The Gorilla Game's Big Losers (March 9, 2001)
By Wynn Quon
The anvil fell on Yahoo! shareholders this week. After the company announced its sales and earnings shortfall, the stock price fell to a new low of $16 (all in U.S. dollars). But this is just the latest in a series of anvils pounding the stock down from last year’s all-time high of $220. Stunned shareholders are staring at a loss of 93%.
By all measures, Yahoo! is a phenomenally successful company, a gorilla in the Internet search engine space. But investors got into trouble following a fatally flawed strategy popularized by The Gorilla Game, a 1997 bestseller that advocated buying shares in giant companies with virtual monopolies. Gorillas benefited from "increasing returns": Because their products were proprietary and the cost of switching to a competitor's wares high, they would only get stronger with time.
The book's advice looks ragged of late. Intel has dropped 57% in less than four months; Cisco, from a high of $82 last March, is down 75%. Investors bought 808 million Cisco shares that month for $58-billion. At yesterday's market price of $22, they are now worth $18-billion. That's $40-billion of shareholder wealth gone up in smoke. If we look at Cisco’s entire market cap, the damage is a mind-blowing $350-billion. The Gorilla Game strategy has two huge holes.
First, it fails to set standards of value. In 1997, when Cisco had a market value of $54-billion, its authors claimed it was undervalued, nowhere discussing what valuation would be fair or, even more important, what would be too high. By early 2000, Cisco's market capitalization was a gut-busting $560-billion. The Gorilla Game failed to recognize that the stock market eventually turns all good ideas (i.e. under-priced stocks) into bad ones. Without some meaningful way of distinguishing between cheap and expensive, the book misled investors into writing blank cheques with disastrous results. In fact, The Gorilla Game was nothing more than a reincarnation of the disastrous Nifty Fifty strategy of the 1970s -- a list of several dozen companies like McDonald's and Polaroid whose market dominance was considered so absolute that they were no-brainer investments, their shares cheap at any cost. In 1972, McDonald's sold at a P/E of 83, Polaroid at a P/E of 90. A few years later, McDonald's P/E had collapsed to 9 and Polaroid’s to 16. The 70s investor were mere pikers compared to their brethren 30 years later. Cisco sold at a P/E over 200 and, even now, has a P/E of 60. Yahoo! had a P/E of 2000 when Internet mania was at its nuttiest.
The Gorilla Game also ignored the Laws of Growth. It advised selling a gorilla stock only when a new disruptive technology threatens the gorilla's franchise. But, to their dismay, investors eventually discovered another time to take profits: before gorillas growth rates have become unsustainable, and investors face the infamous "earnings surprise." The stock price can then fall so fast that investors don't have time to bail out. Take Intel, for example. With $32-billion in sales in the last 12 months, it needed more than $10-billion in new sales to grow at a 30% rate. Gorilla gamers who flocked into Intel's stock were doomed to be disappointed. Last September, when Intel warned of slowing sales, the stock fell 20% in a day. The more successful the gorilla, the faster its market saturates. In the PC market, it was clear at the beginning of this year that the North American market was close to saturation -- over 50% of households owned a computer and no new killer application required users to upgrade. In Cisco’s routerbusiness, annual doubling in Internet usage is over. Cisco must now deal with low double-digit growth (10-15%) that becomes increasingly sensitive to economic factors. Will gorillas ever regain their lustre for investors? Yes, but not soon. A cautionary note for those keen to buy the dip: It took over a decade for the Nifty Fifty to recover from the price collapse of the 1970s.
