In my previous column,
The Care and Feeding of Portfolio Gorillas, I tackled the question of how much stock you should own in a gorilla -- a company that dominates its industry.
Today, let's take a look at a related and I think even more important question: Has the nature of the current market made the stocks of some -- maybe even all -- gorillas less-attractive long-term investments?
As long as an investor just looks at the usual factors that define competition -- and determines which companies will dominate an industry and which will become also-rans -- I think gorillas such as
are as valuable to the long-term investor as any gorilla has ever been.
Examine technology, manufacturing, marketing, leadership -- any of the factors that Geoffrey Moore, Paul Johnson and Tom Kippola look at in their book
The Gorilla Game -- and I think an investor reasonably would decide that these extravagantly valued stocks are actually undervalued in the long run.
But I think it's important to take a look at the way the current stock market has changed the rules of financial competition. For example, soaring stock prices have made it possible to create gorilla-sized companies by acquisition, virtually overnight.
was just one of a number of modestly sized players in the optical-networking arena two years ago. Now, after a wave of acquisitions, the company has gorilla status for many investors.
Established gorillas can go to bed secure that they've conquered all major competitors, only to wake up and find that a deal or a series of deals has created a credible challenger in a matter of hours.
faces exactly that kind of test from
, after that company's acquisition of
. And established gorillas can use these new financial rules of competition to make sure no company can mount a credible challenge. Cisco is probably the master of this among current companies.
All of this suggests to me that investors need to consider how this stock market has changed the rules for gorilla investing -- just as they've been willing to entertain the possibility that it has changed traditional methods of valuing a stock or the meaning of traditional indicators of overvalued and undervalued.
I believe that the ease with which companies can attain gorilla size by using their high stock prices to make acquisition after acquisition should have an effect on how we value gorilla stocks. But I certainly don't think I've got the final word on how or how much.
In this extraordinary market, I believe it is important to note how it is different this time. Hence, three observations:
In the current market, the stocks of gorillas that have mastered the art of acquisition are more valuable than those of gorillas that focus on internal innovation.
Contrast Cisco with Oracle, for example.
On Wednesday, Cisco announced a deal to
, a company that makes systems to deliver television-quality video over the Internet, for about $800 million in stock.
You can see the logic of the deal -- Cisco will give its business customers the ability to deliver real-time video over the Internet. That will give these customers one less reason to look at another vendor for even part of their needs and make it just a little harder for a smaller competitor, with a narrower product line, to win a head-to-head sales competition with Cisco.
Of course, the SightPath deal isn't an isolated incident at Cisco. This is the company's fourth acquisition in March, and it's typical of the way Cisco has used past acquisitions to solidify its position in its market.
For example, on Monday, Cisco announced a second generation of equipment to deliver telephone calls over the Internet to these same corporate customers. Acquisitions, such as the 1998 deals for
provided much of the technology for Cisco's leap into Internet protocol telephony.
Oracle, on the other hand, largely insists on growing its own new technologies and products rather than acquiring them. Its business-to-business software and its customer relationship-management software, to take two examples, is largely the result of internal development.
So while Cisco can look at hundreds of promising research projects at small private and public companies before snapping up the best, Oracle has to make decisions on where to put resources much earlier in the game. And then, rather than co-opting the best potential competitors by buying them, as Cisco does, Oracle has to overwhelm them in the marketplace.
Of the two, I think the Cisco strategy is more likely to extend a gorilla's dominance of its market. And the longer that dominance lasts, the more valuable a gorilla's stock is.
The existence of a number of well-run and aggressive competitors in a market raises the possibility of an acquisition or series of acquisitions that create an actual challenge to the gorilla. This diminishes the value of the gorilla's stock in that market.
Oracle faces exactly this problem. The market for application software built around sophisticated database software is characterized by very aggressive "niche" companies such as
and i2. A combination of several niche companies can create a viable competitor to the market gorilla. After i2's acquisition of Aspect Development, Lou Unkeless, Oracle's vice president of worldwide marketing, told the
The Wall Street Journal
that i2 is now a more important competitor than
And Oracle faces one other potential danger from the nature of its market. All it would take to give one of these newly created combinations the scale to possibly topple the current gorilla would be an acquisition of one of the several faltering, older-generation competitors in the market such as
, Baan or SAP.
Contrast that to the market surrounding JDS Uniphase. That company's acquisition rampage has radically reduced the number of potential combinations. There simply aren't enough independent optical networking-equipment suppliers with decent scale to mount the kind of threat to JDS Uniphase that Oracle faces in its market. To me, that suggests JDS Uniphase is more valuable to the long-term investor searching for gorilla stocks than Oracle is.
It takes more than a gorilla-sized combination made possible by soaring stock prices to create a certified long-term gorilla.
Case in point: the
Lernout & Hauspie
acquisition, announced Tuesday, of
. No doubt, this deal combines the Nos. 1 and 2 independent companies in the consumer speech-recognition market. (Dragon Systems has about 48% of the consumer market and Lernout & Hauspie has about 36%.
is third with about 15%).
And it comes on the heels of Lernout & Hauspie's acquisition of
, a maker of dictation devices used heavily by doctors.
But size isn't everything. Speech-recognition technology is developing so fast that there's a good chance the winning technology is yet to emerge. And we certainly haven't reached the design-in stage so important to creating and maintaining a gorilla.
For a software company, it's only when a company's product is designed into devices in such a pervasive manner that it dominates the market, that the company can reach gorilla status, according to
The Gorilla Game
. We're a long way from that stage in speech recognition.
Does all this mean you shouldn't buy Lernout & Hauspie or any other not-yet certain gorilla, or pass up shares of Oracle or any other gorilla facing potential challenges?
Certainly not. But it does mean you should pay less for companies in these situations than you would for a gorilla such as Cisco. It also means that these stocks require more attention from an investor than those that seem solidly at the top of the heap.
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