to North Carolina. Leading contenders for the Southern Governor Strategy are: 1) Charlie Crist - Popular Governor of Florida. He delivered the Sunshine State for Senator McCain at a crucial time. On the negative side, he has only been Governor since 2006. 2) Mark Sanford - Governor of South Carolina; Conservatives love the 50-year-old Governor who was a strong supporter for McCain in the South Carolina win. 3) Hayley Barbour - Mississippi Governor who was also an effective leader of the Republican National Committee. 4) Mike Huckabee - former Governor of Arkansas. He is charismatic and likeable, strong with the Christian Right but weak with secular conservatives. 5) Rick Perry - Governor of Texas; popular Governor of the third largest State in the United States - probably tough to support on the heels of George W.

Counter the Opposition Strategy: Given that whether Barack Obama or Hilary Clinton is the ultimate nominee for the Democratic Ticket, it's a historical moment that many people will want to be part of. Some of the "smart guys" say the best way to win is to neutralize that by having VP Candidate who is either an African American, a woman, or both. Top potential VP candidates from the Counter the Opposition Strategy are: 1) Colin Powell - former Secretary of State and one of America's most popular and respected people; he would also be a strong candidate in the Commander in Chief Strategy. The negative side is that you effectively "double down" on foreign policy expertise and General Powell doesn't want the job. 2) Condi Rice - current Secretary of State and former head of National Security Counsel - very impressive intellect and experience; the negatives are being tightly linked to a currently unpopular President. 3) Marsha Blackburn - a rising star as political congresswoman from Tennessee. She is popular with conservatives but the negatives are that nobody knows her. 4) J.C. Watts - former Congressman and star quarterback from Oklahoma. He is charismatic and conservatives love him; but the negatives are that he hadn't done enough before he got out of the game. 5) Carley Fiorina - retired CEO from Hewlett Packard (NYSE: HPQ, $47.29) and current Chairman of Senator McCain's Campaign - she has strong experience being one of the nations top businesswoman; her negatives are no public office experience.

Northern Governor Strategy: Some of the logic to this scenario is that Senator McCain will be strong enough to carry most of the South without a Southern Governor so he should look to strengthen his base elsewhere. Leading contenders for the Northern Governor Strategy are: 1) Tom Ridge - former Governor from Pennsylvania and the first Secretary of Homeland Security. Ridge could also be put in the You Only Get to be Friends Once so You Might as Well Do it with Friends camp as a long-time friend of Senator McCain. 2) Mitt Romney - the former Governor of Massachusetts is clearly the favorite VP candidate of the "money guys" of the Republican Party and he would be a good business person balance for McCain's strong foreign policy expertise. The negative side is that part of what appeals to many people about John McCain is his authenticity and having somebody as his Vice President who he clearly didn't like much during the Primary; this would seem phony to the believers. 3) Tim Pawlenty - Governor of Minnesota; the young and popular Governor from my home state is being touted by many as a great compliment to Senator McCain and could help deliver a key swing state. The negative is that he is light on experience and he didn't even deliver Minnesota in the primary against Romney.

You Only Get to Be President Once So You Might as Well Do It with Friends Strategy: McCain is well known for his Maverick tendencies and actually does best when he throws the textbook away and operates from his gut. Long-time and loyal friends of Senator McCain who would be on his short list include: 1) Joe Lieberman - "Independent" Senator from Connecticut and former VP candidate with Al Gore. Lieberman is a well respected legislator and a foreign policy expert. The negatives are that he lacks executive experience, seems old, and the conservatives might "stay home." 2) Rudy Giuliani - former Mayor of New York City - has shown clear effectiveness as an executive and crisis manager. The negatives are his messy personal situation and that he isn't a great "retail" politician. 3) Fred Thompson - retired Senator from Tennessee and current star on "Law and Order" and one of Senator McCain's good friends. True Conservatives love him and he has a lot of experience as a President, and Admiral and prosecutor, etc. The negatives are that he didn't accomplish much when he was a Senator and didn't inspire many in his Presidential run.

Commander in Chief Strategy: The belief that the person who should be chosen to be Vice President is the person who is best qualified to lead the country and be the Commander in Chief in case anything happened to the President (novel concept, huh?). Besides the aforementioned Colin Powell, Tom Ridge and maybe Mitt Romney who I would put in this category in addition to the one I put them in before, I would also include: 1) Michael Bloomberg - Mayor of New York City; Mayor Bloomberg has shown to be an incredibly effective and popular Mayor of one of the most complex cities in the world, and before that, he built one of the most impressive media businesses on the planet. The positives start with his gigantic competence; the negatives are that he isn't dynamic or even a Republican. 2) General David Petraeus - Commander General of the Multi-National Force in Iraq; General Petraeus was the quarterback behind the "surge" which has undisputedly (although I know I will get emails) worked. The negatives are that he has no elected office experience, and having General Petraeus as the running mate - the War would effectively be a one issue election.

So who do I think the Vice Presidential Candidate for Senator McCain will be? The Chairman and CEO of Cisco (NASDAQ: CSCO, $26.51) John Chambers. Mr. Chambers doesn't really fit in any of the buckets that I outlined above with the possible exceptions of the Commander in Chief and You Only Get to Be President Once So You Might as Well Do it With Friends but he is totally consistent with John McCain's M.O. of doing what he thinks is smart, not what the "smart guys" kibitz about on "Meet the Press." John Chambers has been the CEO of one of the most impressive, innovative and global technology company on the planet, leading it from when it had $1 billion in sales to $40 billion and $160 billion market value. Being the Chief Executive of a fast growing, multi-faceted, international business has given Mr. Chambers real world experience that nobody else on this list comes close to matching. Cisco is renowned for its leadership in developing its people through training and investment in education, as one of the primary forces on developing the infrastructure to support the internet. Cisco and Chambers were pioneers and advocates in the critical area of online learning. Through his involvement in the World Economic Forum, John Chambers has, together with King Abdullah II of Jordan, created an education initiative in the strategically vital geography of the Middle East. In terms of balancing John McCain's strength in foreign policy and legislation, Chambers is one of the best organizational leaders in the world being on the forefront of the technology revolution in Silicon Valley and around the world. Food for thought...

Last week, stocks continued to act well led by our favorite growth stocks. For the week, the NASDAQ was the top performing index up 3.4%, followed by the S&P 500 advancing 2.7% and the Dow up 1.7%. Since the March 17th bottom, growth stocks, proxied by NASDAQ and the ThinkGrowth Index are up 16.1% and 19.8%, respectively, versus the S&P 500 up 11.7% and the Dow up 8.5% in that same period.

Our thesis has been and continues to be that in a world where growth is in short supply, sectors and companies that have strong organic growth will be in greater demand. For the first quarter, the S&P 500 had a negative 25% EPS growth, which was the third quarter in a row that earnings declined. Looking at the growth sectors of the S&P 500 - technology, health care, and telecommunications - those areas actually had positive growth of 10%, 11% and 10%, respectively. When you view the ThinkGrowth Index Composite, you see that despite the mainly industrial S&P had overall, a disastrous first quarter, earnings growth for the areas we care were strong.

In that ultimately, EPS growth drives stock price, we are confident in our strategy of buying the highest quality, fastest growing companies, knowing that we will ultimately be rewarded.

 

With an earnings yield for equities of 6.6% (14 P/E on 2008 earnings) and a bond yield of 3.9% for the 10-year note, equities overall are dramatically undervalued. Looking at the U.S. market compared to other global markets, it's interesting that it's ranked number 23 in the world in terms of EPS growth rates and yet it's the eight most expensive from a P/E standpoint.

What this is saying is that while we view U.S. stocks as attractive and particularly growth stocks, other markets such as Brazil, India, China and Russia are more attractive on a P/E to growth basis.

Our conclusion? - Get long or be wrong!

Posted by Michael T. Moe at 01:39 PM | Comments (0)

May 12, 2008

ThinkTomorrow~Today

Starting Monday night, we will be hosting our Fourth Annual ThinkTomorrow~Today Conference in Half Moon Bay. ThinkTomorrow~Today brings over 500 leading venture capitalist, private companies and industry gurus together to discuss what the future might look like and where the big ideas are going to be found.

Over the three days, we will have 80 private companies presenting and panels on subjects as diverse as: how to invest in China, the future of mobile computing, and how the flat world is creating opportunities in the online education market. Keynotes include: Tony Perkins sharing perspective on what's hot; Ron Conway interviewing Marc Andreessen on Ning.com and the internet's future; "Coach of the Valley" Bill Campbell having a fireside chat with Jonathan Rosenberg on how innovation happens at Google (NASDAQ: GOOG, $573.20), and also the Coach will be having a discussion with John Doerr on investing in Green Technology and how the Babe Ruth of venture capital thinks about where he's going to have the opportunity to hit home runs. Additionally, we will have a screening of the documentary "Two Million Minutes" which shows how American kids are competing against their counterparts around the world - eye opening stuff.

At the end of the day, the conference is really about what the entrepreneurs and founders are excited about as it's the power of these people and their ideas that fuel innovation and tomorrow's great companies. Entrepreneurs who are so passionate about their vision and confidence of success that they are willing to bet it all on red against all odds, maxing out the credit cards and borrowing against the children's education fund. With all the sacrifice and risk involved with starting a company, you have to be a little bit crazy but it's these people that make things happen, and we love them for that.

Richard Branson, who dropped out of school at age 15 frustrated by undetected dyslexia, was rejected by over 50 banks before he got the loan to start his mail order business; today, his Virgin empire has over $25 billion in revenue. Jeff Bezos drove across the country knowing only he wanted to start a business involved with the internet, despite all the cynics he has built Amazon (NASDAQ: AMZN, $72.41) into to the largest internet retailer in the world. Steve Jobs started Apple (NASDAQ: AAPL, $183.45) with Steve Wozniak after dropping out of Reed College with the vision of creating an "insanely great computer." After being fired from the company he founded, he returned in 1996 and Apples stock has appreciated 50% per year since. Michael Bloomberg, after being fired by Salomon Brothers founded the media company that bares his name and today, has built it into one of the most respected and most valuable multi-media businesses in the world.

The hunt for tomorrow's stars begins with the entrepreneur and the idea but we then set our sites on the Megatrends that impact the growth industries we care about.

The largest market growth opportunities are those created on the frontiers of the economy, where change at the edge leads to wide-scale change within the economy. A core element of my strategy in successfully identifying emerging growth opportunities is to understand the Megatrends that drive change, productivity and ultimately growth, throughout the economy.

We see Megatrends as the fundamental catalysts for growing markets, through their influence on consumer behavior, business processes and by serving as building blocks for the introduction of new products and services. Additionally, by influencing price and quality improvements, Megatrends unlock latent demand and reinvigorate growth in mature markets, while freeing resources to finance the growth of new market opportunities.

Megatrends effectively create a tailwind at the back of emerging industries. The tailwinds help accelerate the opportunity and provide the fundamentals to grow at a high rate for a long time.

Great growth opportunities are often found where Megatrends intersect the growth sectors of the economy - technology, healthcare, alternative/green energy, media and education, and business and consumer services.

Some of the current Megatrends affecting consumers, businesses and entire economies for that matter are Knowledge Economy, Globalization, The Internet, Consolidation, Branding, Demographics, Outsourcing, Green Living and Convergence.

Below are the key Megatrends that I believe will drive sales and profits for the long-run:

Knowledge Economy - American society has been shifting from an industrial-based economy since World War II to a service-based economy in which the educated are kings;

Globalization - Interdependence between countries is increasing with improvements in communications, technology and transportation;

The Internet - Media, commerce, education, social life, work and leisure move to interconnected computers from traditional forms;

Consolidation - Mom and Pop shops are disappearing into memories as conglomerates eat up market share;

Branding - Creating memorable slogans and logos as well as a consistent reputation is increasingly important in order to differentiate products in a global economy;

Green - With increasing oil prices, scarce oil reserves and enhanced global warming, businesses and the society are switching to Green energy and Green Living; Demographics - Changes in the age, race, educational level, employment status, and economic standards of living create predictable markets;

Outsourcing - As the cost of employing American citizens becomes increasingly expensive relative to the rest of the world, U.S. employers look abroad;

Convergence - Physics, Biology and Chemistry are merging into one science while phones, TVs, Radios and Computers are merging into one;

In the long-run we believe these are dynamic forces that will drive sales and profits of entire industries, some directly and others indirectly, while companies focused on becoming industry leaders will capture the largest share of these rapidly growing markets and ultimately create tremendous shareholder value.

In essence, Megatrends are powerful technological, economic and social forces that develop from a groundswell (early adoption), move into the mainstream (mass market) and disrupt the status quo (mature markets), driving change, productivity and ultimately growth opportunities for companies, industries and entire economies.

Megatrends play a key role in how social, economic, technological and political changes take hold, and as we look backward through history, their effects are easily seen. In real-time however, Megatrends tend to go underappreciated. The nature of Megatrends is that they are relatively slow to develop, driven by bottoms-up, "local" events, that slowly gain in critical mass until they come to define large-scale and pervasive change.

In 1982, John Naisbitt identified several trends that were in various stages of restructuring an industrial economy, which was regionally concentrated, national in focus, with corporate America best characterized by industrial giants with extensive management hierarchies. Technological improvements were often feared, particularly by workers and unions. Politically, power remained concentrated, with business, labor and social issues being polarizing, and resolutions focused on short-term solutions.

In the midst of this restructuring, which the consensus had yet to appreciate and fewer still wanted to embrace, Naisbitt anticipated what most feared: the continued decline of manufacturing and the rise of the information economy.

The trends identified more than 20 years ago have steadily progressed, with many information technology companies as recognizable and mature today as industrial bellwethers were then. Aside from identifying the trends themselves, one of the key insights was that the most powerful of the trends occurred independently, across geographies and throughout communities, only later becoming a large collective trend.

What Naisbitt was able to call out from these seemingly disparate trends, were common factors, or Megatrends, that were in effect catalyzing the restructuring of past, present and the probable future.

Megatrends continue to play just as important a role today as they have over the past 10, 20 and 50 years. What is changing are the smaller but related trends resulting from today's more visible Megatrends. For example, while globalization is clearly not a new trend, in combination with greater geopolitical openness, economic development and more robust information and communications technologies, the pace of globalization, trade and outsourcing has rapidly accelerated.

Likewise, with the explosion in the number of products and services to address a growing number of global markets, the value of "brands" is growing exponentially, as companies find it a necessity to differentiate their products and defend their markets with the value embedded behind their brands.

Information technologies have been around long enough for IT companies to now be mature, although the application of IT continues to rapidly broaden beyond traditional business investments and consumer electronics, spurring growth in new areas of biotechnology, nanotechnology as well as consumer and business services.

Identifying new trends is always difficult, and as the venture capital community notes, by the time something becomes a trend, it is too late for many investors to reap benefits. That said, only by continuing to look for the forces that shape the realm of businesses and consumers, can we hope to understand and capitalize on emerging growth markets in today's global economy.

Within these Megatrends are themes that become increasingly pervasive through economies, though generally remain unrecognized until they are firmly considered the status quo. Below we have augmented the themes first posited by Naisbitt, and which represent recurring themes across the current economic and social Megatrends currently at work.

I have identified some Megatrends that I feel are the key drivers for waves of opportunity.: The Knowledge Economy, Demographics, Globalization, the Internet, Green Living, and Outsourcing, will drive market growth and competition, while Convergence, Clusters and Brands, will be the key enablers of what become successful products, technologies, companies and industries.

Those companies best able to recognize and harness the growth opportunities made available by these Megatrends, will be those that first capitalize on, then extend their lead from the competition; recognizing the rewards of being an early-mover, leverage productivity improvements for the benefit of their customers and their own growth potential.

In the coming years, these Megatrends, as well as many new ones, will continue to create the largest market opportunities, providing the fundamental catalysts to growing markets, through their influence on consumer behavior, business processes and serving as the building blocks for the introduction of new products and services, as well as creating growth opportunities within more mature markets.

My view of current and future trends is that they likely will be extensions of past Megatrends, though the pace of change will be more accelerated; rapidly capitalizing on cumulative advancements in technology, demographic shifts, changing consumer preferences and improved business efficiencies. The time it takes to innovate and commercialize to meet current and latent demand will continue to collapse toward real-time.

In my mission to find the stars of tomorrow, I rely heavily on understanding the Megatrends that are creating significant market growth opportunities. In the years ahead, I anticipate that the dynamic changes that have taken place during the last bull market will serve as stepping stones for future growth opportunities.

Last week, stocks took a pause with the excuses being many but led by $125 oil prices, followed by AIG's (NYSE: AIG, $40.28) mind numbing $7.8 billion first quarter loss and data showing the U.S. consumer is taking out more debt to cope with the sluggish economy. For the week, the Dow was down 2.4%, the S&P 500 was down 1.8% and NASDAQ was off 1.3%. Encouraging to us was that many of the leading stocks had a good week despite the market being mainly down. Strong stock performance came from Mindray Medical, up 10.5%, Priceline.com, up 9.7%, Mercado Libre, up 8.1%, and Lululemon, up 7.4%.

We remain bullish for growth equities as fundamentals, valuations and sentiment are all in the bull's favor.

Posted by Michael T. Moe at 08:28 AM | Comments (0)

May 05, 2008

Sandcastles in the Sky

I spent the last week on a pilgrimage to Dubai the financial Mecca of the Middle East, and Saudi Arabia – the home of Mecca – Mecca. The purpose of my sixteen thousand mile journey, literally half way around the globe, was to seek truth – were the outlandish facts and figures coming out of the Middle East real and sustainable or a bubble that was ready to burst into a mirage in the desert?

Dubai is part of the United Arab Emirates, seven countries that act as a confederation of states with a combined population of 2.5 million people and is the size of Maine. Located on the Arabian Peninsula, the UAE extends along part of the Gulf of Oman and the southern coast of the Persian Gulf. Most of the land is barren and sandy.

Originally, the land was inhabited by seafaring people who converted to Islam in the 7th Century. The United Arab Emirates Federation was formed after British withdrawal from the Persian Gulf in 1971, with the seven “Trucial States” – Abu Dhabi, Dubai, Sharjah, Ajman, Fujairah, Ras al-Khaimah and Umm Al Quwain. In addition to the Federal Prime Minister and President, each emirate has a separate ruler who oversees the local government.

Princeton Professor Burton Malkiel famously articulated in his seminal book, Random Walk Down Wall Street, two investment ideologies – the “Firm Foundation” theory and the “Castle in the Air” theory. The Firm Foundation theory basically says that you should invest based on the actual real value of what you’re investing in – sensible enough. The Castle in the Air theory, ironically practiced by John Maynard Keynes, says that you should invest in response to what the crowds are doing and riding the waves of what is “hot.”

Which camp is Dubai in? Probably both.

By now, everybody has seen or heard of some of the sensational developments in this tiny country of 1.5 million residents; 25% of all the world cranes are in Dubai, the largest mall on the planet which includes an indoor ski slope, “The Burj” that when completed will be the largest building in the world; the fact that by 2012, more skyscrapers will be located in Dubai than Manhattan, etc... My 15-year old daughter wanted to know if I had been to the Burj Al Arab, the sailboat-shaped “seven star” hotel or the man-made Palm Islands, both of which have come to symbolize the “anything-is-possible” attitude of this city-state; similar to how the Statue of Liberty that represents freedom and hope in NYC’s harbor.

The Burj

The look and feel of Dubai reminds me of a cross between the impressive organization of Singapore and the energy of Shanghai. It’s beautiful with white-sanded beaches along the entire country and has as clear and blue water as I’ve seen anywhere.

Like “the 49ers” seeking gold in California, nobody is in Dubai coincidently, but the people I met were extraordinarily gracious with their time and insights. Despite stereotypes I had heard about Middle Easterners’ concept of time and punctuality, every meeting we had started and stopped on schedule.

The grand architect of today’s Dubai is Sheikh Mohammed. Being somewhat skeptical about people who inherit their authority from coming out of the right womb, I was surprised and impressed by the universal respect and admiration the Sheikh garners from a wide array of people I met with; in some ways, a Middle Eastern version of Lee Kuan Yew of Singapore. As Mohammed Al-Shroogi who leads Citigroup’s (NYSE: C, $26.39) operations for the Middle East told me, “the Sheikh’s vision powers the boundary-less possibilities for the future.” The Sheik had told another of my hosts that “yes, the bubble has been created and it had burst, positively affecting the rest of the region.”

Tom Volpe, formally of the investment bank that bore his name, is now CEO of the Dubai Group, one of the Sheikhs investment arms. Tom said that being in Dubai is like “drinking out of a fire hose,” with the opportunities that are seen being “unbelievable.”

The cover story for last week’s Economist, “The Rise of the Gulf”, wrote about the geological serendipity of having 41% of the world’s hydrocarbons (oil and new participant gas) in the region – which is true. Interestingly, however, Dubai itself has essentially zero oil and gas but it has positioned itself as the economic and social center for the region. The “network effect” is essentially the core economic principle at work – the advantage that Dubai achieves over other alternatives exponentially increases with each new participant.

The Dubai Financial Market – 25% owned by NASDAQ – is a modern exchange, aggressively seeking to be the go-to exchange for regional IPOs between London and Hong Kong. Currently, the Dubai International Airport is the largest in the region with 34 million passengers annually. But to accommodate the boom, the new $100 billion Dubai Airport being built is expecting 100 million passengers a year – making it the largest in the world.

Emirates Airlines, which this week reported a 35% increase in profits to $1 billion despite ongoing jet fuel cost increases, is an extremely civilized way to fly; in the caliber of Virgin and Singapore Airlines. With Dubai being approximately 6 hours away from London, 6 hours from Moscow, 3 hours from Mumbai, and 7 hours from Hong Kong, it is geographically an ideal location to be at the center of what’s going on globally.

A monorail system is under construction to alleviate the horrendous traffic but as the “look at the glass half-full,” optimism of Dubaians say, “bad traffic is the symbol of a great city like London, New York, Hong Kong, Shanghai, etc.”

At one point, Bahrain was projected to be the financial center of the region but Dubai is now headquarters for all key players including Citigroup, HSBC (NYSE: HBC, $87.67) Goldman Sachs (NYSE: GS, $200.27), Morgan Stanley (NYSE: MS, $50.31), Credit Suisse (NYSE: CS, $55.49), etc.

While historically the wealth in the region has placed its assets in banks in the United States and Switzerland, 9/11 created a mindset to keep the money closer to home. A huge, almost unbelievable advantage is that there are no taxes on interest income, wages or capital gains. The magic of compound interest will have a material impact to the wealth of participants and a powerful incentive to do business and reside in these areas.

Saudi Arabia is a different animal altogether but fascinating nonetheless. The kingdom of Saudi Arabia came to existence in 1932 after a 30-year campaign by Abdulaziz Al Saud to unify the disparate people of the Arabian Peninsula and form a single nation. In 1933, the new sovereign Saudi Arabia signed the concession agreement opening up the kingdom to oil exploration and forming Saudi Aramco with John Rockefeller.

Flying into Ryadh, the capital of Saudi Arabia with 5 million of the country’s 25 million people, was an instantaneous switch from the comparatively cosmopolitan Dubai. Security was tight everywhere, with women covering their entire head and body with an ibayah and everything shutting down five times a day to pray to Mecca.

The head of the Kingdom of Saudi Arabia is King Abullah who succeeded to the throne on August 1, 2005 following his half-brother King Fahd’s death. Under King Abdullah, Saudi Arabia has aggressively focused on the elimination of terrorists and “modernizing” Saudi society and its economy.

Part of this is seen by Saudi Arabia joining the World Trade Organization in 2005 and steps taken to open up the stock market to foreigners. Foreign investment in the kingdom is expected to be $1 trillion over the next 10 years.

Also noteworthy of Saudi’s desire to be a global force into the future is the development of six economic cities modeled after Dubai’s very successful sector cities. “A new age city being built today for tomorrow’s Saudi citizens” – this project is a multi-stage development, and with an investment of $26.6 billion. Emaar properties, the premier real estate developer based in Dubai, is the master developer of King Abdullah’s city.

My guide for the week was my partner Eric Wilson who had worked for the Saudi International Bank (JV with J.P. Morgan) during the 1980s. I started calling Eric “the Ambassador” partially because we had dinner with the United States Ambassador for Saudi Arabia Ford Fraker who had hired Eric and partly because Eric knew everybody who was anybody. We met with the CFO of Saudi Arabia Basic Industry Company – SABIC - which is the largest petrochemical company in the world (and trying to be very green!). We also met with the number two person at the Saudi Central Bank - the Saudi Arabian Monetary Agency.

My main takeaways from the time in Saudi Arabia are that: 1) the country is misunderstood. 2) it is the land of opportunity 3). Saudi Arabia is opening up in a big way 4) with 25% of the worlds oil reserves, $100 + oil prices and $1 billion of cash flow a DAY, Saudi Arabia is going to be a major global economic powerhouse for the foreseeable future.

Also, announced earlier this year was that Saudi Arabia was going to start its own Sovereign Fund (learned that’s a bad word by the way), with an initial investment of $6 billion. Given the fact the Saudi Governments budget is driven by $45 a barrel assumptions, it’s likely the Saudi Fund will rapidly join the status of its neighbors in the Sovereign Fund Olympics led by the $1 trillion Abu Dhabi fund.

As it’s our mission to identify and invest in the “stars of tomorrow” – the most important emerging growth companies in the world – it’s inconceivable that the MENA (Middle East/North African Region) won’t be one of the most fertile areas to hunt on the planet.

With $100 oil prices, McKinsey calculates the region will generate $9 trillion in petrol dollars between now and 2020. The top 150 public companies have already achieved an average of 35% EPS growth and a 21% ROE over the past five years, according to Citigroup.

Oil and a young and increasingly well educated population will fuel accelerated growth within the region without the drag of an aging population as most western countries face looking to the future.

The MENA regional stock exchanges are all in the process of modernizing-with increased ability for foreigners to invest and with better transparency. Clearly Dubai aspires to be the leading light and this movement and we believe it will be. Rising capital inflows, greater market participation and liquidity are all promises to be a boon for the region for many years to come.

Themes that are clearly going to be winners include infrastructure to support the incredible growth the region is going to receive, including construction, transportation and telecommunications (and WATER!!!). Other themes that have tailwinds include the banking, wealth management and fertilization. Also, with per capita income already at high levels and going higher, global brands like Apple (NASDAQ: AAPL, $180.94), Nike (NYSE: NKE, $67.66), and Starbucks (NASDAQ: SBUX, $16.46) will find anxious consumers for their products. Below is a chart of some leading companies in the MENA Region.

Buy Dubai!!!

Posted by Michael T. Moe at 04:52 PM | Comments (0)