Four years ago, a VC friend of mine was invited to a get together with a prominent Hedge Fund Manager from the Midwest. The meeting was an arrangement between fellow Harvard Grads. The Fund Manager was looking to make investments in the valley, to diversify away from his heavily weighted financial positions. Though, not recognized at the time, the Manager had a few months to rearrange his portfolio away from the coming collapse and into “growth” engines that would excite his Limited Partners. The discussions boiled down to Social Media, “Green” and traditional valley firms. The Manager chose “Green” because of the balance between valuation, growth prospects and requirement for significant capital. The story continues….
Moore’s Law is relentless and unforgiving, even when it comes to “Green.” In good times it can provide great returns, but only for short periods. In bad times, it seems the losses are never ending and you beg to be cut loose from the toxic waste. The Austrian economist Joseph Schumpeter was the first to describe the process of Creative Destruction that well summarizes what Moore’s Law does to an economy that tries to stand still. He wrote the book in 1942.
For the last four years, the valley has operated under a dual economy. Social Media has roared ahead on the backs of cheaper computers, servers, storage and networking. Apple likewise has built a new platform that leverages low cost hardware to create the multitude of synched devices that households find necessary and irresistible. This morning I did a check on the performance of leading semiconductor firms from May 2008 to today. Of the list of firms (Analog Devices, Texas Instruments, Xilinx, Altera, Broadcom, Qualcomm, Marvell, Nvidia, Micron, and Linear Tech) only Altera, Xilinx and Qualcomm are up by more than 15%. I looked at a second group that supports the Mobile Tsunami marketplace (ARM, Cirrus, Cypress, Sandisk, Atmel). They are all up big except Sandisk who was up big until two months ago. Such is the travails of FREE memory.
The Hedge Fund Manager, who moved part of his investments out of the financials and into the Solar Field went from bad to worse (would have been much better throwing a dart at a list of S&P500 companies). If our Manager would have bought from the traditional basket of semiconductor companies, he would have been fine. But better yet, our Manager could have outperformed all of his peers if he would have just invested in the Mobile Tsunami basket of stocks (AAPL, ARMH, QCOM, CY, CRUS, ATML) and gone away for four years. The performance would be so top notch he would probably make the cover of reputable magazines.
The semiconductor industry is no longer seen as glamorous, and has the feel of the automobile market pounding away metal day after day. The lack of attention shows in their compressed P/Es. A turn though is in the offing as we in our field have been trained to expect.
Hedge Fund Managers don’t last if they can’t adapt to a changing environment. The last time the country encountered an “End of the World” Scenario like the 2008-2009 financial crises was at the beginning of WWII. Franklin Roosevelt had shepherded the country through a partial recovery from the Great Depression when we were attacked at Pearl Harbor (unemployment was 9.9%). His greatest triumph, winning WWII, was made possible by his willingness to make concessions to big business that enabled the war machine to ramp beyond what was considered possible. It led to the outfitting of not only the 12M man American Army, but to that of Britain and to a degree – Russia. It was an "All In" strategy against two well armed enemies that were on the verge of winning the war.
Our Hedge Fund Manager, the President, could have from the first day in office taken steps to reduce risk across the board. The financial crises dramatically increased the cost of capital. In addition to the $1T stimulus, he could have implemented tax and regulatory relief that would have led to greater employment in the valley and the US over all. The cost would have been minimal especially in light of the alternative scenario that has developed. The articles about Apple, Google and the rest of the companies in the Silicon Valley off shoring their revenue to avoid taxes is a very big deal because they are tied into well paying operations jobs (think manufacturing, test and shipping) that follow with them. A consumption tax, as one alternative to the corporate tax, would have created economic growth and jobs stateside. Imagine the upside we would be enjoying if our World Class, Export Oriented Semiconductor Industry were going Great Guns!
With negative returns and a flight of capital from Limited Partners, the Hedge Fund Manager has no choice but to take on greater risks for the balance of the year. Let us hope that we get to work off a Pro Growth Playbook starting next year.
Full Disclosure: I am Long AAPL, INTC, QCOM, ALTR