Decoding a Company's DNA

Editor's Note: We're pleased to introduce our newest contributor, Mohnish Pabrai, who is the managing partner of Pabrai Investment Funds, an Illinois-based value-centric group of investment funds. We hope you enjoy the column; as always, let us know what you think.

The DNA structure of any business usually gets set in stone during the first 90 days of its life, and trying to reprogram this genetic code after a few years is excruciatingly difficult. The DNA structure dictates the way in which a company will respond to various business challenges over time.

From an investment perspective, a lot of useful information can be gained from decoding this genetic blueprint and understanding what transpired during the very early stage of a given business. If you're able to decode, you can extrapolate business performance far into the future.

Let's start with a study of Lucent (LU - commentary - Cramer's Take). It used to be called Bell Labs, the research-and-development division of AT&T (T - commentary - Cramer's Take). Before 1984, AT&T was a regulated monopoly with a cost-plus pricing model. Regulators allowed AT&T to earn a reasonable return on invested capital. The more the capital invested, the higher the return. Thus, incentives to spend a lot of money and build a "gold-plated" network infrastructure were in place. Thus, it ended up with a telephone network with insanely high redundancy and fault tolerance. Price was never a priority.

Lucent was where this bulletproof telecom gear was designed and built. With the onset of deregulation and the spinoff of Lucent, a big change occurred. Now Lucent needed to compete. AT&T wouldn't necessarily be buying Lucent gear, but choosing the best solutions from various vendors.

You can't reprogram the bureaucratic R&D arm of a lethargic, regulated monopoly to suddenly become as nimble and competitive as Cisco (CSCO - commentary - Cramer's Take) or Qualcomm (QCOM - commentary - Cramer's Take). It violates fundamental laws of genetics. What transpired at Lucent since its spinoff was totally predictable. Had investors studied its DNA, they wouldn't have taken the stock from $20 to $60 in the late '90s. More important, they wouldn't have ridden it down to $1 today.

---

Mohnish Pabrai is the managing partner of Pabrai Investment Funds, an Illinois-based value-centric group of investment funds. At time of publication, Pabrai held no positions in any securities mentioned in this column, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. He appreciates your feedback at [e-mail]. You can access his Web site at www.pabraifunds.com.