Friday, December 14, 2007

GAME CHANGERS

Now and then we see game changing events. Sometimes we do not recognize these events until they are over. Sometimes, events that are perceived to be "game changers" fade into history as 15 minutes of fame.

Last year, when JetBlue suddenly went from a fast growing discount air carrier to a carrier with problems, it looked like just another story in a long line of "problem stories" in the airline business. Since that time, Southwest Air, by far the most successful of the discount carriers, has started changing its operating model to one in line with the major carriers. In other words, the discount airline business has enjoyed its 15 minutes of fame (it lasted about 25 years but still just a flash in history), but deep discounting is dead.


Yes, I have heard about SkyBus. SkyBus is offering flights for as little as $10. The problem is that the major airlines have revamped operations to the point that in one way or another they are able to match the discounts while giving other benefits. Those who fly frequently are in effect paid to fly on the major airlines or their subsidiaries.

Yesterday, JetBlue sold 19% of the company to Lufthansa. JetBlue sold out cheap. The 300 million purchase was at a 16% premium to the most recent price of the stock but still at a discount to the high flying days of yesteryear. There has been a "paradigm shift". To be successful, airlines have to avoid putting too much capacity on their routes. The discount model was to go find a route with heavy traffic and "win with low price". As any business should know, all sides lose when a price war is fought.

Yesterday, I mentioned the word oligopoly. The rules under which the airlines operate allow them to form "mini oligopolies". The deal just pulled off by Lufthansa illustrates the point. Lufthansa already is a partner with US Airways and United. All three of these major airlines are members of the Star Alliance. Suddenly, JetBlue is going to be careful about avoiding competing with US Airways and with United. Partners do not take business from other partners. In like manner, US Airways and United now have reason not to compete directly with JetBlue.

A reader points out that I might have been showing a little bit of "irrational exuberance" when I said that fares will double in 4 years. He is probably correct. Some fares will more than double but the average fare will be held down. Still, during the late stages of the business cycle, big business will not hesitate to pay double or even quadruple the current fare to get their people to the deal table on time. The "road warriors of business" are highly paid people and they will not put up with being jammed in a small coach seat on international flights. It is one of the ironies of the business that the number of seats per plane loses out to seat size on the routes of highest demand. The bigger the seats, the bigger the fare partly because the bigger the seats the fewer the seats. United and others are currently adding "lay down" seats on long haul planes.

ANOTHER GAME CHANGER

In the lab, scientist have been able to "fertilize" microorganisms that have the sole function of eating oil and spewing out natural gas. The result is that the natural process is faster by at least 1000 times. I believe this discovery is the equivalent of the day the first Indian purposely placed a fish in the ground with his maize seeds. Since that first fish, the amount of corn grown on an acre of ground has been increased by a factor in the 100's. At a time when politicians and citizens are in love with converting food crops to fuel, we leave 83% of heavy oil in the ground. I am talking about oil wells that have been discovered and "pumped dry". There are certainly trillions of barrels of oil that is still in the ground (the "t" is not a misprint).

Clean burning natural gas is being constantly produced deep within the earth. The USA has been expanding its "harvesting" of natural gas being produced from the trillions of barrels of shale oil in the rocky mountain area of the USA. The push to convert plant life to gas is a far more complex process than to convert hydrocarbons to gas. Can you envision the day when liquid fertilizer is poured into coal mines and clean gas comes out some pipes? I can!

Learning how to scale this process will take years. This is not a quick fix but it is likely to be a game changer. It is silly for the US to waste billions of dollars on projects "targeted by congress and the president". The company that brings the best technology to market is going to reap rewards. The incentive to innovate is already present.

HEALTH CARE GAME CHANGERS

During the prosperity phase, for the next 4 years or so, health care innovations will get rewarded. I ask for input from you to help us all discover what these innovations will be. One reader has written about a robotic surgery company. I need to study this one. I was initially put off because of its price but these machines are revolutionizing delicate heart surgery. The leading edge of the baby boomers are getting old. A 65 year old man uses 7 times the drugs of a 45 year old man. A 65 year old many typically has savings to spend whereas a 45 year old man is probably paying college tuition.

Bausch and Lomb sells a new eye surgery robot. It is able to replace an eye lens through an incredible tiny slit. A person can have his lens replaced on one day and be back at work on the next. I don't know the precise numbers but my educated guess is that 75 year old people are at least 100 times more likely to have cataracts than are 55 year old people.

Did you know that reputable scientist say that a child born today is likely to live to be 135 years of age. In David Andrews latest book he mentions that one of the big mistakes of investors is to assume a short life after retirement. At least one member of a healthy couple at the age 65 will live another 30 years. A lot of heart surgery and lot of cataract surgeries will be done in the coming years (unless a drug is produced that will cure a lot of heart problems).

BIG BUCKS FOR INNOVATIVE DRUGS

The prosperity phase is the time when new, very expensive drugs, are readily bought. The drug industry has been pounded hard over the past several years but its time is coming. A lot of my readers are in the industry and they know 1,000,000 times more than I about the pipelines and details of specific drugs. I hope they will respond with comments to the extent that they can. I do not look for inside information or for trade secrets.

INNOVATION PAYS

I have harped on the innovations that are in the works in regard to mobile computing. Google constantly reminds me of the early 60's when the Xerox process was already invented and the factors were already under construction but the machines were few and far between. Those who got on the high priced horse and rode it for dear life made a lot of money. We are just now into the "innovation pays" part of the business cycle. Yes, innovation can pay off at any time and we have already seen dramatic cost cuts as a result of innovation during this cycle. However, the big bucks are to be won in the next few years.

AMERICA INNOVATES

A lot has been made about how many engineers are graduating from Chinese "Universities". The fact is that many of these engineers are graduating from 6 month courses. I will be the first to tell you that there are millions of very smart people in China but America continues to bring forth many of the great innovations. Ironically, some of the top scientist in America are from China. One of the reasons I get so upset about Americas failure to resolve the immigration crisis is that immigration has always been one of the open secrets to our great success.

In any event, we are still the innovators of the world. Investors who find the "next hot technology" will do well. My word of caution is that jumping on what is already hot can lead to dramatic loss if the hot technology is topped by an even better innovation.

FACEBOOK

Facebook is a potential game changer. Google faces a serious challenge from FaceBook. I recently opened an account just to see what all the fuss is about. I can see huge potential for businesses, churches and all other groups or organizations to make use of this innovation. The more I use Facebook, the less I will use Google. Those who own shares in Google have to be at least concerned about a price ratio in the 50's when there are new technologies around. Don't get me wrong, I am still a huge Google fan. My point is that you have to look at the whole picture.

A BIGGER HOUSE OR EYE SURGERY?

The policies of our government include a positive subsidy for buying a bigger house and a negative subsidy for buying eye surgery. We tend to fuss about the high cost of health care but don't mention taking away the tax break for buying an extra couple of bedrooms and baths. There are billions of non productive assets being created in America because of silly tax policies. One of the laws of economics is that bad money is substituted for the good. This works until the need for change is recognized by a significant majority. This is similar to the rule that price cures price, the price of oil can only go up so much until people find alternatives, the subsidy for extra large houses can only go so far until you have the irony of John Edwards campaigning as a champion of the poor while building a 28,000 square foot home.

TRENDS

One trend that is in the early stage is the move to downsize downtown. Marilyn and I plan to move to downtown Winston-Salem in a few months. We will join millions of other retirees across the country who are buying smaller places that are within walking distance of downtown amenities. I urge you to use caution before buying the "big house in the suburbs". Several tax bills have been introduced into the house ways and means committee that would cut or eliminate some of the subsidy for home ownership.

THANKS FOR READING

Thank you once again for reading. Please remember to recommend my free letters to your friends. My goal is to help people. I need your help to find those who might benefit from reading my views. Thanks ever so much!

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