Rule Breaker Portfolio
Rule Breaker To Sell Iomega Corp.
December 16, 1999

**This trade is being made under the regular portfolio policy, namely, once the Fool announces an intention to trade, that trade will be made within the next five trading days. For more detail, please read the New Trades section of the Rule Breaker Portfolio.**

At some point in the next five market days, the Rule Breaker Portfolio will SELL 1,960 shares (its total position) of Iomega Corp. (NYSE: IOM).


Transaction Stats: On December 17, 1999, the RB Port sold its final 1,960 shares of Iomega at $3 13/16, plus an $8 trade commission. The port gained over 200% on the trade, about matching the S&P 500 over the same time period.

And Then There Was Light


In the fall of 1994, something revolutionary happened. Investors around the world met in one place online and began to piece together the complete business of one Utah company. The company's new product that they discussed hadn't even been released to the market yet. It hadn't been marketed. It was just rolling out of production.

The company was Iomega (NYSE: IOM) and the product was, of course, its Zip drive, a simple portable data storage solution. The discussions took place on The Motley Fool and all the detailed analysis of the community caught Tom and David Gardner's attention. The Gardners did more research on the company (almost all of it online and in message boards) and in May of 1995, they bought shares in Iomega for the real-money Fool Portfolio (since renamed the Rule Breaker). The shares represented less than 10% of the portfolio's holdings upon purchase.

Within 13 months, the Fool's Iomega investment represented nearly half the portfolio's total value after having risen over 1,500%. The Zip drive became the best-selling computer peripheral device in history (a rank it still holds), with a million being sold every several weeks. Most major PC makers began to offer Zip drives in their "boxes." The possibility for a new data storage standard held strong. But not strong enough.

At its 1997 peak, Iomega earned $1.7 billion in revenue and $0.41 per share in earnings, with a net profit margin of 6.6%. The market value of the company had soared from 1995's $300 million to nearly $7 billion in May of 1996. So, the stock had began its long descent in the summer of 1996, months before its business performance peaked. Profitability levels are rarely high in the cutthroat data storage industry, and new technology is a continuous threat. In Iomega's case, however, management seemed to make the biggest missteps.

For one, in 1998, management launched an expensive ad campaign to boost declining revenues following price cuts that were in part brought on by competition. With profit margins falling to nil and shrinking, the strangely timed ad campaign (Q1) helped push the company into the red for most of 1998 despite the fact that management had thinned production staff (again) and had long before closed a U.S. plant in favor of cheaper labor overseas.

Revenue declined in 1998 and it is on track to decline again in 1999, while a net loss in 1998 stands to forever tell the story of the harsh transition from the company's best year, 1997, to one of its most disappointing. For 1999, the company is expected to show a small profit, but it all hinges on a very good fourth quarter and "good" things haven't been dished up by Iomega lately. The company has burned through two CEOs since 1998, and despite gallant efforts, it has failed to produce another consumer-wide product hit despite its best efforts with Clik. It is difficult to continually reinvent your business, especially when focused on consumer technology products.

Iomega Annual Results (in millions)

Year Sales Net Income Profit Margin 1998 $1,694.4 (54.2) -- 1997 1,740.0 115.4 6.6% 1996 1,212.8 57.3 4.7% 1995 326.2 8.5 2.6% 1994 141.4 (1.9) -- 1993 147.1 (14.6) --
What can Iomega do to regain topline (and thus bottom-line profit) growth? The Zip drive has been marketed past its peak. Iomega needs a new product that could garner at least half the excitement that the Zip did in its prime. There doesn't appear to be such a candidate on the horizon. The Jaz has played out its role perhaps as well as possible, the Clik drive has been disappointing, and the aging Zip is still the main source (nearly 70%) of Iomega's revenue.

You say the Zip is still a key product? You think it could be the next storage solution? Well, with all due respect, we're a little doubtful. CD-ROM, DVDs and other technologies are bound to leave it in a heap in your basement, or else we'll find Zip drives sold for cheap on eBay. But that's not even the impetus for us selling Iomega. Why are we selling? Iomega simply isn't a Rule Breaker, and hasn't been for a long time.

Let's put Iomega through the Rule Breaker paces.

The Rule Breaker Grinder

1) The top dog and first-mover in an important, emerging industry.

Personal, portable high-meg data storage was emerging in 1994 and earlier; the Zip popularized it. It isn't "emerging" anymore, and the Internet (with its networked databases) makes us question how important off-line storage technology will be. Saving items on a network that is accessible from anywhere, anytime, may make disk storage all but antiquated except in unusual cases (such as on an airplane).

2) A sustainable advantage gained through business momentum, patents, visionary leadership, and/or inept competition.

Iomega does have an advantage because the Zip is an option or even comes standard on many PCs. This is a commendable success. Iomega's business momentum has slowed, however. The Zip has aged with arguably few substantial upgrades along the way. As for patents: Iomega had a problem with a new French competitor, so it acquired it. Patents are in good standing. Inept competition? Well, Syquest was one (the name brings a smile now). Competition in the future will be hard to pin down. The company's biggest competitor could eventually prove to be the storage capabilities of the Internet, alongside, of course, all the new multimedia storage technologies (recordable) that are emerging and declining in price.

3) Excellent past share appreciation measured by a relative strength of 90 or higher; 4) Good management and smart backing; 5) The greater the consumer brand, the better; 6) A significant constituent of the financial media is recently on record for calling it overvalued.

Iomega's share price has languished for three years, while senior management has been a patchwork much of the past two years and now again lacks a permanent CEO. Iomega's consumer brand is generally strong among PC consumers, which is a plus that grants Iomega potential if it can develop successful new products in relation to PCs and storage. But it isn't a name that most of us typically revisit every day or even every week, unlike an Amazon or Starbucks. Finally, regarding number six, the financial media has all but forgotten about Iomega, almost to the extent that many Fools have as well. We admit (perhaps to a fault) that we don't get excited about lagging companies. We're Foolish. Our eyes turn to successful ones. Thus, we left Iomega's lounging room long ago, even though we always hoped that it would turn itself around and get up off the couch. Finally now, though, we have returned to ask it to leave. (This is OUR house, after all, not Iomega's!)

Our Foolish Resolve

We sold 50% of the portfolio's Iomega position on April 16, 1997, raising over $18,000 to make new purchases. The primary new purchase made was Amazon.com (Nasdaq: AMZN), bought a few days later. We're selling the rest of our Iomega position now in order to buy something else, a little number called Celera Genomics (NYSE: CRA). As usual, we sell when we believe that we have found something better to buy. We sell what we consider to be our weakest positions first (logically, because we hope that we've found something better!). In this case, the stocks "on the bubble" were Iomega and 3dfx (Nasdaq: TDFX), both small, hurting positions that are almost inconsequential to our portfolio at this point.

As long time Fools know, we don't try to time the stock market. We could be selling Iomega at its 52-week low. Iomega could be profitable to end the year and profitable again next year, as some analysts predict. Analysts have been wrong more often than right with this company, but perhaps they'll be right next year. Whatever happens to Iomega, we wish it luck as we move on. We have found a new Rule Breaker, one we like better, in which to invest.

Where We Leave Iomega


A Rule Breaker term, "Tweened," is best defined in the Fool's 1999 book, Rule Breakers, Rule Makers (available for a song), and in the Rule Breaker FAQ. Iomega Tweened and then commenced to do a Death Rattle. A company essentially Tweens when a viable alternative to its business is offered. At this point, the company either pushes ahead (or redefines itself) to somehow become the dominant industry leader -- a Rule Maker -- or it begins to lose the fight and it goes into a long Death Rattle, the likes of which we've seen with Iomega's stock. (Sometimes a company will just Tween and Tween for prolonged periods.)

Iomega Tweened almost from the beginning in that viable storage technologies have existed since Zip's creation. The company Tweened in another way as it became a seller to computer manufacturers, too, and not just a consumer-oriented business. This move made Iomega a business-to-business seller as much as it was a consumer company, and in the OEM (original equipment manufacturer) realm it faced even more entrenched competitors. Iomega had to rise above the competitors to become the Rule Maker in the data storage industry -- which means that it would need to become the new storage standard. We had hoped for that from the beginning, and it may still happen one day, but it appears less and less likely.

This Tweener has Rattled long and hard. Rising again will be three times as difficult. We'd rather put our money on something that is still Breaking Rules and is more likely to Tween into Rule Maker status than to suffer the ongoing "Tweening into a Death Rattle."

Thanks for the Memories

Most ways you cut it, Iomega was a great investment for The Motley Fool. The first half of our Iomega holding was sold over two years ago for a 700% gain. Our current Iomega position is good for a nearly 200% gain, while the S&P 500 has returned about 155% during the same period (before dividends). Yes, we did lose much of our advantage over the S&P 500 with the second half of the investment. There are many Foolish lessons that can be taken away from this, none of them cut and dry or simply stated. We'll meet to discuss lessons and questions that you have on the RB Strategies board today and over the coming days.

Aside from the investment offering both success and a qualified failure at the same time, and therefore a multitude of lessons, Iomega will go down in the history books as one of the first stocks to undergo consumer research en masse online. Best chronicled in The Motley Fool Investment Guide and You Have More Than You Think, many 1994 and 1995 Iomega investors participated in something that no investor ever had before: global real-time research shared Foolishly in one place by many.

Good luck, Iomega. Fool on!