Rule Breaker Portfolio

<THE RULE BREAKER PORTFOLIO>

Consolidate to Dominate
Where "the biggest mergers ever" point

By David Gardner

ALEXANDRIA, VA (Sept. 7, 1999) -- So CBS and Viacom are merging, the "largest media merger ever." This comes not long after the "largest banking merger ever" (BankAmerica and NationsBank), the "largest oil merger ever" (Exxon, Mobil), the "largest auto merger ever" (Daimler-Benz with Chrysler), the "largest aerospace merger ever" (McDonnell-Douglas and Boeing), and the "largest telecommunications merger ever" (Bell Atlantic and GTE).

Coming soon, any day now, you have to expect we'll see the largest MERGER merger ever. A merger of ongoing mergers. Should be huge.

Consolidation is all the rage. If I were Jesse Jackson (which would, I think, be fun for a day), I might orate, "Consoli-Date to Domi-Nate."

Or would I?

Are these offensive moves?

I think not. These companies are playing defense. Today's latest and greatest merger marries two very large media companies that have consistently failed to understand, or build anything much useful on, the Internet. It unites older managers (Redstone is 75, Karmazin is 59) who were brilliant back in a day when running a media company involved making use of limited distribution (only a few TV stations, for instance) to broadcast AT people. But any student of media today cannot help but notice that the companies that continue to operate off this model are not the ones creating the most value for shareholders. On the contrary, many are racking up debt (Disney is another good instance) as they work harder to command more and more cable or radio stations when these media are about 5% of the way into a long-term decline.

Why? We're just a few inevitable steps from a world in which most video is put out over the Internet, as the Internet merges with -- really, subsumes -- all other forms of media. Most text (print) will be done and seen online, most radio will be done online, most TV will be done online, most movies will be done online, most communication will occur online, et cetera. The geographical barriers that once justified having a fresh set of network stations in most middle-sized-to-large American cities are no longer present. Thanks to the Internet's reach, geography is increasingly irrelevant, and the barriers are breaking down. In the face of this, The Industry Standard reported, "And one radio trade sheet reports that CBS czar/know-it-all Mel Karmazin may be a worthy recipient of the Luddite of the Month Award: A CBS/Infinity source is quoted as saying Chairman Mel has directed that no CBS/Infinity station netcast. Mel apparently feels Internet broadcasting hurts local ratings. How's that for progressive thinking?"

That much for a media merger, and it looks defensive to me. But the mergers you're seeing in other industries ultimately can be linked back to the Internet, as well. Take banks. How many banks do we need in the increasingly wired world of the United States of America? I'd say maybe 10 -- similar to the number of nationwide fast-food companies we can support. Enough to have competition with some diversity. Beyond that, most people don't want to have 10,000 choices, which is about how many different banks we had in this country a decade ago.

Create the Internet and suddenly many businesses are just a button-click away. If you're running a business in a fragmented industry like banks, this matters. (What do I mean by "fragmented," a new Fool might ask. I mean an industry with many, many competitors who are by and large fulfilling the same function. It's like the fragments of a broken window -- all of which were largely doing the same thing before the window got smashed.) In a fragmented industry, the unprecedented convenience and accessibility created by the Internet can only mean one thing: consolidation. And consolidation is resulting. Banks are buying banks that were themselves buying out other banks, and even these larger banks are merging with each other to create megabanks, which themselves are merging with or buying out other megabanks.

Consolidation occurs because there is little differentiation between fragments, shards of glass. I speak particularly from the consumer standpoint. Exxon and Mobil mean much the same thing to most consumers. These companies could either go to war with each other using incredibly expensive branding campaigns, millions of marketing dollars spent to convince you only to get gas at, say, Mobil... OR, they could eat each other and present a united front. They opted for the latter. Many, many companies across diverse industries are doing just that today, even ones that (like CBS and Viacom) don't have particularly good-looking business models as we enter the new millennium.

Most mergers today are defensive, not offensive. The Internet came along and enabled a total upstart like Amazon.com to compete immediately on the same playing field as established businesses in books, and then music, videos, toys, and electronics. Amazon.com today might be the most competed-against business in America. Why? Because it understood the Internet.

The consolidation we're seeing in the 1990s will continue into the 2000s. (Shall we call them the Zeroes? Or, as they did at the beginning of this century, the Aughts? Nominees, anyone?)

What does this mean for investors? Should we be buying companies in hopes or expectation that they will be bought out? Never. The Motley Fool approach to investing never involves speculation about buyouts or mergers. We're trying to invest in strong companies that can succeed on their own. If they happen to get bought out, we may get some short-term benefit, but for the most part we hope they never will be. The amount of value created by AOL in the past five years would have been seriously compromised (and investors ultimately denied) if AOL had been bought out by AT&T or Disney, or any one of a number of suitors written up in the mid-through-late '90s.

What these mergers mean to the Rule-Breaking investor is this: Tend to look for and invest in companies that FORCE these mergers... companies so revolutionary that they make defensive consolidation ripple through their industry's ranks like Tropical Storm Dennis rippled through the East Coast over Labor Day weekend. We're not hoping for mergers, with our companies. We're hoping that they create them.

The BreakerPort suffered a 2% decline today, losing to the market. The numbers are below.

Fool on!

David Gardner, September 7, 1999






Rule Breaker Portfolio

9/7/99 Closing Numbers
Ticker Company Dly Pr Chg Price
AMGNAMGEN INC-1 1/8$85.25
AMZNAMAZON.COM1/2$62.94
AOLAMERICA ONLINE-3 1/2$93.31
ATHMAT HOME CORP CL A-1 5/8$39.31
CATCATERPILLAR INC-13/16$58.38
CHVCHEVRON CORP-1/2$93.19
DDDU PONT (EI) DE NEMOURS-1 3/8$64.75
DJTTRUMP HOTELS & CASINO RES5/16$5.00
EBAYEBAY INC5/16$133.81
GTGOODYEAR TIRE & RUBBER CO-15/16$56.44
IOMIOMEGA CORP-1/8$3.38
SBUXSTARBUCKS CORP-1/4$23.00
TDFX3DFX INTERACTIVE-5/16$10.44

  Day Week Month Year
To Date
Since
8/5/94
Annualized
Rule Breaker -1.92% -1.92% 1.52% 17.44% 1,080.95% 62.39%
S&P 500 -.50% -.50% 2.28% 9.86% 194.60% 23.64%
S&P 500(DA) -.50% -.50% 2.28% 10.44% 208.86% 24.79%
NASDAQ -.21% -.21% 3.57% 29.40% 293.97% 30.90%

Trade Date # Shares Ticker Cost/Share Price LT % Val Chg
8/5/942200AOL0.917$93.3110,074.74%
9/9/972640AMZN3.188$62.441,858.82%
5/17/951960IOM1.280$3.38163.59%
12/16/98580AMGN42.889$85.2598.77%
4/30/97-1170DJT8.469$5.0040.96%
12/4/98900ATHM28.040$39.3140.20%
2/26/99300EBAY100.527$133.8133.11%
2/23/99300CAT46.964$58.3824.30%
2/23/99180CHV79.169$93.1917.71%
2/23/99290GT48.715$56.4415.85%
2/20/98260DD58.844$64.7510.04%
7/2/98470SBUX27.955$23.00-17.72%
1/8/98425TDFX25.667$10.44-59.34%

Trade Date # Shares Ticker Cost Value LT $ Val Ch
8/5/942200AOL$2,017.62$205,287.50$203,269.90
9/9/972640AMZN$8,415.03$164,835.00$156,420.00
12/16/98580AMGN$24,875.50$49,445.00$24,569.50
12/4/98900ATHM$25,236.13$35,381.25$10,145.13
2/26/99300EBAY$30,158.00$40,143.75$9,985.75
5/17/951960IOM$2,509.63$6,615.00$4,105.37
4/30/97-1170DJT($9,908.16)($5,850.00)$4,058.16
2/23/99300CAT$14,089.25$17,512.50$3,423.25
2/23/99180CHV$14,250.50$16,773.75$2,523.25
2/23/99290GT$14,127.38$16,366.88$2,239.50
2/20/98260DD$15,299.44$16,835.00$1,535.56
7/2/98470SBUX$13,138.63$10,810.00($2,328.63)
1/8/98425TDFX$10,908.63$4,435.94($6,472.69)
  Cash: $11,675.98  
  Total: $590,267.60  



Note
The Fool Portfolio was launched on August 5, 1994, with $50,000. It was renamed the Rule Breaker Portfolio in October 1998. The investing strategy began with the first investments of the Fool Port and has evolved with time and experience. In July 2001, the portfolio began adding $12,500 each quarter (We missed Jan. 2002, so we added $25,000 in April 2002). We skip a quarter if we have enough uninvested cash or cash available in stocks we would prefer to sell to make new investments. All transactions are shared and explained publicly before being made, and returns are compared in each week's column to the S&P 500 (including dividends where noted) and the Nasdaq composite. For a history of all transactions, please click here.