10 Questions With Internet Fund Manager Peter Doyle

The (WWWFX Quote)Kinetics Internet fund beats all funds over the past five years, but it still gets the Bronx cheer.

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With modest assets and a gale-force wind at its back, the fund rang up triple-digit gains in both 1998 and 1999, prompting wunderkind manager Ryan Jacob to strike out on his own with the profoundly battered (JAMFX Quote)Ryan Jacob Internet fund. The Kinetics Internet fund's new management team, led by Kinetics co-founder Peter Doyle, took a beating in 2000, but the team's tech-light approach limited the fund's losses to just 10% last year -- beating some 95% of the fund's ravaged peers.

Still, the fund has many critics who rightly say its biggest gains came on Jacob's watch and that the fund's eclectic portfolio will leave it in the dust whenever tech stocks surge. We've knocked the fund several times, and Morningstar analyst Chris Traulsen told investors "to steer clear of this offering" in his latest report.

But the fund's survival last year and its place atop five-year fund charts merits attention. We sat down to talk with Peter Doyle who laid out his strategy and responded to critics' barbs. Why doesn't he own Yahoo!(YHOO Quote), why is he short Cisco(CSCO Quote) and why should anybody bother with a Net fund anyway? Read on.

1. What's your definition of a Net company these days?

It's a company where, looking out into the future, the vast majority of [its] business models will be centered around the Internet as a distribution platform.

Talking With: Peter Doyle

Fund: (WWWFX Quote)Kinetics Internet

Managed Since: Oct. 6, 1999*

Assets: $311 million

1-Year Return: -21.2% /Beats 91% of Peers

3-Year Return: -2.4%/ Beats 63% of Peers

Expense Ratio: 2% vs. 1.79% category avg.

Top Holdings: Liberty Media Kroll USA Networks

*Co-managed with Steven Tuen and Tina Larsson. Sources: Morningstar and Kinetics Funds. Returns through Feb. 12.

2. Given the drubbing that Net stocks and funds have absorbed, what's the case for Net investing today?

We're focused on companies that should have [the] financial strength to execute their business strategy irrespective of the health of the capital markets. We're also focused on companies that are using the Internet in a very proprietary fashion that will help them generate healthy profits.

Proprietary in the sense that they're doing something different that isn't easy for a competitor to replicate?

Exactly. I think those companies represent good opportunities.

3. What's an example of a company that meets your criteria?

USA Networks(USAI Quote), which is changing its name to USA Interactive. The company, once the deal with selling the TV network to Vivendi closes, will have between $4.5 [billion] and $5 billion in cash. They will own 65% of Expedia(EXPE Quote), and they will be a majority owner of Ticketmaster, which is a near monopoly.

Talk About a Rough Ride Net and tech funds have lived up to their volatile rep

Sources: Morningstar. Returns through Feb. 12.

They own a sizable chunk of hotel reservation networks, and they also own the Home Shopping Network, so they have a distribution network that can handle any type of transaction that takes place on the Internet. They believe that, in five years, they can capture 20% of all transactions that occur on the Internet. They also have the financial health to consolidate the industry. They say on a yearly basis, they plan on making nine to 10 acquisitions.

Is the company profitable?

On a cash-flow basis, yes.

4. What's another company that meets your criteria?

[TV and cable concern]Liberty Media(L Quote) is another perfect example. We believe that broadband is going to be the most successful and dominant way people access the Internet. Right now Liberty is one of the dominant cable players in Europe. They control 73% of UnitedGlobalCom (UCOMA Quote), which owns majority interest in United Pan-Europe, which is the biggest cable company in Europe.

To be successful on the Internet, you need content and distribution. Liberty has content, and now they're focusing on distribution. They're buying these cable assets at a fraction of the cost of what U.S. cable companies are trading at, and [at] a fraction of what European cable companies were trading at just a short while ago. If they're successful in consolidating that industry, they're going to have the dominant channel through which information flows into people's homes. The company literally has tens of billion of cash and marketable securities on its balance sheet, too.

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5. What's an example of a Net company where you don't see a major competitive advantage over the long term?

Amazon.com(AMZN Quote). Obviously, Amazon is considered an Internet business, but in my view, it's more of a regular retailer. The history of retailing is populated with bankruptcies, companies that had interesting or intriguing business models that worked but never made money. Those are the types of businesses that we actually believe don't have anything proprietary on a long-term basis.

After Amazon made money last quarter, it got a lot of fans who said consumers will choose that site over competitors. You don't agree.

I don't really think they have anything proprietary, and as people become more proficient in using the Internet, they can price things out quickly.

Let's use books as an example. Amazon doesn't produce the books; they come from Doubleday or another publisher. In the future, it makes no difference to me where it comes from because it's all being shipped FedEx or UPS. I just want the book. To me, that implies that Amazon has a very bad business model.

Think about the differences between Amazon and Wal-Mart(WMT Quote). When Wal-Mart builds a superstore in a community, there's no need for another one. You have planning, legal battles, all of that. Amazon doesn't really have that barrier. I don't see any clear vision that Amazon has to be a dominant or profitable company in the future. We don't own [its] shares in the funds.

6. What percentage of the fund's money is currently invested in companies that aren't profitable?

I would say that we probably have 20% of the assets in companies that aren't breaking even on a cash-flow basis. I don't necessarily demand that a company report profitability, but as long as they can sustain themselves on a cash-flow basis, that's important to us.

7. Most of the "pure play" Net companies aren't in your fund, and that might surprise some people. Let's talk about a few, starting with Yahoo!(YHOO Quote).

Yahoo's valuation is still incredibly rich despite its massive decline, and it's just a portal. They don't actually have the proprietary content that people want. People use the site and then go elsewhere.

We want companies that have depth and breadth of content that can derive advertising revenues or commerce from that. I don't think that Yahoo! has that. They could build it, but they're up against some pretty big players like AOL Time Warner (AOL Quote) and Liberty Media. So, it's not clear to me that they're going to be successful.

What about AOL and eBay(EBAY Quote)?

AOL Time Warner is just a great company with a tremendous amount of content. But it's leveraged, and even with its decline, I think its valuation makes it more speculation than investment. So if the price came down further, I would be much more inclined to buy it, but we're not there yet. Great company.

Wrong price?

Wrong price.

eBay?

I was always a skeptic of eBay. Let's say we were going back a hundred years ago, and someone was telling me that they were going to sell carbonated sugar water. I'd have said, "Who wants to drink that?" Lo and behold, you have Coca-Cola. eBay actually has surprised me. We have a very small position in it, but based on valuation, a lot would have to go right with it to do well as an investor. The stock would have to come down tremendously in order for us to have to make a commitment to it.

You'd expect a Net fund to own shares of networker Cisco(CSCO Quote). You don't. Why not?

We don't and we never did. That's the reason that we held up so well in 2001.

The reason we never held companies like Corning(GLW Quote), Nortel Networks(NT Quote) and Cisco is that those companies suffer boom and bust cycles. You have a friendly capital market going back a number of years and tremendous demand for fiber optics and tremendous demand for routers, but as they approach completion, there's no need for that anymore. After you complete your network, you don't need to see Corning anymore.

That's unlike, let's say, Coca-Cola; you have a Coke at lunch, and two hours later you might be thirsty again. I was always very suspect of that type of business model.

And in the case of Cisco, I was always skeptical of the type of acquisitions they were making. They were paying literally billions for companies that had no revenue. I didn't believe their insight was any better than anybody else's as to what they could do with those businesses and if they could be successful. So Cisco's valuation, even with the massive declines that we've seen, in our opinion will come down substantially from here. We run a hedge fund, and we're actually short Cisco.

8. In the wake of Enron, are there companies on your radar screen that you're worried about in terms of how they book their earnings and revenues?

I don't think the bellwether technology companies are being accurate in reporting their results. So Cisco, Dell(DELL Quote), all of them, I think overstate their profitability. I think that's why the Nasdaq is going to do poorly over the next several years. An investor would do poorly if they remained in those types of companies.

Because their valuations are based on past earnings and projections that aren't accurate?

Exactly. Valuations for these companies are based on pro forma numbers that are pure science fiction. And unfortunately, it's undermining the whole capital markets, and it's having impacts on the risk premiums, which are going up for all companies, even those that are doing things legitimately and are trying to do things conservatively in their accounting.

9. Your fund is labeled a tech fund, but you have most of the fund invested in nontech stocks. This bugs some; what's your response?

We've always said the Internet is a distribution platform to distribute data or content. The problem with investing in the technology side is that it's like finding a needle in a haystack. There are literally hundreds of companies doing B2B or B2C or whatever, and no one really has any insight into whether these companies are going to do well or not.

It represents speculation instead of investment, and if people really thought about what the Internet is, they would say that it's really a means of reaching consumers. Certain companies have things that people want, and those are the companies we want to be focusing on. So the Internet doesn't necessarily mean technology, it means distribution.

10. Given the volatility and breadth of Net investing, realistically, how much of someone's portfolio makes sense for an Internet fund?

I'll go on record and say that from today going forward our Internet fund on an absolute basis will provide very healthy returns, and the Nasdaq overall will be in decline for the next several years.

All that being said, this fund is designed to take on a certain level of risk, and there's going to be volatility associated with that, so this fund, of somebody's equity portfolio, should represent no more than 10%, and that would be the maximum. The reason being, the returns are going to be very spasmodic. They'll come in very short bursts, and then you'll have periods when things decline like we've seen over the last couple of years.

I'm quite convinced that we're positioned to do very well, and the vast majority of people are focused on stocks that will not do well.