Here’s an enduring lesson about investment. In the mid-1990s, well before streaming (2007) or Blu-ray (2003) or even DVRs (1999), I was convinced that every television would someday have an attachment to record and play back shows digitally. Digital videodiscs were available and personal computers had only expensive read-only drives. But I figured drives that also let users burn DVDs would soon take off, so my partner, Fred, and I started scouring Silicon Valley for technology that would benefit.
In the small city of Milpitas—ZIP Code 95035—we stumbled upon a company named Elantec Semiconductor, which had gone public in 1995 at $7 a share.
and Hambrecht & Quist were the underwriters, for those who remember those days.
of Sequoia Capital and Apple Computer fame was the (pedigreed) chairman. It had $30 million or so in revenue but wasn’t really growing. When Fred and I found it, the stock was broken, trading around $3. It had 10 million shares, so it was trading at a lowly one times sales.
We started visiting the company, meeting the CEO and CFO once a month. They told us they had developed a little $2 laser-diode driver that could allow a compact-disc drive to burn data onto a blank disc. Lights flashed in my mind when I heard this: Could their laser driver do the same thing for DVD drives? Someday, I was told, but it would be really expensive. Even so-called CD-R drives for PCs were still $500. Gut check—time to move on? Nah.
We weren’t discouraged. Everything that comes out of Silicon Valley starts out expensive, then sells like hot cakes as costs decline. We were long-term investors—patience was our middle name. So we started buying stock at $3. It started ticking up: $3.13, $3.25, $3.50. We were geniuses! Then we got too busy to buy more shares for a few days and the stock slid back to $3. Turned out we were the ones driving up the thinly traded stock!
So we slowly kept buying shares and continued to visit the company for updates. Elantec’s only competitor for laser-diode drivers was
and because Toshiba also sold CD drives, every other Japanese CD company bought from Elantec.
Around the same time, music was becoming available online through MP3 downloads, which Napster had made easy. There wasn’t anywhere to play these files except on your PC—the iPod didn’t come out until 2001. About 95% of PCs from Dell and
came with read-only CD drives standard. The “attach rate” of drives for recordable CDs was only 2% or 3%. Over six months, we kept buying the stock as it rose to $4, then fell to $3.50, until we owned close to 10% of the company. We had to file Schedule 13D ownership forms with the Securities and Exchange Commission—a huge pain and needless legal expense. I wanted to sell at $6, but I asked Fred if he thought it could go to $10. He smiled and said, “At least.” We could stay patient for years, but it didn’t take that long.
A company named Roxio started selling software to write music to CDs so you could play downloaded music in a car or on a portable disc player. MP3 players started arriving. And the price of writable CD drives started dropping: $300, then $200 and then quickly piercing $99. In a flash, the attach rate for these drives went from 5% to 85%. Elantec’s stock took off. Momentum investors in mutual funds clamored for it as their earnings took off. We sold our entire position in two afternoons in 1999 for between $175 and $200.
Believe me, I’ve had plenty of awful investments, including more than a few zeros. And I was wrong about what would make this stock work: There never was a market for rewritable DVD drives for TVs. DVRs with hard drives ended up filling that role. I was looking too far into the future. But the investment worked because we had the concept right, and we were in the right neighborhood when things took off. The simple lesson: You don’t need to know the address if you’re in the right ZIP Code.
The same strategy can help you navigate today’s tech world. Think augmented reality will be everywhere? Three-dimensional printing? Drones? Great. Look up and down the supply chain until you find protected pieces of key technology. You don’t have to be 100% right, only close. Maybe those will be keys for other markets as well. How about smart cities? Facial payments? Gene therapy? Think machine learning is the future of computing? Fine, start finding all the new chips and architectures needed. Will it affect retail? Design? Communicating with animals?
The future is always fuzzy. Like horseshoes and hand grenades, you only have to be close. Get in the ZIP Code where the wind’s blowing, and watch things fly.
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