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May 23, 2010

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NeXt Up!Insider Insights on the Growth Economy

Michael Moe, CFA

Luben Pampoulov

ISSUE NR. 18, VOLUME V!

It seemed such a short time ago that the Euro wasbeing held out as the heir apparent to the Dollar as

the World's currency. Come to think of it, was justover a year ago when Dominique Strauss Kahn,Head of the International Monetary Fund, wassuggesting exactly that.

It's more than the other EU members thinking theFrench are "arrogant," or the Italians are "flaky andlazy," or the Germans are "industrious but uptightand humorless," and the Swiss making the Germanslook like stand up comedians. It's about when youhave countries that are sovereign with significant

differences in size of economy, economic policies,debt to GDP and growth.The crisis in Europe rattled stocks last week with theNASDAQ off 5%, the NeXt 300 down 4.5%, the S&P500 off 4.2% and the DOW down 4%.Additionally,the Senate passed sweeping financial regulationlegislation which contributed to investors pessimism.

Euro Trash

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Euro Trash

It seemed such a short time ago that the Euro was being held out as the heir apparentto the Dollar as the World's currency. Come to think of, it was just over a year agowhen Dominique Strauss Kahn, Head of the International Monetary Fund, was

suggesting exactly that. (The Euro At 10: the Next Global Currency?)At the time, theEuro was surging versus the Dollar and progressive minded people were speakingboldly about a new world order.

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http://www.imf.org/external/np/speeches/2008/101008.htmhttp://www.imf.org/external/np/speeches/2008/101008.htm

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Alas, that was then this is now. The credit crisis has made a mockery of the European"Union" and there is some speculation whether the 11-year old Euro will make it tobeing a teenager. German Chancellor Angela Merkel said as much in conjunction withGermany announcing the ban of "naked" short selling of euro government bonds andsome financial institutions. (In a retaliatory move, the Greek government banned naked

short Germans from their beaches :)The realization that Globalization had made necessary the cooperation of disparate"tribes" after centuries of slaughter to create a single marketplace was what forged theUnion together - or has some have said, the EU was the first "miracle created bycommittee." What threatens to blow it apart are vastly different views of fiscalresponsibility, cultures and priorities.

Public Debt % of GDP

Source: Wikimedia Commons

Country GDP Debt/GDPUK $2.1 trillion 50-60%Germany $2.8 trillion 60-70%France $2.1 trillion 60-70%Italy $1.8 trillion 100% +Spain $1.4 trillion 40-50%

Portugal $233 billion 70-80%Ireland $178 billion 40-50%Greece $341 billion 70-80%Belgium $381 billion 70-80%Source: CIA Factbook, Wikimedia Commons

It's more than that the other EU members thinking the French are "arrogant,"or theItalians are "flaky and lazy," or the Germans are "industrious but uptight and

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humorless," and the Swiss making the Germans look like stand up comedians. It'sabout when you have countries that are sovereign with significant differences in size ofeconomy, economic policies, debt to GDP and growth.In todays global economy, where access to capital, technology, information, labor

markets and commodities are increasingly available from around the globe, theconcept of geographic clusters may seem a paradox. However, globalization has hadthe greatest impact in stepping up the pace of global competition, renderingproductivity, not access to low wage workers and inputs, as the key to a companyssuccess.

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Clusters, or geographic pockets of companies tied together by a common industry,though not necessarily companies within the same industry, enable firms within thecluster to be more specialized, benefiting the growth and competitiveness of the entirecluster. While clusters may be defined by the principle industry, such as informationtechnology and venture capital in Silicon Valley, media and entertainment in Hollywood,

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asset management in Boston or even wine in Napa Valley, the breadth of thecompanies within the cluster will not conform to the standard industry classification.

In effect, while the cluster may appear to be comprised of only loosely connectedindustries, the reality is that they are highly specialized in their particular trade orservice as it applies to the clusters principle industry, such as in: legal and financial

services, manufacturing, marketing, transportation, construction and educationalinstitutions.

The three principle means in which competitiveness is affected is through: 1) increasingthe productivity of companies within the cluster by promoting specialization, 2)spurring the pace of industry innovation across the network cluster and 3) promotingthe growth of new companies as a result of the clusters competitiveness, productivityand ultimately success.

As clusters reach critical mass, benefits become more widespread, allowing individualcompanies to reap scale economies as a result of the clusters size, while maintainingthe nimbleness and flexibility of a smaller firm. Furthermore, much as outsourcingallows more mature firms to shed non-core aspects of their business as theiroperations grow, cluster economies enable growing firms to focus on the growth oftheir strategic assets while relying on specialized firms to manage the growth of non-strategic operations the negative side-effect of growth and success.

What the growth of industry clusters are increasingly highlighting in todays globalmarketplace is that competitive advantage is increasingly being driven by local-globalization the specialization of industry linkages, business relationships, localknowledge and labor markets that drive productivity growth in the immediaterelationships between companies as opposed to just the productivity within acompany.

As we are hunting for the NeXt Stars within defined sectors, scouring the region whichis home to the industry cluster can be very fruitful. For example, if trying to find thenext big thing in medical devices, one would be wise to troll in the Minneapolis market,home of Medtronic, St. Jude, and Guidant.

Globalization will continue to expand new growth markets for current and futureproducts and services, though even more importantly, the global marketplace will serveas a means to economize through a combination of labor market cost advantages,production efficiencies, access to global markets as well as handling coordination ofpost- production, sales and services. The advantage of going and thinking global willbe an imperative to free valuable resources for future growth opportunities.

It is not inconceivable that in the near future, the majority of companies will engage inR&D locally, have product components manufactured in China, then assembled inSouth America or Eastern Europe, then re-distributed as finished products back intothe global marketplace, where local product positioning, sales and advertising aretailored for the local-global marketplace.

In the after market, customer service will be handled in India, with product issues sentback up through the supply chain; fixes handled by global product engineers and

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identified enhancements incorporated into to the continual R&D process occurringback at the original R&D center.

Not only do I see globalization as opening up new end-markets to businesses, but alsonew markets for essentially every business function that was once performed in house.The result will be greater capture of global cost advantage and the bringing of market

forces to business functions that were once protected inside of organizations.

It is widely appreciated that rising global trade between developed and developingcountries has important benefits such as holding down inflation in mature economiesand promoting rapid growth in developing economies. What often goesunderappreciated is the increase in variety growth in the types of essentially the sameproduct.

Most think of expanding global trade as a substitution of production and consumptionof a domestic product for a foreign product decline in one and growth of another. Thereality is that rising global competition increases variety, giving consumers as well asbusinesses more choices. In fact, rising competition couldnt occur without an increasein variety.

The traditional view of trade overlooks this and focuses on the potential loss tooverseas companies that export the same product, at a lower price. The moreaccurate view is actually quite easy to see in everyday experience in the rising numberof automobile types, shoe styles, wine varietals and coffee flavors, all due to increasingglobal trade. Globalization creates dynamic efficiency which increases the quality ofproducts and decreases the price.

This increase in variety not only has implications for consumers standard of living, butthe entirety of the retailing industry, where growth thrives from being able to increaseproduct assortment to better match consumers ever evolving preferences.

Moreover, with increasing global trade and rising variety, the dynamics of brandequity shift further toward servicing consumers evolving preferences, with the mostadept retailers being those that view their value proposition from the standpoint ofbeing first and foremost a purchaser for their customers; obtaining the most soughtafter products at the best possible price and providing customers with the largestassortments. These companies recognize global markets and global sourcing as acompetitive imperative for growth, because their first focus is purchasing forcustomers.

Economic and Social Clusters are not a new phenomenon - in New York City, there is

Downtown where Wall Street and many of the Financial Firms are, SOHO where youhave starving artist, Greenwhich Village where you have starving actors, Chinatownand Little Italy, the Upper East Side for the wealth elites, and the Upper West Side forhip professionals.

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During the past 2 years, 11.5 million of new businesses were started, 6,862 of which

were venture backed. Showing the impact of clustering, 45% of all VC backedcompanies were in California.

Source: PWC Moneytree

CA45%

New England13%

NY Metro8%

Southeast6%

Texas6%

Midwest4%

Northwest4%

Other14%

Last 10 Years by Geography

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Silicon Valley is the most famous economic cluster as its been a mecca for high tech

entrepreneurs for fifty years. But even within the geography of the Silicon Valley,roughly defined as the 60 miles between San Francisco and San Jose, there are mini-clusters that have been created. South San Francisco is where you find most of thebiotech companies, Santa Clara County is where traditional hardware and softwarecompanies are located and the corridor between Palo Alto to San Francisco is wherethe Social Media Internet companies are headquartered.O'Brien: Start-ups still don't know the way to San JoseWeb 2.0 companies settling in San Francisco

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http://www.mercurynews.com/ci_15137372?source=emailhttp://www.mercurynews.com/ci_15137372?source=emailhttp://www.mercurynews.com/ci_15137337?source=emailhttp://www.mercurynews.com/ci_15137337?source=email

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Source: PWC

The crisis in Europe rattled stocks last week with the NASDAQ off 5%, the NeXt 300down 4.5%, the S&P 500 off 4.2% and the DOW down 4%.Additionally, the Senatepassed sweeping financial regulation legislation which contributed to investors

pessimism.

On the economic front, while retailers like WalMart, Target and Dick Sporting Goodsposted decent numbers, their forward outlook is weak.Additionally, new jobless claimsrose unexpectedly and loan applications for buying a home fell to 13-year lows afterthe home buyer tax credit expired.

San Francisco

Sunnyvale

Mountainview

Redwood City

Fremont

Palo Alto

Santa Clara

San Mateo

San Carlos

Menlo Park

San Jose

South SF

$0 $275 $550 $825 $1,100

VC Investments in 2009 (million)

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While I continue to be cautious about the economic outlook, I do think we are in greatenvironment to invest in wonderful growth businesses at attractive prices.Both Googleand Apple sell at below 20x P/E with world class franchises. Netflix, Capella and

American Public University are growing north of 40% and selling at 28.5x, 19.3x and17.5x respectively. With 10-year note yields at 3.24%, and little inflation to be found,

investing in growth machines will produce substantial returns over the next three to fiveyears.

___________

For the week, the AlwaysOn X portfolio dropped 3.5%, while NASDAQ was down 5%and the S&P 500 was down 4.2%. Year-to-date, AO X is down 0.5%, NASDAQ is down1.8% and the S&P 500 is down 2.5%.

Salesforce.com met Q1 expectations and posted 100% EPS growth and 23.6% sales

growth. Guidance for Q2 and for the year is slightly lower due to higher costs associatedwith the $142 million acquisition of Jingsaw. Net paying customers were up by 4,800 inQ1, bringing the total to 77,300. For the week, CRM was down 1.7%. We sell our entireposition as we see signs of slowing growth, while the valuation is still high.

Apples iPad is supposedly selling well. On its website, Apple states that the device isnow shipping in 7-10 days, while previously being 5-7 days. Also, Piper Jaffray analystpoints out that many stores are sold out of all iPad models. For the week, AAPL dropped4.5%.

Google announced it will enter the TV space with Google TV. It is expected that gaming

and social apps will be the revenue drivers. Googles TV box will also introduce new

features for channel selection/ranking/searches. For the week, GOOG dropped 7%.

This week, we are selling CRM and TLEO as of Fridays closing price. Both sells arebased on concerns with slowing growth and high valuation. In addition, we are initiatingnew positions in yoga and sportswear leader Lululemon, water desalination anddistribution company Duoyuan Global Water, metrology and semiconductor leader

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Veeco, organic food chain Chipotle, higher education provider Strayer Education andnetwork and application provider F5 Networks. We initiate each with a 2% position.

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Important Disclosures

Information contained herein, including but not limited to research, market valuations,calculations, estimates and other material obtained and other sources is believed to bereliable, however we do not warrant its accuracy or completeness. These materials areprovided for informational purposes only and should not be used or construed as anoffer to sell or a solicitation of an offer to buy any security. Opinions contained hereinare the opinions of Michael Moe. Past performance is not indicative of future results.Michael Moe is a Chartered Financial Analyst.

May 23, 2010