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NOVEMBER 17, 2000 VOL. 26 NO. 45 | SEARCH ASIAWEEK


Asiaweek Pictures.
Myth of 'Picks and Shovels'
How to tell future winners and losers in the Internet world

DAVID M. WILLIAMS is Asia Pacific partner in Draper Fisher Jurvetson, Hong Kong

Over the past year, I have heard numerous equity research analysts, public portfolio managers and venture capitalists note the wisdom of investing in producers of the "picks and shovels" of the Internet world rather than pure-play dot-coms — a reference to the winners of the California Gold Rush of 1849. The logic is that investing in any one Internet play is akin to betting on the odds of a single "miner" striking it rich, whereas an investment in producers of the tools used by the miner population is safer and of more stable value.

How pervasive is this rationalization of the rush to invest in Internet enablers? A quick search by Microsoft's Inktomi turns up 2,472 references to the phrase "picks and shovels"; Yahoo's Google has catalogued 4,190. That's a lot of professionals all voicing the same argument — typically a good sign to be skeptical.

The flaw in this theory? The Gold Rush ended — as all mining booms do. The miners went home. How valuable is a stable business if its cash flows end after a relatively short time? More disconcerting is that the few miners left after a gold rush are typically large, integrated companies with more than a little pricing leverage over the producers of the equipment they need.

Why would a venture capitalist warn about the prevailing wisdom of the market? The overall growth of the Internet is continuing unabated — and companies that offer plays on this activity are quite attractive for capital. The pervasiveness of the Internet is evident in researching the background for this article (portals and search engines), the means of transmission (e-mail) and the photo (digital image). But it is important to differentiate between real growth in the Internet and, more importantly, in entrepreneurialism, versus the speculative investment manias and the herd mentality.

There have been a few "gold rushes" in the past couple of years. The two most identifiable are the waves of investment in B2C (business to consumer) and B2B (business to business) e-commerce. The parallel between a gold rush and the B2C boom is apparent. Both held forth the prospect of any able body being able to "strike it rich" with little in the way of specialized skills or capital. In B2B, specialized knowledge would initially seem a barrier, but the number of middle managers in any old-economy sector provided a plentiful supply of founders.

The losers will be the companies that focus entirely on fueling single-sector booms — because booms and busts inevitably are paired together. However, there will be winners — companies that profit over the long term from all of this activity — well beyond the individual sector booms. The beneficiaries should fall into three categories:

1. Companies that serve not just the pure-play start-ups, but also the business and consumer population. Looking back to the 1800s, Levi Strauss and Wells Fargo offer the best examples of companies that benefited from the booms (although it's not clear by how much or in what years during or after the Gold Rush of '49). More significantly, the broader population was the predominant portion of their customer bases.

2. Companies that build the underlying infrastructure, which can be used long into the future. In the past, railroads; in the present, fiber optic/networking companies.

3. Most importantly, companies that benefit from the trend toward entrepreneurialism. There is no historical parallel. We are globally shifting toward an "equity economy," rather than a cash economy. A growing percentage of individuals own equity. Unlike such shifts in the past, the owners of this equity are often employees of the underlying company, not speculators. Companies that reward workers based on productivity, typically via common stock or options, out-compete companies that don't — over the long run. Silicon Valley has been the epicenter of this phenomenon, but it is spreading rapidly worldwide.

Who in Asia will benefit? In the public sector, companies such as Satyam Infoway (Nasdaq), of India, which meet the first two criteria. IAsiaWorks (Nasdaq) meets criterion No. 2 across the region. Techpacific (HK GEMS) is best positioned to meet category No. 3 — by helping to create a Silicon Valley culture in Asia across multiple sectors. This enterprise makes it easier to start companies by offering the would-be entrepreneur all of the services required to run a business aside from the core competency of each.

Among the potential future listings are companies such as Beijing-based Baidu, which serves start-ups in the B2C sector with its search capabilities as well as both old and new economy players with its hosting business. The same holds true for major owners of high-capacity bandwidth such as China Netcom. Also interesting are companies that focus on bringing new users to the Internet via alternative means of access — the mobile and cable-TV consumer plays.

If you follow the crowd investing in producers of picks and shovels, you will likely become the owner of property in a ghost town. That does not mean that you cannot profit long-term from the advent of the Internet. The key lies in the identification of long-term trends and the courage to pass over what appears to be easy money speculating on the theme of the moment.

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