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Author: CrazyOtto Two stars, 250 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 3855  
Subject: some lessons learned Date: 4/11/2001 12:20 PM
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Ouch, I peaked at my portfolio yesterday and wow is it ugly. I got served up another slap in the face this week when NBC announced it was going to buy back the NBCi stock - of course at a fraction of what I paid for it. This is the second time I've gotten nailed by this same strategy - Disney did the same thing to me last month when it issued DIS shares to replace DIG shares - of course at a huge loss to long term DIG holders.

I invested in both companies for the same reasons and now I'm getting screwed by both companies the same way - and both companies more or less failed for the same reasons as well.

Why I bought
Both companies were involved in the media content sector of the internet, which is based primarily on delivering interesting content to web site visitors and earning advertising revenues. I liked both companies because they were owned by media giant parents (NBC & Disney) which had huge catalogues of content to deliver, huge creative staff to generate more content, and huge off line media presence to drive people to their web properties. That combined with projections that on line advertising will continue to grow exponentially over the next 5 to 10 years seemed like good business. Add in the possibilities for on line commerce and special subscription services, and the picture gets better. They seemed to be from birth, what companies like AOL and MSN still dreamed of becoming. From the beginning, however, both were plagued by huge gaffs in business strategy - frequent turnover of management, lack of clear focus - and my nerd friends always criticized them as 'old economy' companies that would never be able to compete with new economy types like Yahoo etc. Having worked in a large company, I new that large companies are slow to get their gears turning, but once they do, they are nearly unstoppable because they typically have large advantages in their core competencies and strong brand recognition. NBC is the leading broadcast network in the US and Disney is Disney! With big corporate money behind them, and good management in their parent companies (slightly dubious in the case of Michael Eisner, but nonetheless) I thought that despite the birthing pains, these companies would emerge to share top positions on the internet with the likes of AOL Time Warner.

Why I was wrong
Partly the nerds were right - the management gaffs and lack of clear direction for these companies was a major stumbling block - these guys just didn't get it and when they did, it wasn't fast enough - as companies like YHOO, MSN and AOL kept adding more and better features, NBCi and DIG were still trying to work out the kinks in their existing set up. To be fair to DIG, it actually did and does have some successful web properties like ESPN.com, but its flagship Go.com portal never really new what it was doing or where it was going. After a while NBCi kind of figured out that there was no point in competing with the likes of YHOO with a typical portal format and tried for more of an entertainment portal format, which has potential but is still not fully developed. This brings up a second problem - the technology - most of the media content that NBC and Disney are famous for is multimedia - I saw visions of people being able to go to NBCi to download / stream a copy of Friends, old Cheers episodes, or Saturday Night Live (wouldn't that be cool) or being able to go to Disney.com and see old Mickey Mouse cartoons or even entire films. All of this multimedia depends on thick pipes of course, but I knew that and saw broadband adoption rates as key support factors for these media rich companies - once people have the pipes, they're going to want the content - and that's when content will become king. Unfortunately (and don't ask about my ATHM investment) the broadband role out did not come fast enough. Right now I think only about 4% of American internet users use broadband connections. It's growing and it's definitely the future, but wasn't moving fast enough.

Despite all of this, I still think that in the long term the companies would have gotten their strategy focused, hired good hip management, and ultimately benefited as broadband became more widespread - because of these things I think they would have grown from something with nearly zero viewers to something very popular, and as a result I believed their revenues would increase and their stock would have outperformed the market over the next 5 to 10 years, which was my time frame. This is why, despite the huge fall in stock prices over the last year, I was committed to holding them - I was willing to ride out the bleak uncertain times because I felt sure I'd be enjoying a good return years from now. But I never got that chance...

Suddenly both companies decided they were going to buy back their stock. In the case of DIG, it was only a tracking stock for DIS, so DIS was able to issue shares of DIS in exchange for DIG. In the case of NBCi, which was an independent company of NBC, NBC decided to buy all the outstanding stock that neither it nor GE already owned - I think about 36% of the company.

I always see one of my strongest points as the ability to hold for the long term - an advantage of being young and being a net saver. It is this point that, with a minority of my portfolio, leads me to take on some higher risk stocks in search of higher returns, especially in the technology sector where one might invest in new technologies years before they are widely adopted. But lately I've seen a danger in investing in small companies that are then swallowed by larger conglomerates without the same growth potential. On the surface the buy out might offer a 20% premium on the current stock price, but that doesn't help much when the stock price is already 90% down on its highs - and it doesn't mean anything to me when I'm looking for a 1000% premium in 5 to 10 years. I wish I had the choice to say, no, I don't want to sell it now, I want to hold it, but in these buy back schemes / mergers / takeovers, there doesn't seem to be a lot of choice for the little guy. It's like a big GAME OVER sign on my investment when as far I was concerned I still had a lot of time left. Part of the problem is that I looked at a stock as something like a fixed asset, something that I own, like a bar of gold, and I will only sell it when I want to. Unfortunately now I learn that property rights on stocks don't exactly work that way - in some cases someone can just burst into my house, grab my bar of gold, pay me whatever the going down-market rate is, expect me to thank them and begone.

In the future, I will have to be more aware of the risk of takeover. (I was happy to see YHOO take a poison pill measure last month to prevent it being taken over during the current downturn in the market.) I've seen some investors who have viewed as good investments small companies that will be bought out. But now I think that the benefit of the slight premium from the purchase is insignificant compared to the long term growth potential of the independent company. (Imagine if Time Warner had bought AOL in the early 90's - would that have been good for AOL investors?) The problem is that as a long term investor, I value a company based on what it will be worth in several years time - but in a merger or buy out, the purchase price is often based on the recent trading average of the stock - and the time horizon that the market uses to value a stock may be much shorter than my own. When the takeover happens during a bear market (which is a natural time for cash rich companies to come shopping for firms with beaten down stocks) then the long term investor can end up with a big loss.

Another looser investment for me, for similar reasons as NBCi and DIG, was my earlier investment in EMUS, a company that sells downloadable music through the internet.

Why I bought
I invested in EMUS back in 1999 when many people still had not heard of MP3 and downloadable music. Again I had another vision of the future: we will all buy our music on line - it is much more convenient for the customer and much more profitable from a manufacturing point of view (no need to make, distribute and inventory physical CDs). I knew EMUS did not have a big or popular music catalogue, but they were one of the only public players in this field at the time, and I felt sure they would either carve out a valuable niche market, or would be bought out by a big music company for a lovely premium.

Why I was wrong
Well, it just goes to show that just because you can see what is going to happen it doesn't mean you can profit from it. Throughout its life EMUS' success was limited by a catalogue of lesser known artists, and, more significantly IMO, a product (electronic music) that most consumers had never even heard of. Additionally EMUS suffered in the early days from lawsuits from the Recording Industry Assoc of America (RIAA) which tried to ban the MP3 format entirely. (as if !) This of course did not work, but by then a new threat was around - something that totally blind-sided me and something which I think most in this area still do not fully appreciate: free MP3s a la Napster - that is, private people swapping music files through the internet for free. Here I think I was a little stupid for not seeing this coming (this was 2 years ago you know) - but less stupid than people who still do not see it coming. Recently EMUS announced that it was being bought by Universal Music, one of the big 5 music houses, which validates my idea that EMUS would be seen as a successful early pioneer in this business - but the purchase price is in the pennies when my purchase was in the dollars - again the problem of a small independent getting swallowed in down times.

If I had to do it over again I would be more focused on how the company could be an independent success, since it would not be worth investing in a high risk business (e.g. selling a product most people have never even heard of) just for the hope of a 20 or 30% premium that a buy out might bring, maybe someday. Over all I will have to try to balance my eagerness to get in early, with a caution about whether or not the company and the technology will be successful.


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