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McNamee is the cofounder of private-equity firm Integral Capital Partners and buyout firm Silver Lake Partners, two Silicon Valley outfits that invest in tech of all sizes, from venture-stage saplings to megacaps. The hoi polloi need not call their brokers; McNamee's funds are not available to the masses. (His Flying Other Brothers band is more egalitarian: You can receive free concert tapes via the Taper's Section of the band's
Co-founder of Integral Capital Partners and Silver Lake Partners
The last three years have been about eliminating those activities and, just as important, setting new priorities -- figuring out what mattered going forward. Now, superimposed on top of that was a recession. And that's too bad. 2. What effect did the recession have on the technology industry? The recession changed the culture of IT at large enterprises. For the first time in history, IT people found it good for their careers to spend less than their budget. So for the last two years, you have seen budgets reduced. In 2002, you saw almost every large enterprise spend less than they had budgeted for technology. The result: What is being spent is being spent on maintenance-type activities. There are very few, if any, significant initiatives going on in large enterprises. This contrasts dramatically with the consumer-technology world, where the flow of new products is breathtaking. Frankly, consumer spending has defied prognosticators to the benefit of the technology companies that serve the consumer sector. You've seen new products across such a wide range. Fabulous new videos games, DVD players were huge, products like Apple's ( AAPL) iPod. You've seen new generations of wireless data and even new cell phones. And not all of these are doing equally well. The thing to understand is that innovation in the consumer space is proceeding at a breathtaking pace. We can only describe it as incredibly exciting. And it's likely to last as long as consumers are willing to spend.
The good news, though, is thanks to Moore's Law
the computing power of chips will double roughly every 18 months at no increase in cost and the Internet, lots of these technology products are priced at $50, $100, $200. This makes them, for the consumer, operating expenses, not capital expenditures. Think back 20 years ago to the early days of the PC. If a family wanted to put a PC in the home, it really meant deferring the purchase of a car for a year or two. Now, some people can pay for a DVD player with the cash in their pocket, and everybody can pay for them with their credit card. That's why you saw DVD players become a mass market overnight. So, here you have this problem. You're looking forward to 2003, and you say, Oh my gosh, now what? The enterprise side is the one where most people spend most of their time. And the reason is in the 1990s, that's where the action was. And there are thousands of technology companies serving enterprises. The investment world is organized as though enterprise technology were the be-all and end-all of technology. I'm guessing that 90% of the resources on Wall Street and 90% of the resources in the venture industry are directed at enterprise. Fortunately, something less than 90% of the resources of the industry is directed that way. Consumers account for almost half of total demand for technology. Right now, they may be more than half. At least as long as they stay employed -- and that's the key test on the consumer side of the equation. There are no issues on the product-innovation side there. It's very hard to tell which products will succeed, but it's also very clear that certain categories are going to do really well. Wireless stuff is really obvious. I think there's some incredibly cool things associated with digital photography and digital video, digital music as well. I expect a continuous flow of great stuff and a ready market as long as employment stays in a range similar to where it is today. If unemployment were to rise dramatically over the course of 2003, that would be very bad news. The great part about the consumer side is that technology is no longer this weird externality. It's part of the fabric of everyday life. Products like personal computers are standard in the homes of employed families. Cell phones are pretty much in the same place. DVDs are getting there very quickly. MP3 players are there. The idea of living without new technology is inconceivable to most people of the developed world. As messed up as the industry is right now -- particularly in its distribution channel, the way it brings things to market -- there are no issues about really cool new products. I expect the flow to be continuous in 2003 and beyond. As long as people are employed, they're going to be presented with an endless stream of things to buy, and I expect them to buy at least some of them.
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3. The video-game makers have had a decent run. Do you see consumer demand holding up? I think the video-game industry is going to be surprisingly strong in 2003. Wall Street is of the view that the industry is peaking for this cycle. I think there's at least a reasonable chance that it will take another year or two before it peaks. Those who sell software into that market, companies like Electronic Arts ( ERTS), will have something to look forward to. I don't know for a fact that it will be a great year. I just think there's a reasonable chance that conventional wisdom is wrong on this cycle. If you ask my why, I would say that two of the three vendors of equipment are moving to a PC-like model of compatibility from one generation to the next. Quite frankly, they're not going to be ready to ship new hardware in 2004. I think there's a really good chance that customers will continue to buy really cool software because these platforms are really capable. Plus, the demographics have gotten so broad on video games that I just don't see the market rolling over. 4. You did well in 2002 by sticking to the consumer side of technology. What do you like in the consumer arena and what do you expect going forward? We had a surprisingly good year in 2002 and we couldn't have done it without the consumer. We still own a ton of consumer stuff. We had a bunch of things that you don't consider consumer companies that made a ton of money from selling to companies. Like Symantec ( SYMC) and CheckFree ( CKFR), which turned out to be a great investment in 2002. Expedia ( EXPD) and Hotels.com ( ROOM), those were big stocks relative to the market. You still own all those stocks? I think we own all those things. We still own Take-Two Interactive ( TTWO) -- a lot less than we used to, but we still own it. We don't own EA anymore; it hit our price point. But I'll tell you, we keep looking at it because the stock came down. And EA's a great company, and if I'm right about the cycle being longer, that'll probably be a great stock. What do you make of this notion that EA is the Disney (DIS) of the 21st century? People are always putting names on those things. Why can't they just be EA? This is one of the greatest software companies ever created -- I'm biased because I'm a venture investor there. EA and Intuit ( INTU) are two companies I've been associated with that I'm unbelievably proud of. When I made both investments, people hated consumer stocks. But these companies are living proof that mark what people who work hard can do. Technology is not overnight success. It's about doing it every day for years and years.
5. What are the next big things in technology for 2003? You're going to see some kind of product cycle in cell phones. I'm not sure how meaningful that will be. The industry is so big that it's hard to move the needle. There are so many cool new features available in cell phones; I expect at least some of them to reach critical mass in 2003. As to who will benefit, it's very hard to tell. The semiconductor guys who support that industry will benefit. Within the vendor community, it's really hard to tell. Wireless has two big issues. One is the carriers, who seem to have absolutely no understanding of how people use wireless products. The inability of carriers to integrate data with voice is baffling. Is this just on the U.S. side? It's aggravated on the U.S. side by the completely brain-damaged regulation by the FCC. The absence of meaningful technology standards in wireless voice in North America is holding the industry back. But the regulators are not the sole culprit. The carriers seem to be completely clueless. I'm still waiting for someone to explain to me why I can't buy a cell phone that has an RJ-11 or an RJ-45 jack built into it so I can just plug my cell in
RJ-11 and RJ-45 stand for registered jack generally used for connecting to the Internet . Let me just plug my computer into the thing! I'd definitely upgrade my phone to get that. But remember, these are the same people who for years persisted in the belief that cell phones would only be used by people in cars to speak to other people in cars, so they designed their entire network around that principle, which in retrospect turned out to be flawed. I expect the upgrade cycle to be muted by limitations of wireless network. I expect to be surprised by what actually transpires (laughs). For example, think about wireless data. I'm not one of those people who believe there's going to be a big carrier market for 802.11. To me, 802.11 feels like the Internet. It has to happen organically in a rather anarchical fashion. That's going to take a while. I don't know if you use 802.11, but it's truly amazing. Apple has integrated wireless data really nicely for a couple of years. Now, there are Windows-based computers that do. I've got an Acer Tablet PC with integrated 802.11, which assumed the presence of a wireless network. That actually makes wireless data on Windows very easy to use. The incentive to put one in your office or home is compelling. Merchants such as Starbucks ( SBUX) have found a compelling reason to put them into their locations -- not because they can make money off access, but rather because they can make money selling coffee to people using it. I expect all kinds of fits and starts in that world, and that's OK. The one thing I am absolutely certain of is that things are going to move a lot more slowly this next decade than they did the last decade, and again, to me that's OK. On the wireless side, you're going to see more wireless data. But it's not going to be the year of wireless data, I don't think there's going to be one year. It'll be a decade of wireless data, and we're at the very beginning. I think we'll make some progress this year and I hesitate to predict exactly where it will show up. I expect that using 802.11 in public places will be a lot easier by the end of the year. Will it be easy enough to be a mass market? I doubt it -- in fact, I'll be stunned if it is. But I think if you're really determined and willing to put up with a lot of B.S., it'll be in a lot more places at the end of the year than now.
6. Which companies will benefit in this environment? I think cell phone guys will have more data business in spite of themselves. It's probably going to be a lot easier to do on the Sprint ( FON) network and Nextel ( NXTL) network than it is on anybody else's because they have unified technology across the country. I think guys like Verizon ( VZ) and AT&T ( T) are going to have a really hard time. The billing alone will just bury them. But guess what? They're going to be forced competitively to do something. We're going to learn a lot of hard lessons over the next 12 months. Being a wireless carrier means you'll be faced with opportunities, almost all of which will have danger embedded. The in-effect beneficiaries will be semiconductor vendors -- the Linear Technologies ( LLTC) of the world who sell into that market and sell to everybody. I suspect it will be a better year for a couple of the really big equipment guys, but that's a lot harder to predict. I'm not sure which things are going to be successful. In other words, 2003 will be a really good year to be a consumer in the wireless world, but I don't think it's clear it's going to be that great a year for a vendor. 7. Another consumer-tech company you've held for awhile is Overture. It's among your top 10 holdings, right? What do you like about Overture and what do you make about the concerns over competition from Google? We own a huge position in Overture Services ( OVER) -- it's probably our No. 2 holding after Seagate, which we held privately. We were also venture investors in Overture. When we made that venture investment, everybody was convinced you couldn't make money in portals. Now look: The two most profitable Internet companies are Google and Overture, both portals! (Laughs.) This highlights one of the key rules in investing in technology: Always ask the question, is there anything right now that people believe in religiously? If there is, you ought to go back and ask, is there any way they can be wrong?
Google's a different thing. Google's a great company. If you asked me, what's the one private company I don't have any stock that I wish I had, it's Google. Those guys are great! For a while, I think they were confused and thought Overture was a competitor. The reality is, they do different things. Overture is really optimized for when you want to buy stuff -- it's a directory. Google is a search engine. The Google part of the market is much bigger -- my guess is that 75% to 85% of search-engine opportunities come from Google's side. I'm sure you can make a bigger market opportunity out of searches. I've seen the numbers at Google; they are so impressive. Google is one of the most impressive private companies ever. I have such enormous respect for these guys; what they've done there is just breathtaking. I can't wait for these guys to go public because I'm never going to get the chance to own it privately. Let me tell you, it's not for lack of trying. After email, search is the thing people do most on the Web. And they do two kinds of search: They do searches around words and ideas, and that's what Google does. And they do searches around products, that's what Overture does. Can Google do what Overture does? Yes. Does that make any sense given that Google's opportunity is four times as big? No. They might as well go after their market opportunity. You saw that Yahoo! ( YHOO) bought Inktomi ( INKT), which I was a venture investor in, too. Yahoo didn't buy Inktomi because they thought that was a great opportunity. I think they did it because they're really nervous about Google. And they have a right to be nervous. 8. What is the state of the Internet these days and how will it change in 2003? The way to think about the Web in the consumer space is to recognize that there have been three industries absolutely transformed by the Web: travel, brokerage and books/music/video retail. Those industries are fundamentally different from the way they used to be. The travel industry has been turned on its ear. Travel agents now have to charge a fee. The airlines have completely messed themselves because they didn't understand the Web and they did some dumb things. But there have been a bunch of guys who have done great on the Web. Think about Expedia ( EXPD) and Hotels.com ( EXPD) -- those guys have done some really great stuff, and the consumer is benefiting from a price point of view.
Brokerages are totally transformed. The online brokers have been great for consumers because it turns out that human brokers are part of the problem. So what you're able to do online is offer a higher service level, because people could execute trades 24 hours a day without any human intervention and without a sales pitch at a lower cost. Just as in travel, the guys who do online brokerages are incredibly profitable. We happen to be very focused on one of them, which is Ameritrade ( AMTD). It is the most profitable, the fastest growing and the largest of the online brokers. It's funny, everybody said when the bear market comes, these guys will blow away. Wrong! They've gained market share every month. They did a big merger with Datek. They're going to have to show that they can execute that merger. But if they do, boy, you got a really cool situation. Why did you think people sold these companies short? Because the big guys all tell you it's not real, and you believe them. They said the same thing about discount brokers when Schwab ( SCH) was getting started. People said, when the bear market hits, they're toast. Bear market hit in the 1970s, they gained a boatload of market share. Today, Schwab's one of the most important brokers in the business. Same thing's going on here. It's been very hard for the industry to admit that the so-called full service brokerage is a broken model. How about books and music? Yes, where Amazon's ( AMZN) done its thing. The Amazon thing is subtly different because Amazon's really the only guy in that category. 9. What industries do you expect to be transformed by the Web in the coming years? What's going on in retailing is really cool. Traditional retailers have done a tremendous job on balance, especially the specialty and catalog retailers. The experience of buying from LL Bean or Harry & David is just great. Some of the physical retailers have done well. What Circuit City ( CC) has done, where you can pick up goods ordered online at the store is very cool. You avoid the lines and dealing with those stupid sales guys. That's just really smart.
The simple thing to do is look at the industries were the distribution channel is completely screwed up. Nowhere is this more screwed up than in electronics, PCs. PCs are over-distributed, there's no margin for the channel, no product differentiation. It's a mess. How do you fix that? I'm not sure. And I don't see it happening next year. But that one's poised for change. Guys like Best Buy ( BBY) and Circuit City have a chance to be very innovative if they choose to be. A couple of the vendors, like Apple and Dell ( DELL), are benefiting enormously for very different reasons. Apple because it has its small number of stores, which it uses both to build its brand and to educate the 97% of the market that doesn't use Macintosh. And Dell just because they don't have storage and everyone else does. 10. Any other thoughts on the consumer side of technology? The key is: You're going to see an endless flow of new products. I don't know if you've seen this thing called the Roomba, the robotic vacuum cleaner. That product really got me thinking. I mean, holy moly, I never thought about robots as being a real category. But this is a $200 item that vacuums your house without any human interference. That's a really useful product for $200! Who owns the product? It's a company called
iRobot -- a venture-backed company on the East Coast. It's a little venture-backed company! By the way, these are the same guys who made the robots they used in Afghanistan to go in all the tunnels. They got started doing government stuff and now they're doing consumer stuff. My brother's involved in this thing. I called one of the guys up and I said, "Make me one that cleans my bathroom!" And they're saying, "We're all over it!" Will they be going public anytime soon? I don't know how big they are. But eventually, sure. But the point is, Moore's Law has accelerated this stuff so much. That was the first-generation product, it's not the segue. I mean, it's 200 bucks! The stuff that they can do with this is just breathtaking. Tune in tomorrow for the second half of the interview with Roger McNamee, in which the tech investor discusses the continuing troubles in the enterprise side of technology, why he owns Cisco and Microsoft, why he doesn't own Oracle and SAP, and why he expects the S&P 500 -- not the Nasdaq -- to post a double-digit return for 2003.