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Interview with Andy Kessler, Tech Guru: The Future of Silicon Valley and How You Should Invest

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Andy Kessler shares thoughts on his career, his new book, and the companies you should strive to work for, invest in, and/or start yourself.

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Editor's Note: Read more from Brett Owens on his blog, The Contrary Investing Report.

On Friday I had the good fortune to interview Andy Kessler, of Silicon Valley and Wall Street fame, about his latest book, Grumby. Andy is one of the sharpest minds around with regards to the intersection of technology and finance. He's an electrical engineer by training, and after starting his career at Bell Labs, he moved on to Wall Street, where he spent almost 20 years as an analyst, investment banker, venture capitalist, and hedge fund manager.

He co-founded the hedge fund Velocity Capital, which was wildly successful, delivering average annual returns of 55% to its investors. At the peak of the tech boom, Andy and his partner closed up shop, delivering the funds' capital back to their investors. Soon after, he started a second career as a writer, telling witty stories about his unique experiences. His previous works are all non-fiction bestsellers that explore the wild, wacky worlds of Silicon Valley and Wall Street -- and the driving forces behind them.

Andy's latest work, Grumby, is a fiction tale about an entrepreneur in Silicon Valley who's hard at work creating the next big thing. Along the way, he encounters a host of challenges and surly characters, including greedy venture capitalists, Goldman Sachs (GS) bankers, and modern-day technology moguls (including Facebook's Mark Zuckerberg, Apple's (AAPL) Steve Jobs, and Google's (GOOG) Eric Schmidt) who feel threatened by his cutting edge consumer electronic product.

Grumby is a top-notch work of speculative fiction. It makes you question your current assumptions about technology trends, gives an insider's view of life at a hot Silicon Valley startup, and teaches important lessons about entrepreneurship and investing -- all weaved into an entertaining tale that makes the pages fly by. I thought it was so valuable for an entrepreneur to read, I bought a copy for everyone on my team!

In my interview with Andy, he shared his thoughts on:

  • How he got "an edge" on Wall Street while running his hedge fund;
  • The types of companies you should strive to work for, invest in, and/or start yourself;
  • Why the "edge of the network" is where all the action and innovation is;
  • Critical, unapologetic rules for entrepreneurship and investing (hint: focus on opportunities to "eat people");
  • How you can look through the fog and spot tomorrow's winning companies and products.


Interview Transcript
(This transcript was prepared by SpeechPad.)

Brett: Hi, this is Brett Owens, and I'm here today with Andy Kessler. We're going to talk about the intersection of innovation, Silicon Valley, and Wall Street. In my book, Andy is the guy to speak with on these topics. He worked on Wall Street for about 20 years as a research analyst, investment banker, venture capitalist, and also as a hedge fund manager of a very successful fund called Velocity Capital. We're going to talk about that as well. And then interestingly, as if that weren't enough, Andy started a second career, after his career with Silicon Valley and Wall Street, and has written a number of best-selling books, including Wall Street Meat, Running Money, How We Got Here, and The End of Medicine. Those were all nonfiction. He's also has a new fiction book called Grumby, which I just read. It's an excellent fiction, with a lot of nuances in there relating to Silicon Valley and Wall Street. So we wanted to talk about those points as well.

So Andy, welcome. And if we could start with your background, we'd love to hear the "how he got here" of your career, from your early days as an engineer, then how you sort of got hooked into Wall Street, and then things took off from there.

Andy: Yeah, sure, Brett. Thanks for doing this. I was an electrical engineer at Cornell, and I was an engineer because I couldn't write. At least, my teachers and SAT scores told me I had zero aptitude in English.

But I was an electrical engineer wanting to design computers. It was computer architecture. I ended up, after getting a masters at Illinois, working at Bell Labs for a bunch of years designing modems and chips and writing software. This was in the early '80s, when the Internet was just coming into being, with Usenet groups and UUCP -- Unix to Unix Call Protocol.

Anyway, I got tired of working at the giant bureaucracy, bigger than the Post Office and bigger than the Pentagon, which was the phone company. I ventured out and accidentally tripped across a job on Wall Street following the chip business; the Intels (INTC) and Motorolas (MOT) and Advanced Micro Devices (AMD) and Texas Instruments (TXN). I took economics, but I didn't know anything about the stock market or what makes stocks go up or down. Of course, after working there for a little while, I realized that nobody on Wall Street really knows what makes stocks go up or down.

Brett: [Laughs.]

Andy: But they wanted someone with a technical background to go figure out what all these weird chip companies were doing. In '83 and '84, there was an IPO boom that took public quite a few new companies that were doing custom silicon and all this kind of stuff. So I was happy to jump in and learn about how to put together a forecast for an income statement and balance sheet and figure out how stocks work and start recommending stocks. And I was fortunate to recommend Intel early on, when I realized that, while with the 8086 and 286 they had hired other companies to make them -- second sources it was called, Advanced Micro Devices -- and with the 386 they were going to keep it to themselves.

So, I had a great recommendation. The stock was a 10- or 20-bagger over a number of years, and it just helped launch my career on Wall Street.

I worked at Morgan Stanley and in the investment banking world, helping take public the next wave of great companies. And I realized that, when you work on Wall Street, you sort of follow what has happened. You catch these companies on the tail end. I wanted to be involved at the early stages, when these companies were just forming, and provide access to capital -- growth capital or startup capital -- to these companies.

So, I left and went to a small firm and raised a venture fund in '93 or something like that. I thought there was this whole new media world, that technology would intersect with media and create this interactive media marketplace. So I started investing along those ways. Fortunately, a whole bunch of those early investments were the first wave of Internet companies -- those that were selling CDs online, basically selling things online or coming up with the tools to allow others to do that.

The fund was successful. I connected with one of my clients, and sort of one of everyone's on Wall Street clients, a gentleman by the name of Fred Kittler, who was at JPMorgan running a billion-dollar public fund investing in technology. He owned 10% of Cisco (CSCO) right after the thing went public, because he saw these great long-run trends. And I hooked up with him to start Velocity Capital Management.

The two of us were going to do public and private investing. What we were going to do, and what we ended up doing successfully, is duplicate what happened in the silicon world. In the silicon world, costs go down by 30% per year, and it creates these huge new markets that spurt out of nothing because of elasticity. If something gets cheaper, you are going to end up using more of it. We thought the same thing would happen with bandwidth that happened with silicon. It didn't because it was regulated and it was stuffed inside of phone companies. But as that became slightly less regulated, you had this big boon in TCP/IP, Internet protocol companies and devices. We had a very fun time running an investment fund, and we ended up being at the right place at the right time.

Brett: Can you talk about when you started the fund and in terms of establishing what your methodology was going to be? I know you've got a real interesting background in terms of looking for your edge, what your edge and specialty were going to be.

Andy: Right. You know, on Wall Street, you've got to have an edge. Either you know what the next quarter is going to be, or you've got some algorithms that hedge pork bellies versus Italian Lira futures or some weird thing.

I had no such thing. But what my partner and I could do is we could predict the future because we cheated. We knew, we had conviction -- no one knows anything -- but we had conviction that this bandwidth would get cheaper. And as it did, it would go from a 5 or 10 billion marketplace to a trillion dollar marketplace. If that happened. Just like silicon, which ended up being a trillion dollar market, once you added up all the computers and everything else that use it.

So we could look out 18 months or two years, while everyone else was focused from zero months to six months. We could look out into the fog. And if you look out into the fog and you can just make out even the outline of what an industry is going to look like, you can buy companies today that will benefit from these structural changes like cheaper bandwidth and deregulation and the like.

So we would look for these waterfalls. These companies that would start to grow, and then their growth would accelerate until the rest of Wall Street -- the fund managers at Fidelity or Janus or whoever else -- would discover the companies that we had invested in at how much revenue they had or cash they had. And these guys would pay 30 times earnings, or 50 times earnings, and whatever future earnings would be. So we would buy companies at a 40 or 50 million dollar market capitalization. We would buy 5% or 10% of the company. And three years later, the stocks would get bid up to $2 billion valuations. And we were making, not just 10-times on some of these things, but 50-times kind of returns. A lot of it, of course, had to do with the frothy nature and the dot-com boom and all that. But we weren't investing in dot-coms. We were investing in all of the infrastructure companies that these dot-com companies would buy their equipment.

So, you'd look for these waterfalls, where it would be acceleration like gravity in reverse, accelerating growth. But, like a waterfall, you've got to remember to jump off before you hit the rocks on the bottom. Or in this case, you've got to jump off before the thing peaks and heads over, which they inevitably do.

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No positions in stocks mentioned.
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