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Wednesday, December 30, 1998

An Investment Opinion
by Louis Corrigan

Buffet Bets Against Internets!

To top off a year full of surprising stories, this reporter has uncovered one that's so scrumptiously unexpected that you won't read about it anywhere else: Warner Buffet is betting against the Internet! Or, at least, he's apparently betting against many of the lesser known names registering triple digit gains of late. "Buffet isn't known for his high-tech investments," said one trader, who insisted on anonymity. "But he's been quietly doing his homework, and he's convinced he's found a veritable smorgasbord of overvaluation."

The Fool has not been able to ascertain the specific stocks deemed particularly unattractive by Buffet. However, the operator of a burger joint in Omaha reportedly saw the famed investor salivating profusely while reading a Barron's article about tulips. Said proprietor confessed that he knew the smell of his burgers wasn't sufficient to unleash such a flood of lubrication. Yet, he had no inkling prior to this that Buffet had a taste for bulbs. (The proprietor may update his menu).

An exhaustive investigation of Omaha's waste disposal sites uncovered a ketchup-stained Barron's with the words uBid, Multiple Zones, and Creative Computers underlined and circled. A Dow Jones search uncovered a less mussed copy of the same article in which Wall Street's pros discussed the Internet "tulips," stocks that have been bid up by speculators convinced they can trade the shares to someone else an hour later for a fat profit. The article concluded with comments from a hedge fund manager who said short-sellers had suffered bad dyspepsia in this sector and were now backing away from the table. Many believe that to bet against these stocks you need a boundless appetite for risk as well as an endless supply of money.

Enter Buffet. While usually considered a plain vanilla buy-and-hold investor, Buffet is actually something of an investment epicurean, frequently sampling more speculative dishes when the risks make sense. As one of the country's leading insurers, Buffet has essentially built his empire not on value, per se, but on calculated gambles. In addition to forays into silver and zero coupon bonds, Buffet has also practiced the art of arbitrage. One Buffet-watcher believes the cherry Coke addict initially shorted uBid and went long on its majority owner Creative Computers to take advantage of the outrageous price disparity between these stocks.

Others, however, say Buffet has been planning this feast for months, long before uBid went public. The conventional wisdom, established in part by Ames Grant of the Grant's Tomb Observer, was that Buffet's Burkshire Holdings acquired insurance outfit General Lee earlier this year in an effort to water down its equity exposure with bonds and thus head off a veritable Gettysburg should the stock market collapse. However, some permabears who haven't gone into complete cold storage hibernation now read Buffet's pursuit of the General as an attempt to expand his asset base to take on the ultimate reinsurance challenge: protecting himself in a bet against the Internets.

The problem all along for those left aghast by the casino mentality invading the markets is the difficulty of borrowing shares and holding them long enough for the stocks to plummet. The risk of forced buy-ins and crippling losses has sobered those who have attempted it. Options contracts have been unappealing as well, since it's impossible to time the collapse of the Internet also-rans within a matter of months. Meanwhile, Internet index options include too many of the legitimate online names. Well-placed sources say Buffet has found a way to dine on the overvalued dishes by creating a new financial instrument called a REAP.

Though details are hard to gather, a REAP is apparently a kind of zero coupon un-bond tied to a basket of the more speculative Internet stocks. A REAP will appreciate if the Internet stocks tumble, or lose value if the stocks continue to soar. Rumors have it that Buffet has convinced his old friends at Salmon to put together a consortium of banks willing to take the other side of this trade. The banks apparently can call the bonds at any time after December 31, 2003. So Buffet appears to be making what amounts to a multibillion dollar loan to this consortium with the prospect of forfeiting up to 100% of his principal five years hence or reaping what some say could prove a 200% annualized return over the same period if the specified Internet stocks collapse. Some believe Buffet's real goal is to leverage this bet into dominance of the entire financial services industry. After all, the consortium of financial institutions on the other side of this trade might be forced to cede control to him if his gamble pans out.

Others think there's something fishy about this story. They say the executives who've signed off on these REAPS either don't understand what they're doing or are desperately trying to shore up their troubled franchises, which are increasingly dependent on Internet stocks. Though little discussed, it's widely believed that online brokers and bankers will continue to eat into profits at many high-fee, low-value financial institutions. Ironically, this situation makes these same firms ever more dependent on investment banking fees related to taking unprofitable Internet companies public or floating debt issues to allow these firms to lose money indefinitely. Says one cynic, "There's never been an industry in greater need of investment bankers."

The Fool found mixed reactions from others interviewed for this story. "The scheme has a brilliant simplicity, but I don't think it will work," said Lewis Fairweather, president of the Short-Term Capital Management hedge fund. "Betting on fundamentals is simply too risky. I respect Buffet's acumen, but he's assuming the markets can become wildly inefficient and we know that's not true." Fairweather said that while the relationship between uBid and Creative Computers didn't make sense from a fundamental perspective, the well-established historical trading relationship between the two stocks represented only a modest opportunity at best. "I'd feel much better about Buffet's position if he hedged this move with a major bet on Russian debt."

Meanwhile, Raef Acampoopoo of Rock Investments poopooed the move. "Buffet must not realize that I've turned bullish again," he said yesterday. Reports leaked out this morning, however, that Acampoopoo apparently is now calling for Dow 2000 in 2000.

I also contacted Shark Haynes, anchor of CNBC's Day Trader's Coffee Klatch, to see if he could confirm the story. "I wouldn't believe it if I read it in an analyst's report." He paused, and then noted that he hadn't yet heard the story from the Wall Street firms that might be hurt by the REAPS. "So maybe it's true." Haynes immediately called a special meeting of the Coffee Klatch producers to evaluate what impact this news might have on the network's most popular show.

The most surprising response came from billionaire Bill Grates. "Warren is trying to ruin me," Grates said. "He's in cahoots with the government. He's in cahoots with Steve Jobs. I can't believe what a back-stabber he is. And all because I have more money than he does. He's obviously jealous and paranoid."

Famed hedge fund manager and media gadabout James Maimer simply fumed when asked to comment on the matter. "Buffet is a fraud. He's stolen my idea. Greenspan and I have been plotting for months to hype the Internets so we could short them at outrageous multiples, and now Buffet blows our plans. That jerk." Maimer said he's already preparing articles calling for an SEC investigation. The pieces will appear in every major magazine whose editor invests in his hedge fund.

When I caught up with the unflappable Abbie Jo Sewing, the hardest working woman at Goldman Slacks, she was riding the bus into Manhattan. Putting aside a hand-knitted sweater featuring the real 1998 operating profits from the companies in the S&P 500, Sewing reiterated that supertanker America was healthy and strong. She added, with a twinkle in her eyes, that Buffet would surely be a great guy to work for.

If the Buffet news proves true, it would represent a major departure for Omaha's richest resident. Earlier this year, he said that as a final exam, business schools should ask students how to value Internet companies and fail anyone who tried to answer the question. Since then, he's apparently recalled the words of his mentor, Ben Graham, who said that in the short-term the market is a voting mechanism but in the long-term a weighing machine. Buffet's latest move then, would seem to represent his vote of confidence in the long-term sanity of the financial markets. Now that he's weighed in, he stands to reap billions in profits if he's correct. And when was he not?

This Fool will stay on this -- if you haven't figured it out by now -- fanciful and fictitious story throughout 1999. For now, though, Happy New Year!

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