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Friday, November 03, 2006

Interview With Andy Kessler, Former Morgan Stanley Tech. & Inst. Investor Ranked Analyst, Successful HFM & Author of NYT Bestseller 'Running Money'

By Yaser Anwar, CSC of Equity Investment Ideas

Ever since the Tech bubble in 2000, the market has seen resurgence in venture capital investing. In 2006 alone, there were more VC investments made than the sum of 2001 to 2005. Will this trend continue?

To talk about this trend and other industry related topics such as; Venture Capital Industry's Outlook, Intel & AMD Price Wars, The Next Phase In Online Innovation, Google's YouTube Acquisition, What To Look For When Buying Small-Cap Companies & Andy’s latest book, The End of Medicine etc., I conducted an interview with Andy Kessler, Former Morgan Stanley Technology & Institutional Investor ranked "All-Start" Analyst, highly successfully Hedge Fund Manager & Author of New York Times Bestseller, Running Money.

Wall Street Talk with Yaser Anwar

Guest: Andy Kessler, Author ‘The End of Medicine’

Y: Andy, thank you for taking time out for this interview. What have you been up to lately?

AK: My latest book The End of Medicine came out July 3, so I’ve been on the promo and speaking tour, which is almost done. Mostly, I’m doing some writing and some investing, probably in that order. My next book project is very slowly taking shape.

Y: As a former tech analyst for Morgan Stanley, what do you make of the current price wars between AMD & Intel? Who do you think will come out on top?

AK: No one comes out on top in price wars. The trick is to get your next generation parts out first. That means designing it, but also spending billions on fabs to be able to manufacture them in the millions, not an easy trick.

Y: Paul Kedrosky has a rule: The venture business is a bubble business. The industry owes its existence to its participants' ability to find and exploit liquidity bubbles in technology markets. Do you agree with that?

AK: No, there would be a VC business, albeit a small one, without equity bubbles, although an occasional bubble sure helps.

Y: Would you consider the amount Google paid for YouTube, $1.65 billion and circulating rumors that Yahoo's in-talks with Facebook for a $2 billion buy-out, make you reminiscent of the tech bubble in 2000? I'd like to remind readers of your quote in Running Money, "You know, you haven't lived until you've had $1 billion thrown at you in one week."

AK: Google buying YouTube is quite reminiscent of Yahoo buying GeoCities, an acquisition in search of a strategy. But I’m not sure it is reminiscent of an entire tech bubble. It is fairly isolated. There are few IPOs. Equities are not disgustingly overvalued. Sure VCs are overfunding so-called Web 2.0 companies, but there have not been many liquidity events. It is still shoot and wish vs. shoot and score.

We’re not at a bubble, not yet anyway. The market is paying up for growth. When it pays up for “should” or “oughta” or “might someday” kind of growth, then I’d be a lot more nervous.

Y: Your book, The End of Medicine, seems to have struck a nerve in the industry. What computers did to typewriters, ATMs did to tellers and you think will do to doctors, the premise of your latest book 'The End of Medicine'. Will Automated Quantative Strategies do the same to Fund Managers?

AK: The trick is to embed worker’s intelligence into silicon and software and then replace that person. It was relatively easy to do with telephone switching and tellers, and harder as one goes up the value chain. It’s really front line doctors that will be replaced with diagnostics that can look inside of you, which doctors really can’t do. With investing, we are already well on our way replacing traders with servers that can do it quicker and cheaper and probably better. Index funds are an example of an automated portfolio management strategy, although a rather dumb one at that. Quant Strategies? Should be automated. What should not be automated is the job of allocating capital to all these quant strategies. I’m a buy and hold guy myself.

Y: In your book, Running Money, you're on the constant look out to emulate the US industrial revolution to a specific emerging country. Which country do you see the IR happening now in?

AK: I think the BRIC (Brazil, Russia, India and China) are all going through various phases of a modern industrial revolution. It’s not steam engines, but it is manufacturing and shipping and logistics. Banks and concrete and energy companies are the rage, not chip design and search engines and pharma (although there are plenty of small examples to try and disprove the idea). There is huge need to build roads and refineries and chemical processing plants. The U.S. went through this already, probably finishing up with the Rust Belt in the late ‘70’s. I strongly believe that these countries will have to go through this phase and grow to full employment before they begin to outsource low paying jobs elsewhere and climb up the ladder to a more intellectual property based economy.

Y: Do you think we are at an extreme point in the venture capital industry, six years after the tech bubble burst? Considering that since September 1st there have been 7 U.S. technology IPOs, only one of which, Shutterfly, is currently trading below its issue price.

Note: This question pertained to market climate 1.5-2 weeks back.

AK: Not really.

Y: The average performance since inception of these seven IPOs is 47%, more than four times that of the 14 non-tech IPOs during the same period. Do you think this trend is sustainable?

Note: This question pertained to market climate 1.5-2 weeks back.

AK: I think the IPO window is starting to open up as more companies reach the stage of maturity that used to be considered quaint, eight quarters of growth and at least two quarters of profitability. Seven is too small a sample. You’ll see some interesting companies go public over the next six months. The problem with venture capital is not the IPO market, but is too much capital and too few new ideas.

Y: With the astounding growth of YouTube in less than 15 months and Google behind it, YouTube's bargaining power & ability to align itself with big media seems to be solidified. Most of the big media companies; Warner Brothers, Universal etc, don't have an enormous online exposure. That's where YouTube comes in- YT provides an online gateway for big media to hundreds of millions of viewers. What do you think?

AK: The deals you have seen YouTube cut so far have not really been media deals – they have mostly been about music videos which are promotional by definition. Record labels love to have music videos distributed far and wide. The bigger problem is copyrighted material, stolen off the airwaves and cable that end up on YouTube or other video sites. We can agree that as users, this is the right way to watch short clips, just as Tivo is the right way to store and watch TV, but…media companies who pay for the creation of these shows and movies don’t look kindly on copyright infringement. They can’t have free versions floating around. This is going to be a long and hard fight. Lawyers will rejoice. While this is going one, lots of other fun stuff will be created that I think will be more interesting that video clips of Jon Stewart or Diet Coke and Mentos.

Y: In your opinion, what will be the next phase in online innovation that will bring YouTube or Facebook like growth?

AK: Peer to peer is going to change everything. Google is building huge data centers near waterfalls (for cheap electricity) to spit out search results and soon YouTube videos. But there is lots of idle capacity on my hard drive and bandwidth and my neighbors hard drive and bandwidth that there will be an interesting model of sharing streams of video between millions of users, not one to many via data centers. If you look hard enough, you can find some rather illegal P2P programs and watch ESPN on the Web. Pretty cool. This will be a lot tougher for media companies to stop vs. a cease and desist order to Google.

Y: During your hedge fund days, you and your partner, Fred, used to visit a lot of companies to meet their management. When investing in small companies & start-ups, management is all you have. Can you tell us a little about what kind of questions you asked & what to look for when investing in small caps?

AK: We would set up sometimes 8 to 10 meetings a day with companies we owned stock in or were thinking of investing in. Once invested, we would try to stop by once a month, or more. CEOs liked to see us, often because no one else was visiting. We would both ask about technology and what future products might look like and my partner Fred would often ask about how the company was structured, who reported to who, how fast financials are rolled up etc. Fred was great at assessing management’s ability to handle growth. If you own 10% of a small cap company and they glitch a quarter, your position will quickly halve or more in value – overnight. Looking management in the eye is the only way to invest.

Hedge funds will grow from $1 trillion in assets to at least $4 trillion over the next decade. Some will focus on small cap – most won’t. It will remain an underserved investment area with lots of diamonds in the rough, just asking to be found.

Y: Which sector do you think will lead to the next bubble, will it be- Alternate Energy, Nanotechnology and/or some form of online innovation (i.e. Video Sharing, Social Networking etc.)?

AK: I happen to think silicon based early detection for heart, stroke and cancer will be the bubble of 2010 or 2011. But there is all sorts of fun stuff that will grow like a weed between now and then, battery technology, wireless security, new technologies for consumer devices, next gen high def, municipal wi-fi, peer to peer TV, silicon dust, and most exciting, a new media model. Click here to check it out.

Y: Thank you for sharing your insights Andy.

AK: My pleasure.


Like all of Andy's books (Running Money & Wall Street Meat), The End of Medicine is a great read with lots of humor and interesting insights into the medical industry.

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