Jeff Van Harte knows what he's doing.
The
Transamerica stock picker and
Legg Mason's Bill Miller are the only two managers in the country to top the
S&P 500 in each of the past nine years. Few know about Van Harte's accomplishment because he has quietly done it with a fund offered through variable annuities, rather than a more traditional mutual fund.
Jeff Van Harte |  |
| Fund:(TEQUX Quote)Transamerica Premier Equity |
| Managing Fund Since: May 1998. Co-managed with Gary Rolle since Jan. 1, 1999. |
| Assets: $300 million |
| Load/Expenses: None/ 1.3% |
| Top Holdings: EMC(EMC Quote)Charles Schwab(SCH Quote)Palm(PALM Quote) |
| Source: Transamerica. Performance though Oct. 26. Holdings as of Oct. 23. |
He runs more than $5 billion among several funds, including no-load
(TEQUX Quote)Transamerica Premier Equity, a tech-heavy, concentrated growth fund he's run since 1998 that's topped the S&P 500 each year on his watch, and is leading it so far in 2000. And he's hardly a lemming. These days he's a "huge, huge believer" in wireless stocks, even though many managers have soured on the sector.
He's not bullish on one of this year's darling tech industries -- fiber-optical networkers. (And since this interview was conducted before
Nortel Networks' (NT Quote) revenue figures sent the optical sector plunging last week, his stance is looking pretty prescient.) But a big favorite is leading online broker
Charles Schwab(SCH Quote), in which he's made a big personal investment.
McDonald: It looks like the market this month has been going through puberty. Lots of growing pains, and it hasn't been pretty. Van Harte: What a great way to put it. I like it. I can't say things like that.
1. I know, but somebody has to. (Laughs.) Which leads me to the first question: Where are we compared with where we were Jan. 1, and where are we going? Van Harte: Well, you have to remember, Jan. 1, we'd just come off a big fourth-quarter rally. In my opinion, things got way out of control in the first quarter. You had investors and some of the hedge funds, so-called hedge funds, leveraging up to buy overvalued stocks. That was a period of excess. Jan. 1, we were right in the middle of a period of excess. That's why we're flat this year. A lot of stocks got market up at the end of last year. To me, this is just a year of catch-up.
Something like this had to happen. Van Harte: Oh, yes, and it's healthy. There were too many companies becoming public that shouldn't have been public. There were people investing in stocks using leverage that shouldn't have been doing that. They were wasting a lot of capital in that particular period, which is the nature of capitalism. There are periods of excess and overinvestment, and that was one of them.
To answer the other half of the question, are we through this? Van Harte: I think the markets fundamentally right now are much more bullish than most people. I feel that the period of excess is behind us and that the
Fed has also done most of the damage that it intended to do, and I feel there's a good chance that next year, for the first time in a long while, Chairman
Greenspan won't have the opportunity to become rationally exuberant.
You focus on the leaders in many different industries. Now, there's the popular mantra out there, "Buy the winners, buy the winners." That's easier said than done. Van Harte: You cannot just go out and buy something at any price. Everybody knows what's up 500%, everybody knows what's earning high returns on capital, so you're right. It's much easier said than done.
2. What are the criteria you use in picking stocks? Van Harte: We need a very clear vector in terms of future growth. I have to be very confident. For instance, let's take
EMC(EMC Quote), because that has been a winner. I still feel incredibly confident that EMC is going to produce knockout earnings and has huge fundamentals ahead of it, in terms of storage of data.
Also, I would argue essentially a reasonable valuation -- not an undervaluation, but a reasonable valuation. This is a company that does have a lot of earnings and is getting more and more profitable as we speak because the software content and their business. And so it's not trading and 300-400 times forward earnings or 50 times sales, it's I think earnings are $1, I think next year they'll do $1.10, maybe $1.15, so you're looking at 100, maybe 80-90 times earnings, which is still expensive but it is a one of a kind company.
3. Using your criteria, what other sectors are you focusing on, and within those who are the leaders you're intrigued by? Van Harte: Sure. I think I'll use
Palm(PALM Quote) here just to get the contrast on how we evaluate stocks.
Palm is a company right now that doesn't have a lot of earnings and doesn't have clearly identifiable high returns on capital. But it has a lot of the signs of an emerging masterpiece. It has an incredibly dominant market share, and it has revenue streams that we think will develop from their domination of the personal digital assistant (PDA) market. Like controlling the operating system across the board, from which they get very nice, profitable revenue streams, when they license to
Sony (SNE Quote) or
Nokia (NOK Quote).
We think they have a chance to become kind of the
America Online of the wireless Web. So they have a chance to garnish subscription revenues through their Palm.net service. By the way, I'm a subscriber, so I love to invest in companies where I use their products.
We think this is a new emerging technology platform that we're focused on. Mobile computing is going to be a very, very big deal. Palm's still in its controversial stage, like American Online was. Initially, it never looked cheap, did it?
We like wireless quite a bit, we own
Qualcomm(QCOM Quote),
Vodafone(VOD Quote) and a little position at
RF Micro Devices(RFMD Quote). It's a component supplier.
All companies that are working in and around cell phones one way or another. Van Harte: Yep. If I had to pick just one industry that I would invest in for the next five years, it would be wireless. Because I really think these technologies, I mean, they're here. And Qualcomm's about ready to market next year with their 1X Multi-Carrier chip and 1XNC chip, which is going to allow you to use the current spectrum allocated under CDMA to get data speeds of around 150 kilobits a second.
For mobile computing, that's very, very fast. We think all this stuff is going to spread to laptops, cars. It's a much bigger market than what people think. People think of it in terms of cell phones, but it's going to go much further ultimately. And it's here.
This is really interesting, because a lot of managers I've talked to this year have been pulling back from wireless. A few have even said Qualcomm is a great company, maybe a better company this year than it was last year, but the stock isn't going to go anywhere. So, good company, bad stock scenario. Plus, all the telecoms had a very tough 2000. And there's been concerns about slowing handset growth and such. Van Harte: Well, the handset growth is really a function of product cycles.
Motorola (MOT Quote), Nokia and
Ericsson (ERICY Quote) -- they stuffed the channel with a lot of old phones and so that's got to work itself through. And then you'll have the new-generation phones coming, but as soon as these things start hitting higher data speeds and people become more aware of them generally and the Web access and the data they can get on the phone, I think it'll start to move again.
You have to keep in mind, from our perspective, which I think is different from other managers, all this stuff that's going on now is just noise to us. I'm going to have a tough year. I can tell you right now, Qualcomm's going to be an underperforming stock for me this year. It was marked up excessively at the end of last year, in retrospect, we should have sold a little bit but we had a quadruple in the stock within three or four months.
It wasn't our mind-set to flip something out that quick and blow over a big, fat, short-term capital gain to our investors so, we kind of stick with it. So we're going to take that hit this year but we just don't think you should ever take a company like Qualcomm that has the leading intellectual property of the wireless industry and sell it. Because we think its vector is 10 years long.
I'm glad you asked that question, because I think that just that one stock there tells you how we think differently. So, it's not going to help our performance this year, but we're not exactly looking for every stock to outperform every year.
4. On the flip side, where do you see some traps in the market today? Van Harte: I don't like the optical stocks at all. Everybody loves them, and I realize bandwidth cometh, and believe me, I believe it. We're playing it through the cable companies. I'd rather buy cable companies at two-thirds of the private market value than own some of these high-multiple bandwidth stocks at gazillion times forward earnings, where they have to be absolutely perfect to execute and I also think in the optical arena that a lot of these companies have gotten financing from the markets.
I'm talking about a network provider, like a
Global Crossing(GLBX Quote) or a
360networks(TSIX Quote), you know, these guys IPOd and got financing, they're ordering all kinds of equipment to build state of the art networks. But you know what? If you're not able to light your fiber, provide value added services like like
Qwest Communications(Q Quote), which is our favorite in the area, you're out of the game. All you are is just a bandwidth provider. And bandwidth, the cost of bandwidth is going to zero.
So at some point, you should have made your return on all this investment or you gotta stop. And I think what's going to happen -- and we may be a few feet down the road on this -- but I think what's going to happen is some of these guys aren't going to make returns. They're going to have to fold, either get bought up by another competitor or something, and there's going to be a consolidation in the industry and we will probably overinvest in fiber and optical components. And at some point, people are going to figure out this is a growth business, but it can be horrifically cyclical sometimes.
It may go for a year or two, I don't know. I think it's dangerous to invest here. That's all I know.
At these levels? Van Harte: Yes. Because you might play the game for another year, maybe one of your stocks is up another 50% or something. But man, when people find out this stuff is lumpy, cyclical and is subject to the vagaries of market financing -- well, I don't have to tell you how the momentum works on the downside. It works the same way on the downside it does on the upside.
We love the cable, that's one of our fresher areas.
Comcast(CMCSK Quote) is going to finish their network investment at the end of 2001 and we think free cash flow in that company is going to grow from a half billion to $2-$3 billion over the next four years. Huge.
I'm sorry to run on there, but that was one area that I just don't like. The other thing I don't like this year, I don' t like anything that's up: I don't like utilities, I don't like cheap multiple financial stocks, and I don't like oil. Hate it. I don't own any of those areas and I'll never own any of those areas. (Laughs).
Why? Do you think that folks have run into those areas just as that knee-jerk "I need to get defensive" response? Van Harte: Oh, absolutely. None of these people right now -- they're buying the marginal buyer of utility or an oil company at the moment has no idea how the business works or why they really want to own it. They just know it's going down less in a bad market. That's as simple as it gets. That's my opinion.
5. One thing that intrigued me when I looked at the Premier Equity portfolio at the end of September, is that there was 0% health care. And that's an area a lot of people are excited about this year. What kept you out of there and what do you see now? Van Harte: Well, those are good businesses, I think, for the most part in the pharmaceutical side. I don't like the hospital businesses, even though they're up a lot this year, too. I've just never liked that business.
But the pharmaceuticals are good. What's kept me out of it? We do own some pharmaceutical stocks. We own some
Pfizer (PFE Quote) in some of the other funds, I don't -- I haven't had a chance to work it into Premier Equity yet.
Long term, I'm kind of positive on both biotech and pharmaceuticals, but pricewise, I've been looking for a better entry point. Biotech has done well this year and I'm kind of looking for a little better entry point.
Right. Certainly, they're very pricey these days. Van Harte: And quite frankly, I mean, I don't really, it may end up that
Gore may lose the election, but if he does win I think it may, at least psychologically it could be pretty heavy negative for the big pharma for a while. Even though the legislation may end up not having any real bite, it could be a bit of a negative. Again, and the other part of that is, just because I do think that the margin, a lot of people have been buying pharmaceuticals because they go down less in a bad market.
Defensive moves, once again. Van Harte: Yes. I don't have quite the confidence there. As far as Pfizer's concerned, I think is a very good company, they did issue a lot of equity to buy
Warner-Lambert and it may take a little while to work through that, make sure that the cultures are meshing and things are working well. I like Pfizer and I like these businesses, but I guess I'm just looking for better entry point in the bottom line on that one.
One other thing that jumped out to me. There's a lot of talk in the market these days about Old Tech vs. New Tech and the Four Horsemen -- Microsoft(MSFT Quote), Dell(DELL Quote), Intel(INTC Quote) and Cisco(CSCO Quote) -- vs. the likes of Juniper(JNPR Quote). ... Van Harte: JDS Uniphase(JDSU Quote).
Uniphase. Cisco may still be in there, Sun(SUNW Quote) still in there as well. Now, I noticed that Premier Equity owned Dell, Intel and Microsoft into September, and these are some stocks that folks have been -- Van Harte: Very shocked.
6. My question is, what's your take on the Four Horseman as companies and investments? Van Harte: I would say this, just to give you a little historical perspective. When we started our technology positions, we started really going into tech in the early '90s. We owned Intel for a long time, but we really stepped up with Microsoft, Dell and
Applied Materials(AMAT Quote) in the early '90s.
So most of our tech investment was all PC-related. But, of course, that's what happened first, the PC emerged. If you look at our portfolio now and you count wireless as a technology, which I do, it's about two-thirds of the newer-technology -- like storage and communications -- exposure. We own a little bit of
VeriSign(VRSN Quote), which is digital certificates.
It's about two-thirds what I might deem part of new and one-third old. I think about roughly maybe 45% of the portfolio is in technology, about 15% is in the old, what you might say is more PC-related, and 30% is the newer technologies. That said, I don't think you should step out of the Old Technology names. I even hate to really say that because all of those companies, Dell, Applied, Intel, and Microsoft are actually moving pretty quick to bring new products to market.
In the case of Dell, if you look at Dell, they're 50% of their sales now are in laptops, high-end servers and storage devices which is higher margin and faster growth for the company. So they've changed their business quite a bit.
So, you think there might be some unrealized progress moving toward new areas. Van Harte: Yeah, and they're cheap. They're down a lot. They're moving quickly. We think Microsoft is still really good and they've gotten incredibly cheap.
We're much more optimistic on the PC space from these levels than we were in the first quarter. In the first quarter we sold technology across the board. We sold our position in Cisco, and we lightened up all those four names.
Why Cisco, which has been something of a perennial market darling? What soured you there? Van Harte: At the margin, we think things are getting harder for Cisco. Back in first quarter, I think it reached $600 billion in market cap at one point, we started saying, "Hmm, it's a little tough on the valuation."
To continue to grow your market cap at that level, to get a decent rate of return of stock, you're going to have to have double, in five years, which means you have to put another $500 billion in market cap on to become a trillion dollar company. And when you see Cisco at the margin, they have to issue a lot of equity to do acquisitions, to acquire technology and to keep top people.
And that means myself, as a shareholder, I get diluted all the time. That game can go on for only so long, it only gets tougher and tougher to do. We felt like at $500 or $600 billion we'd come out of that one and look for some other companies that we're more positive on, like in the wireless space.
Now, one other area, and it looked to me, correct me if I'm wrong, that you, it looked like you were bullish on was retail. Van Harte: Yeah.
7. There's a pretty big weighting in the fund. What are you seeing there and what are your favorites? Van Harte: We've actually lightened up a little bit there. But in my two favorites, I still have -- let's see,
Safeway(SWY Quote) is at 3.5% and
CVS(CVS Quote) is 5% -- about 8.5% in those two names total.
Here's what I like about retail: For those companies that are winning, the formula that they've figured out is get big, use technology to give you the best information in terms of what's moving on your shelves, and at what gross margin it's moving at, and then turn that back on the manufacturer, when you find winning products to lower your cost of goods sold.
Let's say you're a big retailer with a lot of buying power and you know what's moving on your shelves, as in contrast to 15 years ago when the manufacturers were telling you what price it was going to be and how much you'd get. Now you have much better information and logistics are getting better to manage, too, for all of these companies as they implement supply-chain type technologies. Look at Safeway and CVS. They continually find ways to bring their costs down, as well as grow their sales. And I tend to prefer a little more of the steadier retailing businesses, just because you don't have the fashion cycles or lumpy economic cycles.
That said, we thought that
Gap(GPS Quote) was in a ramp-up of growth and when the stock initially corrected, we bought some. This is maybe a year-plus ago. And you know the rest of the story. As it turned out the fashion cycle on
Old Navy was much more pronounced than we would have ever thought, so that's on area where we made a mistake.
But we still love our CVS and Safeway because the management teams there we think are phenomenal.
Even now, when we talk about cyclicality, obviously retail is in the area where we talk about that in a slowing economy, some not fantastic news for those folks. What's your take on the economy and how it's going to affect these stocks? Van Harte: I don't think it will affect CVS and Safeway too much in the retail sector, but clearly, it's affecting
Wal-Mart(WMT Quote) and
Home Depot(HD Quote) and they said as much.
The economy is slowing. Europe is going to be a problem, because they're much more dependent on oil than we are, the reason the euro is weak is they're just not competitive with us, and when I see the central banks around the world are raising rates, it doesn't exactly make me feel great. To defend your currency by raising rates is going to kill your economy. Fundamentally, you have to get more competitive.
So, I think what would happen is if the economy does slow markedly to a point where the Fed is worried about a recession, that you would see Mr. Greenspan, as I mentioned, become more rationally exuberant. So we are in a soft landing camp, at the moment.
8. Some managers are pointing to businesses like Enron(ENE Quote) and like Williams(WMB Quote), companies that are morphing themselves into New Economy companies in one way or another, either through networking or getting into sort of a B2B bandwidth play. What are some companies out there -- I'll call them butterfly companies -- that are taking advantage of the Internet quietly? Can you name some companies that are taking advantage of the Internet, and maybe what are some companies that are being billed as such that might be more hype than reality?
Van Harte: I'm probably better in the former camp than in the latter. But let's spend a moment on the latter camp. I just never, from day one, really thought that there would be a lot of successful new businesses on the Internet. I'm still not in
Amazon's(AMZN Quote) camp.
You're not alone there. Van Harte: I think that there's a real business there, but I think it might be better off if they just stuck to the original mini. I think they just took on too much, and figured too much stuff would port to the Internet.
Look, you can sell all you want on the Internet, but at the end of the day you have to sell it profitably, so the balance sheet gets better, not worse. (Laughs.) Otherwise, you run out of time. I think books works, tapes, some of the original stuff works. My sense would be at some point the company is going to have to significantly curtail back the number of tabs they have on the Web site. So, what's it worth then? I don't know. I'd have to look at it then.
But as far as the other businesses that I think people have underrated in terms of how well they've used the Web, certainly an example that I would point out is Charles Schwab, which is our second-largest holding. Eighty-two percent of their trades now are done online. When they started this whole thing two years ago, when they cut prices they were around $71 or $72 average price per trade, and they're now at $36 and change over the last quarter. And had you known that one single point of fact you might have been very bearish on the business.
But the fact is, their operating margins actually went up during this period. A key in technology -- or for that matter in nontechnology business that's using technology -- is you must give your customer a better product next year at a better price, whether it's retail, online financial services or technology, that's the formula that works. And Schwab is just an incredible example of serving their customers better using the Web. Bringing the cost of the product down, but obviously scaled up, and were able to do it incredibly profitably. I mean that's the model.
Is there anybody else out there that might be more obscure or maybe that folks haven't picked up on yet? Van Harte: Well, let's see. I think one to keep an eye on is
First Data(FDC Quote). It's actually my fourth-largest holding. In First Data's last quarter, they announced a company that is called
E1 Global, which is going to take a lot of their alternative means of payment and put it into a subsidiary that they're going to incubate for a while, which they'll own 75% of.
What do you do today when you use the Internet and you buy stuff? You use a credit card. I mean, they're right in the middle of the whole shift from cash and checks to electronic payments. I think the company is very underrated, and underappreciated. But they're earn $2.50 next year and the stock is, last time I checked, around $46. And a billion dollars free cash flow, which they're using a good chunk of that to buy in shares. I love that.
9. If you had to pick three stocks to own for five years, what three would you single out and why? Van Harte: I hate to say this, but my top three holdings I think are the best. I think EMC, Schwab and Palm are just wonderful franchises that you can feel good about for a long time. Palm is the most risky, because we're still in early stage development in handheld devices, but the opportunity is just too big not to play.
I am huge, huge believer in mobile data. I think Palm could be one of the most powerful companies in the world five years from now. And as much as EMC has been recognized by the market, it's around $200 billion in market cap. They are benefiting from all the investments that are going into bandwidth and they're just isn't anybody else that can do high end storage. It's very, very hard to do. And they're going to spend over the next two years, investing $2.5 billion in these new technologies that already have the leading platforms for high-end storage. And storage bits are doubling every year, so I think they're just a huge rider on the bandwidth trend.
Schwab to me is just -- they've won. The war is over, they're, it's just a matter of collecting all their tolls as the world and the demand for saving and financial services grows especially among the high net worth individuals.
Helped, of course, by the U.S. Trust deal. Van Harte: Oh, I think it's masterful. I think it was a fantastic acquisition by Charles Schwab. So those three stocks I love and, and a closer runner-up would be Qualcomm, just because we're a huge believer in wireless.
10. Last question. What is the most recent addition to your fund -- Van Harte: Comcast.
-- And also, to your personal portfolio? Van Harte: (Laughs.) I can't even buy stocks in my personal portfolio any more because it of conflicts that we have. That said, actually I do have an answer there. I had one day last year to buy Charles Schwab.
Where you weren't in it so you could actually ... Van Harte: I had one day in the entire 250 trading days, there was one day and I bought it. I put 5% of my liquid net worth in it, so ...
You're a believer. Van Harte: Oh, yeah. That was the last time I got to transact. Otherwise, I have, you know, about 20% of my entire net worth in the Premier Equity fund and then I'd say roughly 50%-60% of my entire net worth is in various Transamerica funds with 401(k) or variable annuities or stocks that we own.
Do you want to tell us a little bit about Comcast? Van Harte: Oh, Comcast was the most recent purchase. Again, we really think that the market for consumer bandwidth to the home is in its infant stages here. The cable companies have been kind of out of favor with the market for a while. While we were accumulating our position in Comcast it's about $60 private market value and it was in the low- to mid-$30s. We just felt that it was an excellent entry price, with more and more awareness in terms of what you can do with cable modems or DSL modems. We think it's time to own these stocks again, so we bought Comcast.
The other thing we liked about it is that they have about $8 or $9 billion in debt on their balance sheet, but they have about $10 billion of cash investments, so you effectively the company is debt-free.
You don't really have any balance sheet risk in their capital cycle -- the majority will be done by the end of next year. I've always loved to invest in companies that are coming out of their capital cycles as opposed to going in, because there's always more chance of risk, earnings or not getting a real immediate payback on large capital investments.
In a recent visit with Comcast, they actually put up a pro forma of a fully built out system in Baltimore and demonstrated how their new high bandwidth connections are starting to ramp and the cash flow from a couple years ago. It acts as a model for the whole company. We see just exploding free cash flow, three-four years as they upgrade people to digital TV and cable modem service.
At some point the market is, going to notice these companies again as real growth companies.
