2000 01 02 Bubble

© Oaktree Capital Management, L.P. All Rights ReservedMemo to: Oaktree Clients From: Howard Marks Re: bubble.com The book "Devil Take the Hindmost" by Edward Chancellor does an excellent job of chronicling the history of fina ncial speculation. In doing so, it recounts the story of "the South Sea Bubble" and provides a backdrop ag ainst which I'd like to examine some of the events of today. The South Sea Company was formed in 1711 to help deleverage the British government by assuming some of the government's debt and paying it off with the proceeds of a stock offering. In exchange for performi ng this service for the Crown, the company received a monopoly for trading with the Sp anish colonies in South America and the exclusive right to sell slaves there. Dema nd for the company's stock was strong due to the expectation of great profits from these endeavors, although none ever materialized. In 1720, a speculative mania took f light and the stock soared. Sir Isaac Newton, who was the Master of th e Mint at the time, joined many other wealthy Englishmen in investing in the stock. It rose from £128 in January of l720 to £1,050 in June. Early in this rise, however, Newton realized the speculative nature of the boom and sold his £7,000 worth of stock. When asked about the direction of the market, he is reported to have replied “I can calculate the motions of the heavenly bodies, but not the madness of the people.” By September 1720, the bubble was punctured a nd the stock price fell below £200, off 80% from its high three months earlier. It turned out, however, that despite having seen through the bubble earlier, Sir Isaac, like so many investors over the years, couldn't stand the pressure of seeing those around him make vast pr ofits. He bought back the stock at its high and ended up losing £20,000. Not even one of the world's smartest men was immune to this ta ngible lesson in gravity! * * * It's obvious from “Devil Take the Hindmo st” that many elements of speculative behavior were present during the South Sea B ubble. I'll cite some of its passages below and point out the parallels to today that I see: “The ideology of self-interest had recovere d after the battering it received after the crisis of the mid-1690s ... its thesis [was] that private vices - avarice, prodigality, pride and luxury - produced public benef its.” [Sounds like the "greed is good" rationalization of the 1980s.] © Oaktree Capital Management, L.P. All Rights ReservedThe success of South Sea spawned talk of any number of speculative schemes, some of which was probably apocryphal. “The most famous of the legendary bubble companies was that ‘for carrying on an undertaking of great advantage but no one to know what it is.’” [I can't unde rstand what it does, but that's okay; just tell me the name, II. or maybe the symbol's enough.] Despite their lack of profits, companies li ke South Sea were able to finance their operations by issuing stock at higher and higher prices. “T he circularity inherent in the scheme made a rational calculation of the shares' fair value difficult to compute. Some argued that the higher the shares rose , the more they were actually worth .... ‘Was there ever such a delusion from th e beginning of the world ... according to this Way of Computing, no Person can Purcha se at too high a Ra te, since his Profit will increase in Proportion to the Price he gives.’” [There's no such thing as too high a price if the concept is right, and the ability to issue stock at rising prices will lead to profitability.] "Adam Anderson, a former cashier of the South Sea Company, later claimed that many purchasers of shares ... bought knowing that their long-term prospects were hopeless, since they aimed to get 'rid of th em in the crowded alley to others more credulous than themselves.'" [The great er fool theory is nothing new.] “As Edward Ward observed in hi s poem ‘A South Sea Ballad’: Few Men who follow Reason's Rules, Grow fat with South-Sea Diet, Young Rattles and unthinking Fools Are those that flourish by it.” [The profits went to those unrestr ained by reason or experience.] Robert Digby wrote “The South Sea Co mpany is continually a source of wonderment. The sole topic of conversati on in England revolv es around the shares of the Company, which have produced vast fortunes for many people in such a short space of time. Moreover it is to be note d that trade has completely slowed down, that more than one hundred ships moored along the river Thames are for sale, and that the owners of capital pr efer to speculate on shares th an to work at their normal business.” [The name of the company was on everyone's lips, the fortunes it created were front-page news, and the average Joe was willing to give up his day job to participate ... sound familiar?] * * * I will devote the rest of this memo to what certainly seems to me to be another market bubble. Before doing so, however, I must point out a few things: First, as usual, little that I will write will be orig inal; instead, I hope to add value by pulling together ideas from a number of sources. Second, a single word suffices to describe my recent caution regarding the stock market: wrong. Neverthe less, I'll admit my negative bias and © Oaktree Capital Management, L.P. All Rights Reservedthe fact that I have found the bears convincing and the bulls Pollyanna, and then move on to discuss the effect on the market of technology as we move into a new millennium. In short, I find the evidence of an overheated, speculative market in technology, Internet and telecommunications stocks overwhelming, as are the similarities to past manias.  Changing the world -- Of course, the entire furor over technology, e-commerce and telecom stocks stems from the companie s' potential to change the world. I have absolutely no doubt that these movements are revolutionizing life as we know it, or that they will leave the world almost unrecognizable from what it was only a few years ago. The challenge lies in figu ring out who the winners will be, and what a piece of them is really worth today. The graph at the left shows the stock price performance of the leading company in an industry that was thought capable of changing the world. For that reason, the stock followed the explosive price pattern that has become typical for technological innovators. The predictions were correct: the industry did change the world, and the company was its big winner. The industry was radio. In the 1920s it was expected to change the world, and it did. Its ability to communicate without wires created entertainment in the home, electronic advertising and the live delivery of events. The company was RCA, and as the industry leader its stock rose from $8 in mid-1927 to $114 in mid-1929. While part of the stock's appreciation was due to the market boom in which it shared, certainly part was also due to an overvaluation of its potential. Af ter the onset of the Great Crash, RCA's stock fell from that hi gh of $114 to $2½ within three years. The Depression can be blamed for some of this decimation, but it is worth noting that even 25 years after the 1929 peak, when the Depression and World War II were well over and the post-war recovery was underway, RCA's stock had yet to get back to a third of its earlier high. The times, the industries and the companies are certainly different today, but it makes one wonder whether investor s aren't again overpaying for the ability to change the world. Similarly, a recent article in Fortune re ported Warren Buffet's observation that airplanes and automobiles had been expect ed to change the world and did ... and almost all of the manufacturers of both are now gone. Few things have had the impact on the world that aviation di d, but from its founding through 1992, the cumulative profit of the ai rline industry was zero! © Oaktree Capital Management, L.P. All Rights ReservedAs usual, Buffet puts it as succinctly as anyone could: “The key to investing is not assessing how much an industry is going to affect society, or how much it will grow, but rather determining the compet itive advantage of any given company and, above all, the durability of that advantage. The products or services that have wide, sustainable moats around them are the one s that deliver rewards to investors.” (Emphasis added) (Three years ago, everyone wanted to be Warren Buffet, or at least read books about him. Now, appearing to have missed out on the technology movement, he and his investment approach are dismissed as passe by the dot-com gang.)  Altered lives -- During the South Sea bubble, as described above, boats were put up for sale and people with capital shifted from being workers to being investors. In a striking parallel, the Internet -commerce revolution is also changing lives. Of course, we know that thousands of Americans have become on-line traders either full- or part-time. Articles describe people who are trying to "ride the trend" of hot stocks and benefit from their momentum, but there' s little indication that they have any idea what makes companies do well or stocks go up (or even what some of their companies do). The Wall Street Journal of December 7 cited an individual who has spent his full time in the prior five mont hs trading the stock of one company, CMGI, which invests in Internet ventures ; he doesn't know the CEO's name. Also striking is the effect this is ha ving on business education and young careers. A front-page article in the New York Times of November 28 reported that applications at many business schools were flat or dow n, the number of Americans taking the GMAT exam was down sharply, and not-insignificant numbers of MBA students were dropping out after the firs t year to join the hot fi elds. As a professor of entrepreneurship told me, all of the e-commerce claims will be staked out in the next year or two; students can't risk staying in school and s eeing someone else act on their ideas. Five years ago, the hot area for ne w MBAs was investment banking. Now, I hear, investment banks can't get the top students to sign up for interviews and are having trouble meeting their recruiting goals. The pressure to move toward the high -change areas is great, and people are succumbing. Everyone in the investment profession knows (or knows of) somebody who has made hundreds of millions (or a billio n) this year on a dot-com investment. One can imagine that this makes the buyout specialists who built fortunes over a lifetime feel like underachievers. Privat e equity firms are getting involved in companies at earlier stages, and with the dot-coms. On November 30, a Wall Street Journal article about defections of buyout sp ecialists to venture capital firms cited a KKR partner who had resigned to do just that. Venture capitalists and technologi sts, in turn, are moving to Internet firms. As a sign that it's even becoming hard for more ma ture technology firms to hold onto people, the CFO of Microsoft recen tly quit to join a fiber-optic company. Remember, Microsoft has already been public 17 years; the gold-rush is over at the established firms, and the overnight fortunes have been made. Even investment bankers are in transit; on December 14, a New York Times article on the subject was headlined “Wall St. Is Flush With Cash But Also Green With Envy.” A Harvard Business © Oaktree Capital Management, L.P. All Rights ReservedSchool professor aptly mixes his metaphors, likening the rush of executives to Internet-related ventures to “a tsunami of people chasing a pot of gold.”  The lure of venture capital - I recently presented the case for distressed debt to three classes in entrepreneurial finance at the University of Chicago Gra duate Business School. The response of half the students was simple: Why settle for 20-25% per year when you can make 100% in venture capital? Just as venture capital is attr acting young businesspeople, it is also turning heads in the investment community. One university treasurer told me his school's $29,000 investment in Yahoo! via a venture fund gr ew to $54 million (and would be more than twice that today if it hadn't been so ld). Why do anything else, indeed?! Before we succumb to this reasoning, howev er, (and run out to start the OCM Venture Capital Fund), we should first review th e data concerning venture capital's brief history.  For funds raised between 1984 and 1989, the median return to Limited Partners ranged from 7.5% to 15.1%. For funds raised between 1990 and 1994, it ranged from 20.4% to 29.7%. These are healthy returns, but certainly the typi cal v.c. investor enjoyed no bonanza in that peri od. A quarter or more of the funds raised in almost every year provided returns ranging dow nward from 10% to negative territory.  It's only for funds started in the mid-to-lat e 1990s that the returns have been so eye- popping. For each vintage year beginning in 1994, there has been at least one fund with a return above 200%/year. And yet, th e median returns thus far for vintage years between 1994 and 1999 range only from zero to 33.7% (although it can be argued that it's still early).  While it's hard to settle on a "typical" vi ntage year for venture capital, 1994 is a reasonable candidate. Its funds are five year s old, so there has been time to bring companies to fruition and to market. And certainly, the environment has been positive. In fact, 1994's top fund has return ed 235%/year so far, and the average fund has returned 45%/year, an impressive figure. But averages can be deceiving, and this one has certa inly been pulled up by the best performers. The median fund is up only 22.5%/year. Half the funds have a nnual returns below that (by definition), and the returns in the bottom quartile range from 6.4% to minus 13.2%.  The recent years all show similar pattern s (although it's too early for meaningful results to be in): phenomenal for the bi g winners, good on average, but certainly not universally successful yet. © Oaktree Capital Management, L.P. All Rights ReservedHaving reviewed the historic data, what can we say about the future? Certainly, the venture capital funds are "where it's at": the toll bridge through which world-changing companies are likely to pass. Does that mean they're a good investment today? I feel strongly that no investment opportunity is so good that it can't be screwed up by the wrong relationship between supply a nd demand. Too much money for too few ideas can mean ruinous terms and purchase pr ices that are too high. To my mind, the immediate outlook for venture capita l is called into question by: - the ardor that has been ignited by recent “headline” returns, - thus the huge amount of money looking for a home in ventures, - the expanded amounts that v.c. firms are accepting in their new funds, - the strengthened negotiating position of entr epreneurs relative to venture capitalists, - thus the need among v.c. firms to comp ete in haste to make investments, - the ease with which junior members can l eave v.c. firms to st art their own funds, - the strengthened negotiating position of venture capitalists relative to their investors, and - thus the ability of v.c. firms to ra ise their incentive fee percentage. In my experience, the big, low-risk prof its have usually come from investments made at those times when recent results have been poor, capital is scarce, investors are reticent and everyone says “n o way!” Today, great results in venture capital are in the headlines, money is everywhere, investors are emboldened and the mantra is “of course!” In this context, it's very much worth no ting that in 1994, someone looking at venture funds formed from 1981 to 1992 would have s een only one vintage year with an average net return above 12%, and nine out of twelve years with single dig it average returns. Despite the lukewarm results as of that date, a few forward-looking investors were willing to commit $7.8 billion to venture capital funds, and it is they who are earning the returns we see. In 1998, on the other hand, th e 200%+ results on the top funds formed in recent years egged investors on to commit more than three times that amount: $26.1 billion. Today one hears only that investors want to put more into venture capital but can't get access to the most desirable funds. I' ll leave it to you to deduce the implications for future returns.  The role of the IPO : A “mania-within-a-mania” has taken flight in the high-tech investment world, and it surro unds Initial Public Offerings. In years past, new issues had to be priced to sell, and companies accessing the public equity market for the first time had to hope they could get invest ors to pay a fair price. Now, investors are sure that buying stock on a new issue - at the price the founders are willing to sell at - is the ticket to easy money. And to date it has been. It is reported that the average new issue of 1999, which on average is probably about six months old, is selling roughly 160% above its issue price (for four times the average gain in the next-best year). For an example, Th e Wall Street Journal of December 8 described the case of Akamai, which went public on Octobe r 29 at a price of $26. It closed that day at $145, for an equity market value of $13 billion. “Fourteen months earlier, ... it could never have gotten such a reception,” The Journa l added. “It didn't exist.” Akamai's price © Oaktree Capital Management, L.P. All Rights Reservedis $328 today, bringing its market capitalization to $29 billion. (By the way, in the first nine months of 1999, Akamai lost $28 million on $1.3 million of sales.) The ability to participate in IPOs has beco me a major perk. Investment banks compete with other money managers by promising wealth y individuals allocations in their IPOs. Technology companies allocate IPO shares to their customers as a way to cement business relationships. As usual, I don't think investors are thinking this through. The Akamai IPO was priced at 18% of the first day's closing price. So either (a) the founding entrepreneurs and investors sold it 82% below its fair price (and who would know better than they would?) or (b) the market's wrong. It may well be that issuers intenti onally underprice their offerings so that the first day's rise will create the "buzz" that will enable (1) the companies to finance their losses and their expansion through addi tional stock issuance and (2) the founders to sell their remaining shares. I'm sure some of that is at work here, but how much? If the closing price of $145 was "right," Akam ai left almost $1 billion on the table in the IPO by selling eight million shares at $26. Further, how much due diligence is being done on each new issue? How experienced are the people doing it? How strict are the valua tion parameters they're using? How will the post-deal prices hold up when the lock-up periods end and the founding entrepreneurs and venture capitalists start sell ing the 80-90% of the stock that they still own? And what will happen when the options used to attract employees - and to pay service providers - begin to be exercised and the shares sold? What price will supply/demand dictate when the supply of stock increases five or ten times? Today, it seems companies are formed and start-up financing is raised not through discussions of the companies' profit potential , but with reference to the possible timing and pricing of an IPO. The recent book "The New, New Thing" by Michael Lewis, about the career of venture capitalist Jim Clark (S ilicon Graphics, Netscape, Healtheon), makes it clear that in many cases, today's entrepre neur isn't thinking id ea/startup/company as might have been the case in the past; rather, it 's idea/startup/IPO. Cashing in used to be the result of successful company-building. Now it' s often the end in itself. It's the IPO that's “the thing.”  How will the companies make money? -- Many of the new firms have great ideas for making money, but it's appropriate to wonder whether they'll work, how the competition in each “space” (that's the dot-com term for a business niche) will develop, whether profits will materialize, and wh ether they'll be sufficient to justify today's stock prices. I don't think anyone would disagr ee that it's one thing to i nnovate and change the world and another thing entirely to make money. Business will be different in the future, meaning that not all of the old rules will hold. On the other hand, profits come from taking in more in revenue than you payout in expense, and I don't think that's going to change. I'll highlight below just three of the areas in which I have questions about profitability. © Oaktree Capital Management, L.P. All Rights ReservedFirst, will the Internet an d dot-com companies be able to charge enough for their products to make money? Fr ont page articles in The Ne w York Times (October 14) and The Wall Street Journal (July 28) discussed the fact that many of the Internet's offerings are free. Decades ago, merchants discovered that they could sell more if they cut prices. The Internet firms have taken that one st ep further: they can move even more merchandise if they give it away. As the CEO of Egreetings Network says, “Charging for [greeting] cards was a small idea. Giving them away is a really big idea.” Says a venture capitalist, “.... it's a f act of life on the Internet: Peopl e expect a lot of things for free. And if you don't give it away, some other start-up will.” Internet firms are giving away faxes, long- distance phone calls, music, web browsers and even Internet service itself. "The margin al cost of adding another user is practically zero," says one venture capitalist. The trouble as I see it is that the marginal revenue is exactly zero. Obviously, these firms are givi ng their services away in order to build traffic, tie up market share early and/or sell advertising space. It's far from clear that profits will follow. As I read the articles mentioned above I wa s reminded of a great series of jokes my father told when I was young: “I lose money on everything I sell.” “Then how do you stay in business?” “I make it up on volume.” “I lose money on everything I sell.” “Then how do you stay in business?” “I'm closed Sundays.” “I sell everything at cost.” “Then how do you stay in business?” “I buy below cost.” The riddle of profitability is very much present in this area. I'm sure some firms will solve it - but far from all of them. Second, how practical are the business models of the dot-com firms? It seems like ancient history, but I seem to remember that doing business in cyberspace was going to eliminate the need for conventi onal advertising, and “virtual inventories” were expected to replace brick-and-mortar warehouses filled with merchandise. Now we read about the huge sums Amazon.com is spending on warehouses , and media advertising is sold out at high prices because the Internet firms are bi dding for it so aggressively. EToys will do business without stores and w ill just own warehouses, but what is a Toys 'R' Us store other than a warehouse with the front pretti ed up? Webvan Group sell groceries over the Internet, saving on store costs but providi ng free delivery. According to the December 15 Journal, however, “as of Sept. 30, Webvan' s average order size was $72 -too small to absorb the costs of home delivery. For the first nine months of 1999, in fact, Webvan © Oaktree Capital Management, L.P. All Rights Reservedhad a $95 million loss on revenue of just $4.2 million.” Lastly, what will be the effect of competition? It will take time, and there will be big cannibalization issues, but eventually the in cumbents in each area will move to defend their businesses against the e-commerce firms. Merrill Lynch bit the bullet and decided to enable customers to trade on line as a re sponse to E*Trade. Albertson's and Kroger have announced that they'll mount experiment al home delivery systems rather than let firms like Webvan have the grocery business. The December l7 L.A. Times reported that Toys 'R' Us and Walmart had opened online shopping sites in competition with EToys. (EToys' stock is now off 70% from its high three months ago, wiping out $7.1 billion of market value). Dot-com companies will get there early, make inroads and drive up costs for the conventional firms, but they will face determined competition from incumbents fighting for their lives. Even among just the dot-coms, competition is bound to delay and limit profitability. Most of today's e-commerce companies can, at best, boast of early entry and leading market share (the so-called "first-mover advant age"). Rarely is th ere patent protection, meaningful product differentiati on or other substantial barrie rs to entry. The companies can't count on brand loyalty, because it's all just about low price. There'll always be someone waiting in the wings to cut price (per haps to zero) for market share, and given the ease of gathering information on the Web, consumers will always be able to immediately find the lowest price. Location won't matter, because in cyberspace, everyone is everywhere. I thi nk factors like these are likely to render profitability elusive and transitory.  What are the companies worth? - Eventually, this is what it comes down to. It's not enough to buy a share in a good idea, or even a good busines s. You must buy it at a reasonable (or, hopefully, a bargain) price. Vast amounts of ink have been devoted to the valuations being put on the new companies. For The New York Times's time capsule, David Letterman compiled a list of The Top 10 Things People in the Year 3000 Should Know About Us. As a sign of the times, he included “If you wanted a billion dollars, all you had to do was think of a word and add dot com.”  Priceline.com, which auctions off discount air tickets, (September quarter sales of $152 million, net loss of $102 million) has a market capitalization of $7.5 billion, while United and Continental Airlines ($7.1 billion sales, $469 million earnings) are worth a combined $7.3 billion. © Oaktree Capital Management, L.P. All Rights Reserved Webvan Group, which started up in busine ss in 1999, had sales of $3.8 million and a $350,000 profit in the September quarter. The stock market currently values it at $7.3 billion.  On December 9, VA Linux went public at $30 and soared 698% that day to $239, for a market value of $9.5 billion, half that of Apple. To that date, the company's 1999 sales were $17.7 million and it had lost $14.5 million (versus Apple's profit of $600 million in the most recent twelve months). (VA Linux broke the record for an opening day rise. It had been held si nce November 1998 by theglobe.com, whose stock rose 606% on the first day, from $4½ to almost $32. Now it's at $8.) Among non-Internet tech companies, Yahoo! is worth $119 billion, more than General Motors and Ford together. At the curr ent stock price of $432, its p/e ratio on 1999 estimated earnings is just over 1,000. Am erica Online trades at almost 250 times projected earnings for the June year curre ntly underway, and Cisco trades above 100 times. Charles Schwab, the apparent winner am ong brokers in the new era, trades at 54 times estimated 1999 earnings, triple the mu ltiple for Goldman Sachs. According to Barron's, the price/earnings ratio of the Na sdaq crossed 170 in November and may have reached 200 at year-end ... and that's the average An analysis by Sanford Bernstein shows that on September 30, you could have bought America Online and Microsoft for $625 billi on and gotten $25 billion of sales and $7 billion of earnings. Alte rnatively, for $635 billion you c ould have bought 70 industrial, financial, transportation and utility co mpanies including Bank of America, Chubb, Federated Department Stores, Litton, Philip Morris, Ryder and Whirlpool and gotten $747 billion of sales and $43 bill ion of earnings. The future certainly looks better for AOL and Microsoft than for those other comp anies, but does the differential warrant a p/e ratio 6 times as high (89 versus 15)? And that's for “established” companies. Becau se the price/earnings ratios of Internet companies are so outlandish - usually negativ e - one may be forced to look to the price/sales ratio in order to speak about valu ation. Red Hat, for example, sells at about 1,000 times its annualized revenues in the A ugust quarter. Many of the Internet and tech companies are just concepts, and thei r stocks have truly slipped the valuation moorings. Under these unusual circumstances, The Journal wrote on December 10, “stock valuations take on an unusually large importa nce in gauging a business's performance.” In other words, in the absence of other signs , people must look to the share price for an indication of how the company is doing. Isn't th at backwards? In the old days, investors figured out how the business was doing and then set the share price. In this valuation parameter vacuum, a “lotte ry ticket mentality” seems to govern the purchase decision. The model for investments in the tech and dot-com companies isn't the likelihood of a 20% or 30% annual return based on projected ear nings and p/e ratios, but a shot at a 1,000% gain ba sed on a concept. The pitch might be “We're looking for first-round financing for a company valued at $30 million that we think we can IPO in two years at $2 billion.” Or maybe it's “The IPO will be priced at $20. It may end the © Oaktree Capital Management, L.P. All Rights Reservedday at $100 and be at $200 in six months.” Would you play? Coul d you stand the risk of saying no and being wrong? The pressure to buy can be immense. There have always been ideas, stocks and IPOs that produced great profits. Yet the pressure to participate wasn't as great as it is today because in the past the winners made millions, not billions, and it took years, not months. The upside in the deals that've worked so far has been 100-to-l (give or take a zero). With that kind of potential, (a) the upside becomes irresistible and (b) it doesn't take a very high probability of success to justify the investment. I have said in the past that while th e market is usually driven by fear and greed, sometimes the strongest motivat or is the fear of missing out. Never was that as true as today. This only intensifies th e pressure to join in and crawl further out on that limb of risk. With broader relevance than just the dot-com stocks, the relative performance chart below from Barron's of September 27 (alr eady quite outdated) shows two things: 1. over the last two decades, technology stocks have had periods of both underperformance and overperformance relati ve to the large-cap universe, and 2. the recent outperformance is unparallel ed even in this bullish period. Nothing in this chart suggests that it'll be easy money in technology from here. As Alan Abelson wrote when he ran the gra ph, “Our reservation here is that (a) technology, like everything else in life, is cyclical; and (b) there's something goofy about the price of a stock discounting as much as a century of earnings for a company in a field where change is the only constant and where the pace of change is constantly quickening .” (Emphasis added) In September Steve Ballmer, President of Micr osoft, said he thought tech stocks were overvalued. The stocks are much higher t oday, and his own is up more than 20%. Whose opinion matters? Is ther e a price that's too high? © Oaktree Capital Management, L.P. All Rights ReservedBarton Biggs, Chairman of Morgan Stanley Dean Witter Asset Management, is a well- respected observer who has been somewhat cautionary to date (and wrong). His November 29 strategy piece was without equivocation. I'll let him sum up. The technology, Internet and telecommuni cation craze has gone parabolic in what is one of the great, if not the greatest, manias of all time ... The history of manias is that they have almost alwa ys been solidly based on revolutionary developments that eventually change the world. Without fail, the bubble stage of these crazes ends in tears and massive wealth destruction ... Many of the professional investors involved in these areas know that what is going on today is madness. However, they argue that the right tactic is to stay i nvested as long as the price momentum is up. When momentum begins to ebb, they will sell their positions and escape the carnage. Since they have very large positions and since they all follow the same momentum, I susp ect they are deluded in thinking they will be able to get out in time, because all other momentum investors will be doing the same thing. (Emphasis added) * * * I am convinced that a few essential lessons are involved here. 1. The positives behind stocks can be genuine and still produce losses if you overpay for them. 2. Those positives - and the massive profits that seemingly everyone else is enjoying - can eventually cause those who have resisted participating to capitulate. 3. A “top” in a stock, group or market occurs when the last holdout who will become a buyer does so. The timing is often unrelated to fundamental developments. 4. “Prices are too high” is far from syno nymous with “the next move will be downward.” Things can be overpriced and stay that way for a long time ... or become far more so. 5. Eventually, though, valuation has to matter. To say technology, Internet and telecommunications stocks are too high and about to decline is comparable today to standing in front of a freight train. To say they have benefited from a boom of colossa l proportions and should be examined very skeptically is something I feel I owe you. January 2, 2000 © Oaktree Capital Management, L.P. All Rights Reserved P.s.: The apocalyptic view of the current situation states that the world economy is dependent on the prosperity of the United Stat es; the prosperity of the United States is based on the health of its stock market; the performance of the stock market is being driven by gains in a relatively small number of tech, Internet and telecommunications stocks; and therefore, when the inevitable correction comes in those few stocks, the ramifications will be worldwide. No one knows the extent to which this hypothesis will be proved correct. The column below, from The New York Times of January 1, 2000, presents a more benign and enjoyable view. © Oaktree Capital Management, L.P. All Rights ReservedLegal Information and Disclosures This memorandum expresses the views of the author as of the date indicated and such views are subject to change without notice. Oaktree has no duty or obligation to update the information contained herein. Further, Oaktree makes no rep resentation, and it should not be assumed, that past investment performance is an indication of future results. Moreover, wherever there is the potential for profit there is al so the possibility of loss. This memorandum is being made available for educational purposes only and should not be used for any other purpose. The information contai ned herein does not constitute and should not be construed as an offering of advisory services or an offer to sell or solicitation to buy any securities or related financial instruments in any jurisdiction. Certain information contained herein concerning economic trends and performan ce is based on or derived from information provided by independent third- party sources. Oaktree Capita l Management, L.P. (“Oaktree”) believes that the sources from which such informa tion has been obtained are reliable; however, it cannot guarantee the accuracy of such inform ation and has not independently verified the accuracy or completeness of such information or the assumptions on which such information is based. This memorandum, including the information cont ained herein, may not be copied, reproduced, republished, or posted in whole or in part, in any form without the prior written consent of Oaktree.