The tech bubble may have cost you a lot of money, but it cost Robert Sanborn his job.
At least that's the story according to Sanborn, who ran the
OAKMXOakmark fund at Chicago-based Harris Associates from its 1991 inception through March 2000. That's when the
Nasdaq peaked; he was dismissed after a 10% fall in 1999, which motivated shareholders to vote with their feet. The bubble's bursting triggered the steep losses many fund investors are seeing in their bleak third-quarter statements these days. As part of today's special report, Statement Shock, we turn to Sanborn for some perspective on the past year's pain.
A strict value investor, Sanborn topped his average peer six out of seven years between 1992 and 1998, but he says his reluctance to hop on the tech bandwagon in 1999 was his downfall. Now that tech's wheels have come off, he isn't shy about touting his profits from betting against Net stocks like
Yahoo! YHOO.
It should be noted, however, that the Oakmark fund's new manager, Bill Nygren, managed to steer the
OAKLXOakmark Select fund to a 14.5% gain in 1999 while choosing names from the same list of stocks as Sanborn.
Now Sanborn is running his own hedge fund, where he is long cheap consumer products companies like
Fortune Brands and short big-cap tech stocks. He's reluctant to name names, but doesn't have good things to say about
Cisco
CSCO and thinks hanging on for a dramatic tech rebound is a fool's errand.
Talking With:
Robert Sanborn |
|
| Fund: Elkhorn Fund* |
| Managed Since: July 2, 2001
(inception) |
| Assets: $50 million |
| Source:
Sanborn. *This is a hedge fund, which are primarily unregulated portfolios
for accredited investors. |
1. Can you briefly lay out your investment approach?
I'm a traditional value investor. I'm trying to buy companies when they're trading for 50 cents to 60 cents on the dollar compared to what I think is their underlying value. That value is what I think it would cost to buy 100% of the company. My short strategy is exactly the opposite. There I'm trying to find the most overvalued stocks I can, stocks I think are trading at a premium to their underlying value. I have the same long-term time horizon on my shorts that I do for my longs.
How long are we talking about?
Very long term, about three or four years.
2. From where you sit today, what's your take on the tech mania we saw in 1999 and early 2000?
Well, I called it at the time. You can actually go into my old
quarterly reports. I talked about the bubble while it was going on. At the time, I was getting letters saying I was the biggest idiot in the world. I was even getting some pressure from some of my partners.
I was convinced that I was in the middle of what would be one of the biggest moneymaking opportunities for value investors in my lifetime. When I was removed as the manager from the Oakmark fund in March 2000, I remember telling them at the time that this was really a dumb move because it was about to turn.
One thing that told me that was the Super Bowl, which was sort of amazing. An incredible percentage of the ads were from dot-com companies, and I bet many of them, if not most of them, are not even in existence any more. One company had $6 million in start-up money and they spent $4 million on a Super Bowl ad.
The other thing that happened in the first quarter of 2000 was an IPO orgy. The underwriters were doubling and tripling prices, and the average tech IPO was up huge on the first day. Those were the kind of signs that indicated we were getting very close to the end.
My point was and is that the ultimate winners in the Internet would be the companies that were already established; that Mattel.com would be more valuable than an etoys.com. There was a time when the market cap of etoys was greater than the market value of
Hasbro HAS and
Mattel MAT combined.
It was very tempting to become a closet indexer at the very least, or to buy tech at the very most. I was convinced that was insanity, that valuations were ridiculous, and ultimately in the U.S. marketplace, price and value would come together. I can remember arguing at the time with one of my partners about how we had missed Cisco. I was saying that it was grossly overvalued. I said time would show that the growth in the earnings and revenues that Cisco had was related to bubble demand and users who were getting avalanches of free money from venture capitalists. I can honestly say that I was surprised by how far it went, but I haven't been surprised by anything that's happened in the last year and a half.
Falling
Down
Sanborn's refusal to pay up for tech
cost him in 1999 after a string of solid years |
 |
Oakmark |
Avg.
Peer |
| 1999 |
-10.5% |
8.9% |
| 1998 |
3.7 |
3.7 |
| 1997 |
32.6 |
26.9 |
| 1996 |
16.2 |
20.3 |
| 1995 |
34.4 |
29.7 |
| 1994 |
3.3 |
-2 |
| 1993 |
30.5 |
18.2 |
| 1992 |
48.9 |
15.5 |
| Source: Morningstar. |
3. Did you act on that idea with your personal portfolio?
Oh yes, I was hugely shorting. I started shorting Yahoo! presplit at 125 and it went to 500 on a presplit basis. Now it's to down to around 10 [after a 2-for-1 split in early 2000]. I never sold a share and shorted more all the way up. Psychology and human behavior can take much longer than you want. I remember the famous quote that the market can remain irrational longer than you can remain solvent, so the key thing is to be able to be proven right. I was aggressive, I was heavily short those stocks.
4. Given your style, what are your favorite long and short ideas now?
I don't like to talk individual names. But I'm short large-cap tech companies that have come down a lot but are still grossly overvalued, in my opinion, for any kind of long-term outlook.
I'm long what I would call solid mid-cap companies that have very solid fundamentals. When I say that I mean companies that have very slim chance of facing major structural changes over the next five years. Virtually every company I own is number one or two in their marketplace, companies with free cash flow, companies that are buying their own shares.
OK, but no names that you can mention?
I'd rather not give names in this world. I own no tech, no energy and no utilities. I'm short tech.
5. With the Nasdaq 100 down 62% over the past 12 months, it seems like there's more room on the upside for tech over the long term. What's your response?
The opportunity to be short these stocks is much less than it was a year ago. However, I still feel that excess returns will be made just shorting these names. Just purely shorting these names is a moneymaking situation. I look at a Cisco and I think its valuation is greatly excessive.
You're in the camp that these big tech companies are growth companies that don't know how much they're going to grow, so it's tough to know what they're worth?
They're growth companies that haven't grown over the last five years, really. It's questionable what they're going to look like in five years. Very clearly there's a lot of uncertainty. The market value of Cisco is $80 billion. It has sales of $20 billion. So it trades at over four times sales. I think that's excessive for a company whose growth is highly questionable.
6. Do you see a situation where the Nasdaq goes back below 1500 and stays there after topping 5000 last year?
I think the Nasdaq in general is grossly overvalued. One of the reasons is that the mispricing we saw in the sector has caused major value destruction. A company like
NortelNT, for example, has gone from 90,000 employees to 45,000 employees. The whole process of adding all those employees and then getting rid of them has destroyed a lot of value.
The other problem is that analysts are making a huge mistake by saying, "OK, here were the margins on these companies 1997 to 1999. This is an unusual period now, so if they go back to that kind of margin in 2003, then they'll have these kinds of earnings." I think that's highly flawed because the margins that existed from 1997 to 1999 were bubble margins. You had customers calling up and saying, "Look I just got $100 million from a venture capitalist, so just send me the stuff. I don't care what it costs."
So Cisco and the companies that supplied Internet hardware were in the driver's seat. All these companies that just had an idea and a Web site were buying all their equipment from Cisco and other companies, and they were very indifferent as to what they paid for it. As a result, the margins they experienced proved to be a peak, and they will not go back to those margins.
I think if the Nasdaq does poorly and bottoms out at 1000, I don't think it's going to see 5000 for 20 or maybe even 30 years.
7. Do you see more volatility ahead for growth funds and tech stocks?
I say that in the fourth quarter there will be major redemptions from growth funds. They're going to be forced sellers, and as the manager of a fund that went from $9 billion to $3 billion, I know what that's like. You've got to sell and there're no ifs, ands, or buts about it. You've got to sell and there's no flexibility.
The second thing is that when people have gains, they're going to try to offset them with losses, and that's going to be in the growth stocks and growth funds.
Third, there will be window dressing [where fund managers buy soaring stocks at quarter-end or year-end, so they'll show up in portfolio reports to shareholders.]
A lot of these fund managers are going to try to show that they're not as idiotic as they really are, so there's going to be some window dressing. Also, people's expectations for results are a lot higher than the results they'll see. So I think those four short-term factors make it pretty comfortable for value investors. I really have pretty high expectations for returns in the next year or two here.
8. One knock that value-style folks face is that ignoring an area wholesale is not a good idea. Do you still spend time looking at tech companies?
Oh, definitely. When I'm short companies, I'm comparing them on a valuation basis to companies I do own long. No, definitely I do believe any company or security at a good price is a value. I have no problem buying a tech company at the right price. Right now, I just do not see many in that situation. I do believe that there will be a time when I'm long on those names big time, but it will be a while.
9. As you look back, do you wish that you had modified your style a bit? You missed out on the past year's losses, but you missed big gains in 1999, too.
No, because if I had bought Cisco in '98 at 20 and rode it up to 80 and sold it at 80, that would have been nice. However, what would have happened is I would have bought it at 20 and now sold it at 10. My strategy is disciplined. I don't try to guess what people are going to pay for things. So it would have been nice to have caught that wave, but as I look at it from point to point, I doubt there are many investors who have done as well as I have. I wouldn't do anything differently.
10. Today, investors are looking for a company that has a solid management team, modest valuation and the groundwork for predictable growth. Do you see a company that fits that description?
I'll give you a perfect example and I own this company:
Fortune BrandsFO. They own Titleist, the golf company, and Moen faucets. They've got huge free cash flow and they've been buying their own shares. They're also trading at about one or two times sales. I know and trust the management team. It's a company that is No. 1 or No. 2 in all their markets. The question is what will this business look like in five or 10 years? I'm pretty comfortable it will look like it does today. To me this is a very good place to invest for a five-year time period.
Is there anything else on your mind that we haven't discussed?
God bless America -- just like everybody else.
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