tetsuo : Über High Tech, Unternehmerkultur, und Optionen
Nasdaq 500: Bank On It
I didn't want to believe it. Really, I think there are substantial bargains in stocks right now. But I've come to realize that a toxic combination of arrogance, greed, and circumstance is going to knock the biggest technology companies significantly lower.
Of course, I've been pretty negative about valuations in the technology industry for some time -- first from a valuation perspective, then from a business prospects perspective, and then finally from a corporate governance perspective -- though I've been fairly arrogant about the fact that I'm a bottom-up investor (I analyze individual companies first and foremost). Nasdaq at 1,100? Well, some companies in that mix may be overpriced.
And I still believe this -- if I have found a company priced under its intrinsic value, then I'm not real concerned about whether it drops another 40% or 50% before it recovers. Some companies are priced devilishly low and will provide some magnificent returns eventually. But I can't ignore the factors that will crush the market in the interim, because some of the obvious choices are nothing more than false prophets. The technology industry is most susceptible, and I think we're going to see drops of at least another 50% before it's all said and done. That would bring the Nasdaq back to a bit above 500. Here's why.
1. Contempt toward corporate governance
I recently read an interview with Mark Mobius, the renowned emerging markets portfolio manager for Templeton Funds. Due to his work in some regulation-impaired environments, Mobius has a particularly visceral definition of corporate governance. "This euphemistic term 'corporate governance' [is] nothing more than stopping the theft," he said. In Mobius' world, reliance upon improving corporate governance can mean the difference between a good investment and grievous losses.
But what's so different about Mobius' position and that of individual investors? We depend on corporations to tell us the truth. We depend on boards to protect our interests. We depend on auditors to certify the results. And we've seen company after company forced into restating their results for past years. In 2000, the number of restatements of publicly traded companies was 232. In 1991, it was three.
And yet, there's Scott McNealy, CEO of Sun Microsystems (Nasdaq: SUNW), whinging at a Business Council meeting last week in White Sulphur Springs, W. Va., that, "signing documents saying that nothing's changed -- that's a cost to my shareholders. Answering questions from journalists like you about it -- it's a cost to my shareholders." Michael Dell of Dell Computer (Nasdaq: DELL) joined in, calling it "socialism."
Such contempt toward good corporate governance is contempt toward shareholders, period. So, Scott, is answering journalist questions, in your opinion, more or less expensive to shareholders than the $1.4 billion in stock your company repurchased in direct relation to Sun's stock option plan in the past three years? Remember the arguments that stock options aren't a cost to companies, but rather a cost to shareholders? Yeah, we do, too. I'd frankly rather you answer the damn question about corporate governance than try to account for 376 million shares granted as options over the last three years.
Using a tax accounting method, I come up with an estimated value for those shares of $1.074 billion, or nearly 50% of Sun's accounting earnings for the same period. A few months back, you lamented how it was obvious to you just how overvalued your company's stock price was before the crash. Should we assume, then, that your company purchased $505 million on share repurchases in 2000 over your objections?
A Community member on our Advanced Micro Devices (NYSE: AMD) discussion board put it very well: "When the management of AMD makes a public statement that the investor had better beware... [investors should] consider the worst-case possibility, since AMD's management will never give an honest warning about what is actually going on." One of the biggest liabilities facing Advanced Micro Devices is that even its own highly knowledgeable investors no longer believe its management is capable of telling the truth, unless it benefits them."
Corporate governance is all about giving shareholders accurate information so they can make good investment decisions. Scott McNealy and Michael Dell treat it like a hassle. News for you, boys: There are many investors, like me, who automatically discount your companies' performances due to what we consider a high chance of earnings grooming. Your stocks have a long, long way to drop before I would be interested, simply because I don't trust you. And I'm not alone. The technology sector has the largest preponderance of companies abusing the daylights out of stock options, and the biggest of the big are in the Nasdaq Composite.
It's like this: Which is more valuable -- a watch made in Switzerland or Bulgaria? Know the answer? Good. You're Bulgaria.
2. Stock options
We just talked about stock option accounting, or the lack thereof. There's a deeper problem, though. Companies that depend on stock options for their economic advantage will have an awfully hard time the longer their stocks stay low, as employees begin to demand good ol' cash.
I saw an unbelievable interview the other day, in which JetBlue's (Nasdaq: JBLU) CEO said stock options were a main reason his company can keep its fares low. So, the next time you fly JetBlue, be sure to thank a shareholder. She's subsidizing your ticket. That's been part of the game for so long: The company pays you some, but then the idiot shareholders make up the difference.
We saw it the other day when Siebel (Nasdaq: SEBL) said it would be less reliant on stock options in the future. What's that going to do to its cost structure? Unless Siebel is simply going to pay less, its cost structure will rise. Until recently, more than 60% of all Siebel's earnings would've been eaten up by Tom Siebel's stock options package alone.
Where was the criticism from Siebel's cohorts when this was going on? Nowhere, because they were doing the same thing. And now they want us to believe that corporate governance is a waste of time. Please. How else can we separate the moderately greedy from the truly corrupt? If individual shareholders don't believe you anymore, it's not necessarily because you ripped us off, but you sure didn't do much to reveal the shams going on around you. Don't want to get painted with the same brush? Shoulda acted in shareholders' best interests and tried to differentiate yourselves when money seemed to grow on trees.
In less colorful terms, investors are questioning the premium they've given for growth to technology companies in the past. One reason for this is investors' lack of confidence that these technology companies are using retained earnings in a way that benefits outside shareholders. Until this perception changes (for example, Microsoft (Nasdaq: MSFT) pays out some of its $37 billion in a dividend), we're not coming back without an enormous drop in share price.
3. The tyranny of Chapter 11
American bankruptcy laws are among the world's most dynamic. When companies file for Chapter 11 or Chapter 7, there's an orderly process involved to assign rights to the various interests in the company. When a company invests its capital poorly, it should go bankrupt -- it keeps the entire capital system healthy. I'm convinced one of the reasons Japan's market has been in the doldrums for 12 years is its government won't allow companies and banks that have destroyed capital to fail. It just keeps feeding them more capital, which they, in turn, destroy.
Our Chapter 11 laws do have a downside. They punish competing companies. Think about this: WorldCom's management has lied, cheated, and stolen to the point where the company is insolvent. And yet, due to Chapter 11, WorldCom can keep competing, and, if things go well, it can emerge on the other side with a balance sheet spanking clean of debt. How are other telecom companies, which have been more responsible (in varying degrees) with their capital, supposed to compete? They can't, and, as a result, destruction of their capital is almost guaranteed. So AT&T (NYSE: T), Sprint (NYSE: FON), Verizon (NYSE: VZ), Cable & Wireless (NYSE: CWP), BellSouth (NYSE: BLS), and SBC (NYSE: SBC), as survivors, won't feel less pricing pressure, but more.
How can equipment manufacturers sell to an industry in which the biggest companies are concerned about their survival? They can't. Global Crossing will emerge from bankruptcy as a private company and wreak havoc on the companies it couldn't defeat back when its management was shopping bogus capacity swaps to pump itself up. In this case, sympathy for those on life support can be murder for the walking.
4. Oh, yeah, the economy and debt
Still not any better. Not looking any better. Doesn't matter so much, since things will start to improve long before we actually notice. Companies are still drowning in debt; individuals are running out of spending power; and the government isn't stepping in to spend a nickel or two. None of this spells quick turnaround. Things will, however, turn around.
But I'm having a hard time, looking at the actions of the technology companies in the past and their comments in the present, thinking they will be any better at sharing profits with shareholders in the future. Until they do, they can't drop far enough to make me want to invest. If that doesn't concern them, then I don't know what will.
Bill Mann, TMFOtter on the Fool Discussion Boards.