.comment: Surprised by Poverty

By: Dennis E. Powell
Wednesday, August 22, 2001 12:27:30 AM EST
URL: http://www.linuxplanet.com/linuxplanet/opinions/3721/1/

It Wasn't As Good As It Looked

I received email over the weekend from a long-time friend who has fallen on hard times because his professional fate has been tied to the success of Linux. Last year he was doing very well. So, it seemed, was Linux.

Linux World, he suggested, is going to be a very somber place, even as Linux trade shows the last few years have been scenes of tremendous -- Alan Greenspan would have said irrational -- exuberance.

History demonstrates the accuracy of what some of us were saying last year and the year before: That things like the equities prices in the tech sector were based on ridiculous assumptions, and sooner or later someone was going to notice this, pronounce the emperor naked, and it would all come crashing down. Which it has done and to some extent continues to do.

It's very much like the story of the counterfeit money in Morocco. The way this story goes, Americans visiting that country on buying trips a few years ago would use a color copier to produce fairly large sums of counterfeit U.S. currency. It wasn't bad looking stuff, though it wouldn't make it undetected for very long in the U.S. But in more remote regions of a foreign land, it would pass for the real thing. It worked. It worked so well, in fact, that there are nice little local economies there that are based entirely on the phony cash. It's a decent portable store of wealth, for as long as everybody involved in the transactions has faith in it. Of course, if the whistle is blown the whole local economy will collapse and whoever is holding the "currency" at the time will be out of luck. In this particular situation, there's no reason to believe that the whistle will ever be blown. But that cannot be said of the American stock market.

It was inevitable that one day someone was going to say, "Hey. Aren't these companies we're investing in supposed to make money at some point, rather than lose huge amounts of money all the time, for as far into the future as can be seen?" And somebody else was going to say, "Once everyone who wants one has a computer, can we really expect people to blow a grand or more on a new one every single year?" Whereupon the unsettling noise of cracks forming in the flimsy foundation were heard. They broadened quickly. Some people escaped with their lives, while others were crushed.

A whole lot of money, much of which had existed only on paper, simply disappeared. Ceased to exist. People who were surprised by wealth were even more surprised by its departure. The smart ones didn't behave, when they were rich on paper, as if they were rich, and therefore do not now face huge debts they have no way to repay.

Unfortunately, many in the technology industry, and this includes companies as well as individuals, just sort of assumed that it would go on forever, despite the fact that this flew in the face of any brand of sense you can name except for nonsense.

When the whole stupid thing collapsed, it did so with a vengeance. Even those who are not familiar with finance are familiar with inertia, the tendency of a thing in motion to remain in motion. Set a brick on the ground and it will just sit there; drop it from 10 feet up and it will dig in, making a hole greater than would be justified otherwise by the weight of the brick and the consistency of the soil.

So it has been with the stock market, especially as applies to Linux companies. Let's look at some numbers.

At Friday's close, VA Linux shares could be purchased for $1.83. Last September, the same share would have cost you $63.64. In late 1999 it would have cost as much as $250!

Red Hat closed Friday selling at $3.86. Remember all the anger when developers had difficulty exercising their options to buy the stock at its IPO for, what, $12 or $14? It's been as much as $28 in the last year, and was in the $150 range as 1999 became 2000.

Caldera came late to the IPO party, so it topped out at about $30 soon after it went public in the spring of 2000. In the last year it's sold for $9, and on Friday you could get a share of it for -- get this -- 67 cents. A company that scuttles along the bottom like this for very long gets delisted -- becomes a "penny stock."

I propose that these low prices are as ridiculous as were the prices at their height. Call it "irrational despair" that has swept the market. It has as little reasoning behind it as did the insane heights to which share prices soared. Anybody who thinks that Caldera, as a company, is worth less than a buck a share is just cuckoo. But VA wasn't worth $250, either. When prices plunged, they didn't drop to and stop at the value of the companies, they kept going -- inertia.

These phenomena -- insanely high share prices and insanely low ones -- affect more than the specific companies' equities, for two reasons. When a sector is generally deemed to be a poor place to invest, people with money will either put it somewhere else or keep it in cash. This applies to venture capital that had been available to Linux startups back when people were believing their own P.R. and which, now that the same people don't believe the law of gravity, is no longer available. Besides that, much of that venture capital has disappeared through poorly chosen investments made when it was thought that any damn fool idea would make money: now, there's less money to go around. (And heaven help the bozo who bought VA at its height and then borrowed against it to buy more.) So even nonpublic Linux companies are hurting.

The situation sure is bleak, isn't it?

The Trading Pit and the Pendulum

No, the situation isn't all that bleak, at least for companies that employed even vestigal common sense when they were flush.

One of the reasons that human beings currently populate the planet is that they learned early on that there are times when food is abundant and times when it is not, and they gathered food when it was available so they'd have something to eat when it wasn't. This is a basic survival skill.

We will learn whether Linux companies had that basic survival skill; the ones who did will be sticking around.

That's because business works in cycles, too. These are not always easily discerned due to a lot of exogenous variables -- anyone who thought, for instance, that the typewriter market would pick up following the recession of 1980 and 1981 was mistaken, not in predicting that the economy was coming back but in failing to take into account a little something called the personal computer. For the most part, markets never achieve exactly what economists call "equilibrium," the state in which price and value, as determined by supply and demand, precisely coincide. In the calmest of times there is constant adjustment based on news having to do with particular companies or the economy as a whole. It always lags behind events a little.

With the advent of truly gargantuan stock trading, the calmest of times have disappeared, maybe forever, replaced by wild gyrations. But they do follow a cycle, even as a swinging pendulum follows a cycle. Equilibrium would involve the pendulum sitting still at the bottom of its arc. In this case, the pendulum is given a little push one way or the other, but it does swing back. And when it does, it goes beyond the point of equilibrium, in the opposite direction. After years of being pushed ever higher by forces that could not be sustained, it has come screaming back. Its apogee on the positive side was not equilibrium, and its apogee on the negative side -- whether it is there now, is just past, or is yet to be achieved (if that's the word) -- doesn't represent reality, either. You can be sure that when the pendulum swings one way, sooner or later it will swing back the other.

The question then turns to whether Linux companies socked away a little something to see themselves through these hard times, and whether if they did it will prove to be enough. There are stories of companies spending money they didn't even have at the time, in hope that the gravy train would be making a stop. Those companies are going to disappear entirely; indeed, it is in situations like these especially that the phony-baloney "boom" of the late 1990s most harmed the Linux industry, because it allowed and even encouraged such baseless assumptions.

There are, tragically, some exogenous variables at work here, too: Each of the publicly traded Linux companies mentioned above is the target of a class-action shareholder lawsuit, the sole purpose of which is to enrich lawyers who do nothing useful, produce nothing useful, and who in my personal opinion would look mighty nice feeding the crows from the ends of ropes dangling from gallows on courthouse lawns. (Here's an idea: a class-action lawsuit against the class-action division of the plaintiffs bar; real damages could certainly be proved.) Without serious reform, these hyenas are going to be stripping life and treasure from companies forever, to the detriment of everyone else. But I digress.

The pendulum will swing back. It's funny to hear people rail on against the privatization of Social Security, citing the current market downturn. But here are a couple of facts that apply to that argument and which I bring up only because they apply to the kind of view people ought to be taking when looking at Linux investments: It takes 11 years to become "vested" -- entitled to a pension upon retirement -- with Social Security. And there has never been an 11-year period in which the stock market has not produced greater returns than has the Social Security system. Never. The market is down now, but it's much higher now than it was 11 years ago. If one tries to be a day trader, one risks everything. But if one gets in and stays in for the long haul, the risk is very nearly nonexistent. (If one borrows to buy on margin, one is an idiot.)

Let's say that you bought a share of VA at $250, and you still have it. How much have you lost? Nothing. You weren't too bright, but you have not lost a penny until you sell, unless VA rises again to $250. (If you made money someplace else, you could sell and take the tax offset, of course.) Fact is, in this example, you might have to wait a very long time to have a share that's worth what you paid for it. But if you bought at, say, $4, or bought Caldera at $2, or Red Hat at $5, there's a good chance that patience will pay off. How much patience? I have no idea. My point is that the assumption that the only possible direction is down is as moronic as was the notion a year or two ago that the only possible direction was up. These things even out, but only over time as measured not in days, weeks, or months, but in years.

None of this will provide much comfort if you're someone whose next meal depends on the performance of Linux companies, or if you are someone who has already been denied the last several meals due to the lack of performance of Linux companies. Yet it would be very foolish indeed to suggest that all is lost. It isn't.

Look at the fundamentals, the real fundamentals: Linux is continuing to develop and mature. The products produced by $3.86 Red Hat are far, far better than the ones produced by $150 Red Hat. Microsoft's products are taking all kinds of hits, almost all self-inflicted -- they got too greedy, and they now will pay, in bad P.R. over their lack of security, in punishment in their antitrust problem, in revulsion over .NET and XP. They won't go out of business, but their vulnerabilities are there. Linux has achieved sufficient maturity that it may actually spell a useful price difference in the increasingly competitive computer hardware business. (Computer companies have in some cases charged extra for a Linux preload. The smart player will sell machines preloaded with Linux for less, relieving the end user of the Microsoft tax. Microsoft would have to respond by giving away its system, something which it could not sustain.)

Over a reasonable period of time, Linux companies, the ones that didn't believe the market 18 months ago and don't believe it now, will do okay. It's good, amid the wailing and gnashing of teeth, to remember that.