The TSC Streetside Chat: Glenn Hutchins and Dave Roux of Silver Lake Partners

When Silver Lake Partners was busy raising cash last year, the idea of setting up a leveraged-buyout fund focusing on fallen-out-of-favor technology seemed downright contrarian.

These were heady times, after all, when most of Sand Hill Road -- the venture capital corridor of Silicon Valley -- was trying to flush out the new new thing, and Wall Street bankers were rushing hot companies to market at a feverish pace.

Yet Silver Lake raised a bundle of cash -- $2.3 billion -- for its little venture. In part this was due to the fund's strategy, but mostly it was because of who was behind it. The seed money came from Integral Partners, the Kleiner Perkins offshoot run by Roger McNamee. And Silver Lake itself was run by a high-powered troika: Jim Davidson, who had managed Hambrecht & Quist's banking business, Glenn Hutchins, a buyout specialist from Blackstone, and David Roux, who had cut his teeth at Lotus and Oracle (ORCL Quote - Cramer on ORCL - Stock Picks).

It turned out that when a bunch of smart guys get together to do something, their strategy ain't so bad, either. The idea of the leveraged buyout for tech (LBO specialists use leverage, usual debt, to buy undervalued companies) seems to have worked so far. Last March, Silver Lake led a $2 billion buyout of Seagate (SEG Quote - Cramer on SEG - Stock Picks), the once-proud disk-drive maker.

When we sat down with Glenn Hutchins and Dave Roux, we couldn't talk about that one -- the deal hasn't closed yet. Nor could we talk much about their big investment in Cabletron (CS Quote - Cramer on CS - Stock Picks) last February. But what we could do was talk to them about how they view the technology landscape, where they think tech is going, how they go about finding value. And although our conversation began with a quip about Genesis, what eventually unfolded was a lot more like Deuteronomy.

Participating in the chat were TheStreet.com reporters Carolyn Koo, Justin Lahart and Tom Lepri.

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Justin Lahart: To start with, could give us a little bit of history on Silver Lake and ...

Dave Roux: Genesis is the only chapter of the Bible that we currently have ...

Glenn Hutchins: In the beginning, it's our observation -- it's not mine, but I'm perfectly happy to talk about it -- that we are in a new stage of the development of the technology economy. Which is very broadly described as having had two prior stages, one being about start-up, the next stage being about initial public offerings ...

Dave Roux: Go-go growth companies ...

Glenn Hutchins: And the third stage being about large-scale companies with cash flow and profitability, stable market positions and about technology conglomerates.

Dave Roux: The simple-minded observation, which is formed largely as a result of hanging around for the last 20 years in the business, is that the conventional wisdom about what constitutes "tech" is, in the public's mind, 26-year-old kids riding bikes to work, a lot of body piercing, tattoos, dot-coms ... that's tech.

Glenn Hutchins: Bad hygiene.

Dave Roux: Bad hygiene. And there's surely an element of tech which is that. But the truth is that tech has now reached a level of development and maturity that few people recognize or understand. And it turns out there's not just one or two or 10 or 20 -- there are hundreds of very large developed tech businesses, which now constitute a backbone part of the developed economy, both here, in Asia and in Europe.

Now there are hundreds of companies, financial firms and investment firms available to work with start-ups. You know, if you need $5 million or $10 million, there are 500 good companies you can go talk to about getting it. And if you're a kind of go-go guy, and you need to mess around and you just went public, maybe there aren't 500 but 50 great companies you can talk to who can write you a check for $25 million.

But if you're a $6 billion, 20-year-old business with 50,000 employees and you operate in 30 countries and you've got a strategic issue, it turns out there's no one you can talk to about getting a check for $500 million.

Glenn Hutchins: There's people you can talk to, but they don't know the first thing about technology, which turns out to be important.

Dave Roux: It's a funny thing, and Glenn's absolutely right because what you have is a choice. You can either get a check, but without any real strategic content to the money in terms of getting help, advice, experience and so forth, or you can get the advice and experience, but without any money.

You go to Wall Street and get a check, but no help, or you can go to BCG or Bain and get help, but no money.

Glenn Hutchins: So, you can think about this thing cyclically: At each stage of development of the technology economy, new asset classes have developed. New tech companies, investment opportunities, cumulative asset class, and a first mover in that asset class is to define the business model and build a franchise position for it. Think about it.

And if you're in the venture capital world, we modestly think that Kleiner Perkins [an investor and what Integral Partners came from] is head and shoulders above everybody else. They kind of moved in the late '70s to institutionalize that space. And that was what the technology economy was, for all intents and purposes, until about the late '80s.

And then about the late '80s, a new part of the technology economy grew up through all these public companies. And there was a whole bunch of very good people who were investing in either public stocks or midventure rounds or mezzanine, or late mezzanine.

And again, we modestly think that our affiliate Integral Capital is the best at doing that and they established that franchise.

And so it was our view that this was a new asset to the technology economy, which people outside of that economy didn't really understand, which is the mature phase of the technology economy. And our design was to define the marketplace, develop the business model and occupy the franchise position, so that we would combine the techniques of large-scale, private equity investment with the ...

Dave Roux: ... intimate knowledge and extended network of relationships that would make those two things function well together. And one of the things that your readers may be very interested to know is that we've grown up in the '90s with tech being the big news in public stock investing. It's a large part of the economy, it's the fastest-growing part, it's been the most dynamic sector, it's built the Nasdaq and so on and so forth. People forget, though, that as recently as '89 there were, I believe, what, 300 technology stocks?

Glenn Hutchins: Not even that many, I don't think. I think maybe 200, 200 stocks.

Dave Roux: But the interesting thing is that the total market cap in the entire tech sector was $300 billion.

Glenn Hutchins: Half of which was IBM(IBM Quote - Cramer on IBM - Stock Picks).

Dave Roux: Half of which was a single company. And that was 10 years ago.

Glenn Hutchins: And there were four or five mutual funds that did nothing but technology.

Dave Roux: And that was it. And Roger McNamee, by the way, started two of the four or five.

Glenn Hutchins: I can remember in the early '80s when Apple (AAPL Quote - Cramer on AAPL - Stock Picks) couldn't get blue sky. That means being able to sell to individual investors in a particular state. In addition to a national Securities and Exchange clearance, it needed state-by-state clearance. It couldn't get blue skies in Massachusetts because it was too speculative. This was a profitable company.

Dave Roux: This is after being on the cover of Time magazine, after inventing the personal computer and leading the revolution. This was considered to be so wild and speculative that not only would we advise against it, but we thought it was so dangerous that we weren't even going to let you invest in it.

Glenn Hutchins: And so the whole public market in technology stocks is only a 10-year-old phenomenon -- a little more than 10-year-old phenomenon. And people lose track of that. And so our view is there's a new phenomenon, that being the mature technology economy.

Dave Roux: Which presents scale-growth opportunities.

Tom Lepri: Does that transition -- from start-ups to an IPO phase to mature companies -- does that imply maturation of the market in general? I'm assuming that it implies we've moved out of the froth?

Dave Roux: I don't think it necessarily does. Remember, we started this before the froth settled down, and in fact, when we started the business, or announced it, in early '99 and went out to raise the money, one of the things we said was, "Look, this is not a business that's about investing in dot-com this and dot-com that. This is a business that recognizes that for the first time, there is a very large number of big technology businesses out there without a natural strategic investment partner." And so our analogy was, in fact, that it's really very much like the industrial or manufacturing landscape of the U.S. economy in the late '70s, early '80s. For the '50s, '60s and early '70s, that just rocked. It grew like crazy, there were acquisitions, big capital investment.

Glenn Hutchins: Conglomeratization.

Dave Roux: Conglomeratization. And guess what? At the end of that 20 year run there was a bunch of really big companies that had grown like crazy, but not always fully rationally, not always efficiently. The last 15 years has seen a very systematic rationalization and restructuring of that manufacturing economy to the point where it is, today, probably the most efficient in the world."We're in the latte, not the cappuccino part of the economy, and so what we're focused on is the mature deal."

Glenn Hutchins: And one of the outcomes of that process of rationalization was the leveraged buyout, which was a financial technique, and investment pools that were developed to facilitate that rationalization. That wasn't the only thing: There were hostile takeovers, there were spinoffs, there were a whole bunch of things around that.

So, to answer to your question directly, I think there's simultaneously a very important growth dynamic in the technology economy around the dot-coms and the network economy. And we'll continue to see small, rapidly growing companies that will be incorrectly valued by the market.

Dave Roux: There will always be froth, but it will be in different companies.

Glenn Hutchins: Exactly right. We're in the latte, not the cappuccino part of the economy, and so what we're focused on is the mature deal.

Dave Roux: And that will change over time. If you asked 10 people on the street last year, they would have said, "Ah, Internet." But if you asked 10 people three years before, what tech was about, they would have said, "Network." And if you'd asked three years before that they would have said client-server software, and three years before that, it would have been the PC and three years before that, it would have been semiconductors.

There are successive waves of technology that kind of come crashing onto the beach, and they're not going to stop coming. A little hard to predict, but they're not going to stop. And so if you just look back over a 30 or 40 year period, what you see is that the technology economy that operates today is really a set of tech strata, the same way you look at the Grand Canyon and say there's the Mesozoic period, and here's the Paleolithic, and so forth. Same deal, right? And it's laid down on the foundation of the semiconductor business, which really grew up in the late '50s and early '60s. That was the whole Fairchild (FCS Quote - Cramer on FCS - Stock Picks) and Intel (INTC Quote - Cramer on INTC - Stock Picks) and all those guys. The whole modern economy, the Hewlett-Packards (HWP Quote - Cramer on HWP - Stock Picks), the Intels, IBM, all those guys are built on that one, that core set of innovations.

And then after that, you've got the mainframes, that was the next layer. Then you have the first big layer of software that came on that -- the applications guys. Then, after that, you had the PC -- basically a small version of the same thing. Boom, a big explosion in that. Then after that you got Microsoft (MSFT Quote - Cramer on MSFT - Stock Picks), the Lotuses, the Ashton-Tates, the Novells. And then you've got all the networking. As they started putting all the LAN stuff together, you got the big networking boom. You get Cisco (CSCO Quote - Cramer on CSCO - Stock Picks) and 3Com (COMS Quote - Cramer on COMS - Stock Picks) and Wellfleet and all the other guys that happen there. And after you put this stuff all together, you think, my goodness, if you made the statement, it would be easy to do.

The Internet is to the networking phenomenon as the PC was to mainframes. It's a better version of what came before it. There's actually no net new functionality, it's just cheaper, faster, more simplified, more standard, which enables a whole bunch of additional applications. And so here we are, everyone's sitting here saying wireless transformation, we'll have to change everything, but it's just another wave that's going to come cracking down on the beach and for three or five years, we're going to be gaga about wireless.

And so in some sense, when you think about our business, you can sort of back up from the beach, because that's not where we are, and go back and say what was hot 10, 15, 20, 25 years ago and you look across and you'll find, "God, there's a $3 billion company that does that." And you know what? It's not growing 50% or 75%, it's growing 15% or 20%. It's growing three or five times faster than the rest of the U.S. economy, which is good business. That's a top 5% kind of business.

Glenn Hutchins: But the stock market doesn't like it because it's not growing at 50% to 100%. In the M&A market, which follows the stock market, it's all about growth. And so it's also not a good M&A target. The average tech company is growing 20%, right? And it just so happens that the tech economy is not like Lake Wobegon. Not every child is above average.

So half the tech companies are growing at this below-average rate, which is really quite a nice rate relative to the rest of the economy. But they're attractive neither to the stock market nor to the M&A market because they're growing at the average rate in an economy where everybody wants to grow at an above-average rate."And we happen to actually like companies that are growing 10%-20% per year and are solidly profitable."

Justin Lahart: Is it the rate of growth, or is it the rate of growth relative to what the rate of growth used to be?

Dave Roux: It's both. It's slower than it used to be. But the really interesting phenomenon is that statistically it's actually quite easy to show that, first of all, there's remarkably little rationality to the pricing of tech stocks generally, when the criteria is how fast you grow. Because there's fast guys who are cheap, slow guys who are expensive ... it's kind of all over the map. But what is true is the top guys, the grow grow grow guys. So there's a huge amount of inefficiency in the market, but what is true is that the very highest guys are always the big growers.

Glenn Hutchins: So there's a valuation opportunity for us associated with this mania for growth and we happen to actually like companies that are growing 10%-20% per year and are solidly profitable.

Dave Roux: We don't object to 25% or 30%, mind you. But the point is that it doesn't need to be in the top 10th of 1% to be a legitimate and attractive investment holding for us. Because there's a kind of odd phenomenon that goes on, which is that the lower half of tech still turns out to be dramatically better than the rest of the economy.

Glenn Hutchins: But we're in a world in which the tech buyers want growth and the value buyers don't understand tech and are afraid of how to do it right. The other thing is that there's a deverticalization occurring. It's obvious if you look at it broadly speaking, whether it's AT&T (T Quote - Cramer on T - Stock Picks) spinning off Lucent (LU Quote - Cramer on LU - Stock Picks) or HP spinning off Agilent (A Quote - Cramer on A - Stock Picks).

Dave Roux: Which again is just an updated version of what went on 20 years ago when Ford (F Quote - Cramer on F - Stock Picks) said, "You know what? I don't have to make the steel that's in my cars. I don't have to run the River Rouge Plant and make the steel that goes in my cars. Somebody else can make the steel, and it will still be a Ford."

Glenn Hutchins: And value is accentuated today by the fact that a number of the original technology companies were technology conglomerates because they had to be vertically integrated, because they didn't have a supplier.

Dave Roux: You couldn't build a mainframe by going to all the third-party suppliers. They didn't exist.

Glenn Hutchins: Today they do. And the top players in the key subsections of the technology economy have tremendous advantages because of their focus over the technology conglomerates.

Imagine a company doing a bunch of things trying to compete with Cisco, Dell (DELL Quote - Cramer on DELL - Stock Picks), Intel or Microsoft, who do one thing really, really well. So the result is you have to deverticalize, in our view, to survive in the modern technology economy. That is not to say that the businesses like Lucent inside AT&T and Agilent at HP are not good businesses.

Dave Roux: They're better businesses independently.

Glenn Hutchins: They're much better businesses independently, and so one of our other goals is being one of the agents of deverticalization.

Dave Roux: Liberation capitalism.

Tom Lepri: Is there a better example than IBM, a tech counterpart to the auto companies?

Glenn Hutchins: There are a whole bunch, I don't think we want to single out any particular ones, I only used the names in this example because they're kind of obvious and well-known. If you look, the older and more established, profitable, cash-flowing, very successful technology companies have lots of different pieces.

Dave Roux: And to be fair, a lot of guys over the years, have, without a lot of fanfare, done substantial deverticalization already. We simply observe that it's one of those macro trends. Whether we show up or not, eventually, all the firms that will compete successfully will need to have very focused business models to do a few things incredibly well.

Carolyn Koo: You were saying earlier that you were looking at what was hot maybe 10, 15 years ago.

Dave Roux: It's not so much that we only look in the rearview mirror. We used to jokingly say last year that we were the last value investors in technology. And that in a sense we're not different from value investors in any other sector of the economy. We look at quality of management, market position, quality of revenue, cash-flow characteristics, profitability -- all these incredibly mundane things.

The issue is that we make two other really difficult judgments in addition to all of that. One is, how good is the underlying technology in the business? How good are the people? How good are the engineers? If it's a software company, how good is the source code? How good is the underlying architecture? How well developed are the standards? What are the APIs? What is the quality of their technology relationships? These are very difficult things to judge if you haven't spent 20 years doing it.

It's like saying, "Hey, you can drop me into Sloan-Kettering, give me a book on cancer, and the likelihood of my making a correct diagnosis is low." It's not because I wouldn't be wanting to do the right thing, or trying to be a good doctor, or as smart as the doctor, but, you know, the guy's had 20 years' experience. And he is, on balance, going to make a better call more often.

That's not to say that I won't on occasion get lucky, as some people do in technology. Walk in, buy a software company, stock goes up, they say, "I'm a genius!" And that happens, right? We think over time it happens less often, but it does happen. So, one judgment that we make is around the technology. And it's just one of those deals where having played the course, been around the block a few times, helps a lot.

The second thing is to make a judgment about the business model. Everyone knows about innovation being important in technology -- the new gizmo, the faster semiconductor chip, the faster version of the software, the faster router, blah, blah, blah, blah.

What people I think often miss is how important the innovation is around the business model itself. And a great example is the pitched battle that got waged say, in the PC business, between Compaq (CPQ Quote - Cramer on CPQ - Stock Picks) and Dell."Over the course of the last 15 to 25 years, some of the very, very smartest people in our country have gone into technology, and have gone through these Darwinian struggles for survival."

Now, these are two companies that sell almost identical products, right? It's like United and American flying the same air route. The same plastic housing, same power supplies, same disk drives, same keyboards, same microprocessors, in fact the same microprocessors from the same company, same operating system. There's really very little difference between those two things.

And yet, through most of the '90s, if you'd asked, again, a poll of your knowledgeable readers who was the best PC company, nine out of 10 would have said Dell.

And what would have been the difference? The difference is the business model. One guy had a different business model and it proved to be incredibly powerful. Many people would say the same thing about Cisco. Is the Cisco router really faster or better? Sometimes it is, sometimes it's not, it depends on what the generation it is. But boy, have they got a system for selling and installing and particularly developing and implementing new technology.

Their way of acquiring R&D was absolutely path-breaking. No one had ever tried it. No one had ever really built their own -- that was an uncool thing to do.

Glenn Hutchins: This highlights a different issue, which is very interesting to me, being a person coming out of the Old Economy. If you think about the Compaq/Dell analogy, over the course of the last 15 to 25 years, some of the very, very smartest people in our country have gone into technology, and have gone through these Darwinian struggles for survival. And so the companies and the management teams that have come out the other end are really very, very, good at what they do.

If someone said to you 25 years ago there will be a company that will cut its prices in half and increase the performance of what it does by a factor of two every 18 months for the same period of time, you'd have told them they were nuts.

But we've just described one of the great companies in the world, which is Intel. And the reason why they were so good at what they did was they went through this Darwinian struggle with the other technologies, led by some of the smartest people in the world.

When those companies come to the point where they are mature, where they are growing only 10%-15% per year, what you still have are phenomenal management teams and great businesses. And it's really quite stunning to see.

Dave Roux: Appreciate some of the dynamics associated with the importance of the business model innovation. People have not appreciated the strength and enduring value in some of the tech brands. And mean consumer brands, I don't mean an Apple -- although that's a good example of a consumer brand that was underappreciated.

All the industrial brands out there that will be our generation's Allied Signals and Johnson Controls, and so on and so forth; there's a lot of great situations. It's not to say that all the companies don't have large-scale operating issues. If you have a $5 billion or $10 billion business and 50,000 or 100,000 employees, it's just not possible for that to hum like a top all the time.

Glenn Hutchins: And it's also not possible for it to continue growing at 50%-100% per year.

Dave Roux: It doesn't work. But it doesn't mean that those aren't, on balance, good situations. If you think, "OK, I'm not the CEO of a $5 billion company with maybe four or five different divisions, operations in a bunch of different countries, and I got some winners and I got some laggards, and I'm running, in a sense, a portfolio of assets, who's going to help me? What kind of help would be most valuable? I'm generating a lot of cash. It's not so much that I need financial help. But say a guy's running a business in -- pick your place that's not Silicon Valley -- you're in Chicago. Nice town, right? Good music, food's not bad, weather sucks -- but not the heart of the technology economy. Seoul, Korea, or Frankfurt, Germany. Same issues.

Now, what's important to that guy? What's important to that guy is, "Do I have access to the latest and greatest technology, because I've got to keep renewing what I have and updating it and integrating it and making it work with other stuff? Am I getting access to the right talent in terms of recruiting? Do I have the right people at senior management level? Do I have a great board of directors that's in touch with the future? Am I doing that business model innovation? Do I have the right management techniques? Do I have the right compensation system in place?" Where do you think the big innovation on stock options is happening? Not in Cleveland. It's happening in Silicon Valley.

Glenn Hutchins: "What's the best way to optimize my shareholder value? Do I stay in this business? Do I get out of the business? Do I combine it with somebody else's business? How do I get from my divisions the right capital structures and the right management team and the right board of directors?"

Dave Roux: And that is what we do. It happens that we have a great pot of money. But, it turns out there's a lot of guys with great pots of money. What we have, and have uniquely, is a team that's been brought together with a specific set of very complementary operating skills and industry experience, so that when we sit down with a CEO or a management team, we don't just know the name of the company and how to spell it correctly. We've probably followed it, we've probably done business with it, we've probably bought things, sold things, we probably know people on the senior management team, we know all their major competitors, we understand the key technology components that drive the business, we understand the underlying kind of economic value proposition that customers going through, we understand what their distribution system looks like. And so we sit down with them and start off with a very granular understanding of what's going on.

Glenn Hutchins: There's always been this dichotomy in the financial markets between the strategic partners and the financial buyers. And what we've tried to do in our business is to make that a false dichotomy. What we try to do in the business plan is implement what Dave talked about by first acting with the insights of a strategic partner, knowing enough about the business to be able to have the knowledge of the company and its industry the way a strategic partner would. Second, bringing to our investment the skills of a long-time operating management. Being able to assist the management team in its mission in a way that really adds value. But third, retaining the financial discipline of a world-class financial investor, and bringing with us the skill sets around financing and restructuring, allows us also to generate the kind of capital that our investors are looking for. That's the kind of business model here and we've been talking about how we implement that.

Tom Lepri: Is it possible for an individual investor with a very small pot of money and without the kind of expertise you guys have in your heads and at your disposal through the people you work with to emulate what you do? It seems as if value investing in tech has a lot of pitfalls if you don't know what you're doing.

Glenn Hutchins: You mean selecting individual stocks?

Tom Lepri: Yes.

Glenn Hutchins: That's a good question.

Dave Roux: I think you can. Well, let's back up and say, in reality, what we are positing is that you will have better returns, whether you're investing in private equity, tech debt or public equities. Whatever the asset class is, you'll have better returns if you understand what you're investing in.

Glenn Hutchins: That's an insight into the LBO business, which sounds like a truism everywhere else.

Dave Roux: Yes, it's really as simple as that. Our fund is based on the notion that specialization counts. There are really two planks to the value proposition. Plank one is, you'll do a better job investing in things you know and understand, and the more you know and understand it, the better you'll likely do.

Glenn Hutchins: I analogize that first piece to buying real estate in your own neighborhood.

Dave Roux: Anyone can go buy real estate, and if the market's going up for everyone, everyone will do OK. But year in and year out, the guy that lives in the neighborhood is not going to get snookered, won't overpay, probably buys on the right block, and probably not next to the guy who has the fireworks and beer parties on July 4th.

Justin Lahart: I love that guy! That's me!

Glenn Hutchins: You can be Dave's neighbor. The houses all around him are selling very cheaply.

Dave Roux: The second thing is that however good the quality of investment you make, if you have the unilateral ability to help make that a better business, that'll also help your returns. And that's the notion. Our notion is that we think not every single time, not every single situation, but over the long haul, year in, year out, we will, on balance and on average, do better investing in things we know and understand.

That's where we start. And if we show up with the ability to make good introductions, provide the right technology guidance, help them get a great board of directors together, do great senior recruiting, improve their distribution operations worldwide ... It's because we come in with a great epiphany. We know something you don't. It's based on the fact that says you know we can help you make this 1% better and make this 2% better and that 2% better and that 1% better ... the business 10% better.

Glenn Hutchins: It's three yards and a cloud of dust.

Dave Roux: Right. As an operating guy I can tell you that running a business is not about getting up in the morning with an epiphany. It's about getting up in the morning and thinking how can I get 30 basis points out of my distribution margin in Japan? It's a whole bunch of little things that aggregate together into a piece of advantage.

Glenn Hutchins: The second piece allows us, we hope, not to have to rely on the stock market to create our returns. In other words, we should be able to sell into the public market the companies that we have investments in at the same price measured by the multiples of earnings that we buy them for, but bring an improved company into the marketplace.

Dave Roux: Said a different way, we're not a hedge fund.

Glenn Hutchins: We're not trying to run arbitrage. We're not trying to buy something worth 101 for 96 and do it on 75% leverage so you get a 15% return for a quarter, so that's a 60% annualized return. That's not what we're doing.

Dave Roux: Which is not to say we're not pleased to sell something to someone who would like to pay more. But our model is not predicated on that.

Glenn Hutchins: And that's a lot of what happened in the last 15 or 20 years as the multiples in the stock market have continually gone up from unsustainably low levels in the early '80s. So a lot of financial success has been about multiple expansion.

Dave Roux: It would be an unfair indictment of private equity in general.

Glenn Hutchins: I wasn't talking just about private equity.

Dave Roux: No, I understand, but financial sector in general. But if you looked across a lot of the private equity world and you looked at the average leverage, the returns there, while good, aren't substantially different or better than buying the S&P 500 with the same degree of leverage over that period of time.

Carolyn Koo: Any specific areas that you like at the moment, specific sectors or technologies?

Dave Roux: I don't know if we're going to get into specific stocks ... But I think one of the other things that distinguishes us from the other people who are practicing in this field is that we act with a point of view. Most of what we spend our time on is not opportunistic. It's more that we start out with a viewpoint about where the world's going, and then essentially break that down into areas of opportunity we're interested in and then look for investments in those areas. We act almost entirely thoughtfully, as opposed to opportunistically.

Let me give you one example. If you imagine a world in which the PC is ubiquitous, the vast majority of hookup to the Internet is support by broadband architecture. If you think that's true about the future, you can pretty well predict the things that are going on. Now, in the private equity world, one of the things you see is people pouring money into broadband build-out, because the insight only goes as far as I've just described. And the conclusion is, let's put fiber in the ground.

Our conclusion is, let's imagine that fiber is already in the ground, because it's being done, and it's obvious that it will be done. It's like laying the transcontinental railway -- it happened. A huge feat, but it happened. Then what we think people will want to do next with that broadband network is add value to it. So, one example of a company that we've invested in, and we won't talk about it in detail but in general, is Cabletron (CS Quote - Cramer on CS - Stock Picks). Several of the Cabletron products are about adding value and functionality to the network. It's the equivalent of real estate and water towers, coal stations.

Glenn Hutchins: Off the transcontinental railroad. It's not that someone says, "Don't you want to invest in XYZ company?" We start with a point of view about where we want to go, and then look for opportunity."Being great the last generation can position you very nicely for continued success."

Dave Roux: I'll give you another example, which doesn't address your point specifically in the sense of a list, but maybe gives you a sense of how we think, and why it may be a little bit different than a lot of other folks. Dial back a year, this time last year heading into the Christmas 1999 season, the dot-coms were absolutely rocking. The consumer market was going out of control, stocks were doing great, people were buying tons of stuff, and we looked at that and said, "Hmmm, a lot of people are trying to figure out how to play the right thing, who's going to be the big winner in apparel sites, who was going to be the big one winner in this that and the other thing. And in particular we looked at them and said, "You know, it's really not that hard to build a Web site, and we knew that from having built a lot of Web sites."

So we looked at it and said two things. One is we think this e-commerce thing is real, actually going to be transformational -- 10% of retail, 20% of retail, who knows, but if it's any number like that it's gigantic and 10 times or 20 times bigger than it is today. So that's a big play.

So then the question becomes which sites. We looked at that and said, "Building a Web site's not hard." Building a warehouse, that's hard. And it's expensive. And it's complex and it needs to be integrated with all of this front-end stuff, but no one's really figured out how to do that in a warehouse with distributional logistics.

So, on that basis, we came to a conclusion that was different than, I would say, 999 out of 1,000 people, which is that it's not a good place to spend money, but it would be a good place to spend money on the back end, and so we spent 10 months fanatically reviewing what it would take to be successful in the e-commerce world to support local brands. We looked at warehousing, at distribution facilities, how we'd have to work with logistics providers like UPS, FedEx, Airborne and what kind of Internet stuff, what kind of customer support, gets provided.

We looked at all the guys doing it in the states. We visited 27 different facilities, talked to all these different guys, and we ended up buying a core property and we've since expanded it with another couple of hundred million dollars worth of capital to be an e-commerce outsourcing provider. To do back-end e-commerce. And it's the unglamorous, prosaic scutwork of e-commerce.

And again, instead of focusing on dot-coms, we focused on global brands. The idea is, "Look, I don't know which of these dot-coms is going to make it. Some are going to do great, but I just can't figure it out. I'm not that smart. But, I think that they're going to do well, because they already are. They're big, they have an equity, they have a big brand, they've got global presence, they've got merchandising skills, they've got marketing skills and, lo and behold, they've got tons of cash. They may not get it right the first time, or the second time, but five years from now I think those guys are going to be terrific, so we're dedicating all of our resources to supporting them."

And of course it turns out that those guys are the ones who don't have a lot of e-commerce skills, they don't have the Internet skills, and, frankly, they don't think it's that important. They just want somebody today that for sure can do it. We put our hands up and said, "We're your guys."

We like e-commerce but we like a different part of e-commerce than almost everybody else. And to be fair, there wasn't a place where we could just go as investors and put our $100 million down and say, "I'll have one of those." We went down to the store and there wasn't one in the window. They didn't have what we wanted to buy. We had to go and say, "Hmmm, here's a basic thing, and if we were willing to spend a couple of hundred million dollars and help round up the management team and put these pieces together and get these guys and build that thing and create that, then we'd have something really cool."

But it was only because we felt confident about doing the roll-up-your-sleeves at the value part that it really made sense as an investment opportunity.

Carolyn Koo: That's Submitorder?

Dave Roux: That's Submitorder. Didn't mean to be cryptic about that.

Glenn Hutchins: But it comes out of a kind of point of view about the infrastructure behind the Internet, rather than trying to buy the next hot whatever it is, consumer property, trying to find the next eBay (EBAY Quote - Cramer on EBAY - Stock Picks) or the next Amazon (Amazon Quote - Cramer on Amazon - Stock Picks). "Old and crusty vs. old and crafty. It's oftentimes a very subtle distinction."

Justin Lahart: Do you also find situations where maybe there's a whole technology company, but they have an expertise that is applicable to new technology?

Dave Roux: Sure. Let me give you an example, actually, of one that we're very enthusiastic about. It's an investment we've already announced. It's a company called Xoriant. Xoriant's 10 years old, they're based out in Silicon Valley, they have about 800 or 900 consultants. So it's a professional services firm, IT professionals, and originally they used to install and do client-server ERP systems. I mean, it's hard to imagine something that would be more boring and prosaic than installing accounting systems, or manufacturing systems.

But they were one of the best guys out there, and it turns out, to install a very highly complex SAP manufacturing system or to set up Oracle financial apps, or a People Soft HR system, requires a level of technical sophistication that you just don't see on the Web.

They're mission-critical, they're on big fast servers, highly complex network architecture, multicurrency, multiorganization 'round-the-world stuff.

Well, fast forward 10 years and they've built the business up brick by brick, 10 guys and 30 guys and 50 guys and 100 guys. All that stuff was all about the back end, so if you were Morgan Stanley or if you were a big car company or you made sinks and faucets, then first thing you did was, you get an automated accounting system, you get your manufacturing system and you get your HR system. And that was all about the back office.

Well, the big revolution in application software came four or five years ago when people started talking about the front office, all of the sales force automation, customer relationship management, data warehousing, all the things about customer-facing applications, most of which, because of the timing, were Web based.

Coincidentally, it just happened that all the software that's been built in the last three or four years is all built on top of the Web. Well, if you think about building a sales force automation system and let's say you're Siebel (SEBL Quote - Cramer on SEBL - Stock Picks). Hard to imagine a hotter stock, or one that more of your readers on TheStreet.com would like to have owned or claim they do. You say what's your hot stock from last year and everybody says, "Hey, I own Siebel." If all the people who say they own Siebel actually do, the stock would be 10 times higher than it is today.

It's a great stock, very good technology, wonderful management team, fantastic growth, but guess what? Stuff doesn't install itself. Tom goes out and sells them, guy buys it, loves to have it, says, "OK, now I need to install it." Well, what do you need to do to install that? They've got 20,000 sales guys, they're spread around a bunch of different countries -- you can't call Tom, Dick and Harry's Web consulting firm and say do that, because they'll do the one in Des Moines and they'll do the one in LA and they'll do the one in New York and they'll say, "Now, tell me again, where is Ougadoudou? Do I need a passport to go to Seoul?" They're just not there. That's problem one, they just don't have the scale and the global reach to be able to. Second thing is, if you were running a sales force, you're an executive vice president of sales, where does that sales system plug in?

You have such a piece of software, you write the order, "Mr. Customer, let us know what you like." You write it in, tiggedy, tiggedy. Then boom, the guy says, "Yes, I'd like to order that." We agree on a price, I hit the send button, where does that go?

It goes slamming right into your general ledger system. It goes into an old-fashioned, crusty client server order-entry system that hooks up with your general ledger and your hardware and your financials. And if the order is to buy, say, a computer, people then go to a manufacturing system. And the manufacturing system will chunk out a bunch of stuff. And so Xoriant -- its ability to know both the front end and the back end, which is a long way of saying learning some new skills, but, fundamentally, leveraging a very, very arcane and difficult skill set -- is a great example of a company that was able to get there.

Now, there's a whole bunch of consulting firms that are flat on their ass because they didn't figure out how to do the Web part of it. They only do the ERP things. So they can't install CRM, they don't understand all the Web stuff. The cool thing about these guys is that they recognized it three years ago and invested in the skills, the people, what they needed to be able to do, and they now have those two skills which are highly complimentary, because of, again, the accretive nature of a lot of this technology. It's oftentimes the case that being able to do the thing that came before well helps you in the new thing.

You can think about it in the semiconductor world. If you can do the .5 micron wafer geometry, when it comes time to do .25 you're probably in better shape than the guy who's starting brand new to get to that next generation.

Being great the last generation can position you very nicely for continued success. But you've got to double down in terms of continuing to load new skills and new technologies into your business mix, sort of like the Girl Scouts, making new friends but keeping the old, that's part of it.

When technology companies get into trouble it's because they don't make new friends. They're just good at the old thing and eventually they just drift out to sea, because it's very rare that you need only the old thing. You may need some of the old thing but you need, as we're just describing with the sales force automation thing, some of the new as well and that's the part that's really hard to do.

Glenn Hutchins: That's the trick, and to refine your question, the trick in this end of the business is being able to tell the difference between the old company that has the skill set to make the transition and the one that doesn't.

Dave Roux: Old and crusty vs. old and crafty. It's oftentimes a very subtle distinction.

Glenn Hutchins: And that's when you get back to this issue of buying real estate in your neighborhood. You know the people, you know the teams, you know their products, you've seen them operate over 20 years in the marketplace. You're much better at making that judgment than if you parachute in your three-piece suit and your limousine from Wall Street and try to make a decision.

Dave Roux: A favorite visual image.