The week following the release of Warren Buffett's annual letter to shareholders is a good time to reiterate a basic axiom: Quality management rules.
I hate to sound like a broken record here, but it seems like every day brings new reason to think that great management makes a great business. Not the best product, not the most research, not the biggest head start. In our discussion of sustainable advantage earlier this week, we repeatedly came back to management's vision, marketing skills, and investing/acquisition acumen. Everything depends on management's ability to allocate capital properly. Of course, strong management is not infinitely sustainable, but a strong foundation can support a few interregna.
Which companies at ground zero of the 'New Economy' demonstrated responsible management? Let's look at some examples, positive and negative.
Thumbs down
1) Amazon.com (Nasdaq: AMZN): Amazon's problem was allocation of capital. The company spent like it rains in Borneo. It overbuilt its distribution systems, initiated tough businesses like tools and hardware before it had even plucked the low-hanging fruit of cameras and photography, and took big equity stakes in uncertain partners with considerably worse chances of survival than Amazon itself.
For this last one, it is possible to forgive Amazon, since it was the fashion of the times. But Amazon spent more and harder than most e-commerce companies, driving itself over $2 billion in debt and putting its working capital in peril. The company received a letter from the New York Society of Security Analysts saying that Amazon's management faces "a credibility crisis" over its assertion that cash will not be a problem in the end of 2001. Amazon maintains that it will end the year with more than $900 million in cash.
I won't presume to guess that I can make a better estimate than management can. It may be that it can manage payables enough to have that level of cash at the end of the year. I will just say that we could use more than semantic arguments from Amazon. It talks of pro forma operating profitability as though it were profitability. It's not. It ignores at least Amazon's debt payments, which should be around $25 million. It also passes over non-cash stock compensation, amortization of intangibles, and impairment related expenses -- the graveyard of poor investments. They may be non-cash, but they're costs to shareholders.
2) Yahoo! (Nasdaq: YHOO): Yahoo!'s was a sin of omission. This company had it all. In the wake of the AOL - Time Warner merger, Yahoo! was being wooed by companies like News Corp. (NYSE: NWS), as people talked about Yahoo! the great media company. Its stock had a valuation over $100 billion.
Yahoo! didn't act -- well, it didn't aim high, anyway. In 1999, it did buy GeoCities for $3 billion and Broadcast.com for $5 billion, both all-stock transactions. Evaluating the benefit of those acquisitions is probably a little premature -- though it would be difficult to believe that the price paid was too low -- but Yahoo! didn't take the big step that it could have to, as they say, cover its butt. The opportunity to merge with a company that offered a broader revenue base came, and now it's gone.
Yahoo!'s biggest mistake, in my mind, was that it had the opportunity to buy eBay (Nasdaq: EBAY) and didn't. The reason, reportedly, is that Yahoo!'s management couldn't accommodate eBay CEO Meg Whitman. That's not a good reason, especially since eBay's management has looked a lot better than Yahoo!'s.
Thumbs up
1) eBay: eBay has gotten great mileage out of its marketing and the viral effects that have gone along with it. Its main achievement has been in its acquisition strategy. It refrained from spending when Internet stocks were on everyone's Christmas list. It passed on QXL.com (Nasdaq: QXLC) at $8 billion. Now QXL is valued at about $36 million, well below the $65 million that it has in cash.
In July 2000, eBay snapped up Half.com for about $240 million. It's still early, but Half.com looks like a real winner. It complements eBay's service well and has already become the third-most-visited site on the Web. Together, eBay and Half threaten to surpass Amazon as the largest online seller of books, movies, and videos.
eBay also acquired iBazar, a French auction site that operates in eight European countries, including six where eBay has no current presence. It looks like no great shakes, but the price is right: eBay will pay 2.25 million shares of common stock, at a minimum valuation of $66 million and a maximum valuation of $112 million. I like the price cap of about $50 per share -- on the day the deal was announced, eBay closed at $45.68. That's attention to price.
2) America Online (NYSE: AOL): AOL is guilty of making some, shall we say, pricey acquisitions in the day. It paid $4.2 billion for Netscape, which has arguably not offered an equivalent level of value to the company. It bought MapQuest, a popular service but not a real revenue generator, for over $1 billion. And let's not forget the 1999 acquisitions of such fine names as When.com, Spinner, Nullsoft, AtWeb, and PersonaLogic for 16.4 million shares all told -- around $1 billion back then -- in exchange for a combined $2 million in revenue.
But AOL has exhibited marketing genius in its operating history. It zoomed to the pinnacle of its industry through a blizzard of junk mail with the notion that AOL is the easiest way to get on the Internet -- however dubious that claim.
Let's not forget, too, that AOL pulled off the ultimate coup by leveraging its position into a merger with an enormous, well-established media company, Time Warner. It can certainly be argued that the merger "lowered the ceiling" on AOL's business by saddling it with assets and debt, but these days folks are handing out kudos for "raising the floor" on a business. At least AOL diversified its revenue sources.
The future
Of course, all of this is hindsight. Lots of companies overpaid for "assets" in 1999. Lots of investors did, too. Still, it's worth reviewing which companies stayed objective during the run-up, especially those who were in the thick of it -- the Internet. If you could stay level-headed managing an Internet company in 1999, you can make it anywhere. The future is brighter for eBay and AOL because of their superior management.
Brian Lund still looks for change in the back seats of station wagons whenever he can. At the time of writing, he owed eBay. To view all his holdings, check his profile. The Motley Fool is investors writing for investors.
