The next Microsoft

Finding the next growth stock to return 10 times your investment is the Holy Grail for aggressive investors. Most stock-pickers focus their searches on small high-tech outfits only a few years old, trying to find the next Microsoft or Apple Computer. Unfortunately, most young high-fliers cannot sustain the momentum needed to turn a good product into a market force. Casting a narrow gaze around high-tech toddlers, you may overlook a critical fact: Microsoft had been around for about a decade before it went public. All of the good money was made in a company that had become a recalcitrant teenager.

So let’s look at what defines Microsoft, and then pick a likely candidate, with the same market-shaping characteristics, out of the sea of older growth companies. First, the company should be a master marketer with strong brands. Second, it has to own a delivery vehicle for the branded products. Microsoft sometimes describes itself as a “platform company” — perhaps implying that it builds an operating system platform merely to launch applications such as the Office suite, the Internet Explorer browser, and the Exchange server product. We’ll apply “platform” loosely and equate it to a delivery mechanism. Finally, our pick should be poised to enter a period of sustained, above-average growth as its business model collides with Internet mania, just as Microsoft’s growth was fueled by the previous paradigm shift toward PC-based desktop computing.

So we feed these criteria into our stock database, set the growth rate and company age knobs appropriately, and run a screen, right? Wrong. If you could characterize “Internet leverage” as a screening variable, you’d be able to run the world’s most overvalued mutual fund. No fancy stock screens here, just a good old-fashioned, opinionated selection: The Walt Disney Company.

Before you scream “Eek! A mouse!” let’s look at the facts. Disney excels at global marketing. Their branded products – movies, theme parks, characters, and the occasional professional sports team – are respected around the world. Pick a random point on the earth, and more children in that place could pick Mickey Mouse out of a crowd than Bill Gates. Would “Toy Story” have created less of a splash without the Disney marketing catapult into prominence? It’s hard to say, but any company that can generate more than a billion dollars in merchandise sales from “The Lion King” derivative products must be doing something right.

The platform part was worrisome for a while: theme parks aren’t exactly portable or the universal interface. You can’t browse them on the Web, or find differentiated merchandise unique to a park. You have to be there to be enjoying the brand, and there’s finite line-waiting bandwidth available with which to do so. The Disney Channel is not exactly the most popular premium channel. You can only have so many Goofy pens before you stop visiting the Disney Store at your local mall. So how does Disney increase its bandwidth into your home, into your mindset, and eventually into your wallet?

At one Wall Street sell-side conference last year, a speaker pointed to Viacom’s inclusion of Nickelodeon and MTV on the basic cable package as a serious strategic blunder on Disney’s part. Viacom changed the economics of delivering a cable service by emulating a broadcast channel. And late last year, Disney charged right back with a way to deliver premium content over a broadcast channel: it bought ABC, and the Disney platform was born. Now only a few months after the deal closed, I am enjoying “Muppets Tonight!” on ABC, refreshing pleasant high-school memories and making my kids want to go see the Muppet movie at Disney World again. And again. Weekly. So we bought a Muppets video. The content delivery platform works.

But what about the Internet mania part? Consider the Internet as another platform over which Disney can deliver content — that’s media convergence, right? You use the captive infrastructure — the broadcast channel, theme parks, filmed entertainment — to create demand for products on the cheaper, anytime, anywhere access platform. As you grow your ability to deliver content over a non-captive means, you grow your audience and revenue stream as well. The Internet is a new delivery mechanism, but one with a hideous confusion of brands, quality, and editorial control. Adding a simple, strong brand to the mix – a mouse and his friends – may actually add to the value of the brand.

Think about how this plays out for your typical family of four. Let the kids watch part of the Muppet show from Disney World on the PC, and charge .00 each week. Want to catch the newest parade down Main Street, or see what the lines are like on a sunny day in April? Eager to check out the variety of resort rooms for your next trip to Florida? For a few dollars, the Internet can bring you images, video, and audio. Want to keep your branded products in front of the consumer? Feed them a steady stream of events – otherwise known as “news.” Disney is sitting on top of an untapped, unending news feed in its parks and studios. If this sounds a bit crazy, why is Microsoft investing in a new cable news channel with NBC?

There’s a minor problem with meeting the promise of those rosy consumer scenarios — there’s a lot of software that has to be written to allow navigation, selection, video delivery, and ordering or payment transactions. That software will have to evolve as new services are brought into the online portfolio, and it has to be distributed to (ideally) millions of customers worldwide as quickly and seamlessly as possible. Does this sound like a Java commercial yet? It’s an ideal Java environment — extending your Web browser to give you an ever-changing view of Disney wares. Some of the technology already exists, like the Thinking Pictures RockPipe (http://www.thinkpix.com) that is equally capable of bringing Roger Daltry or Roger Rabbit to your desktop. What I’d like to see is a bit more animation capability on the desktop; let me bend, pose, and script my favorite Disney characters with a bit of Java or JavaScript.

I started working on this column by comparing the total value of Disney and Microsoft products purchased by my household in the last three years. Disney won, by a long shot, with park admissions and video releases combining for an early lead. Now let’s add a twist to the comparison and look at the second-place finisher — Coca-Cola, by a nose. We drink a lot of Coke and will continue to do so no matter what the economy looks like. That sort of pattern should represent the next wave of opportunity for Disney in reaching the online consumer. Disney has put its retail store and some basic product information online already , but that’s not sufficient.

If it can shift its income stream out of the mostly-durable filmed and live entertainment business into the non-durable, consumable world of sound bites, video clips, and online games, Disney will build in protection against the invariable economic downturns that put a damper on theme park business. Can’t afford eight days in Mickey’s Starland? No problem, send the kids there online with a license to spend your Virtual Disney Dollars.

This presents another Java opportunity. Software for the kids has to be remarkably reliable, because children have no tolerance for machines that hang or applications that crash; they’ll leave the PC and go determine which 11-inch action figure causes the greatest trauma in a collision with your head. If, as they claim to be, Java applets really are more robust than your standard desktop fare, my kids will find out pretty quickly. As a corollary, any software for online games or promotions has to be tamper-proof and verifiable or little Johnny is going to be rolling in promotional coupons and online credits. As with all security problems, if the prize is interesting, someone will try to take it through a back door. Again, this is the kind of thing that Java is supposed to address, and we’re waiting for some field test results.

Is this going to be an easy transition for Disney? No at all. The first challenge is for Disney to capitalize on the urgency of the Internet. A slow branding process just doesn’t work; you can’t wait nine months after the final silver screen showing of a movie to begin offering derivative products online. Similarly, the online products have to be refreshed at an alarmingly fast rate. The goal is to keep the consumers coming back for their latest Disneyana fix, interacting with the online brand and spending money at the same time. When online content stays fresh as long as a maiden fruit fly, “timeliness” becomes the watchword of your Web production shop. Online Disney World also has to be useful and relevant to the entire range of consumers, from kids to adults. This means integrating the various properties from the theme parks to the movies to print media like the Disney Adventures mini-magazine. When you produce the right mix of utility, timeliness, and scarcity (something that nobody else can claim as their own), you have created information — something to be sold online.

The final challenge I’d like to throw to Disney is to look at the consumer desktop of three to five years from now. It will have an awesomely powerful frame buffer on it, probably with enough triangle-grinding silicon to do a nice job on a computer animated short clip. But how will the massive bit-pile make it into your home? It’s time for Disney to consider its next infrastructure project, namely, building its own distribution network that brings the content as close as possible to the eventual consumer. Disney already knows the power of owning the infrastructure — they own the power, light, water/sewer, and telephone companies that service Disney World in Florida. Add in “network access” and you may have the world’s most efficient, friendliest ISP.

And now for the 64,000 baud question: Does Disney “get it”? I think they do, but that fact isn’t public yet, which is an entirely Good Thing from an investment perspective. It’s not too late to get in. As proof, I offer a simple observation: scientist, inventor, and JavaDay keynote speaker Danny Hillis is rumored to have landed at Disney in an executive position. If Disney doesn’t recognize the potential of the Internet, and the effects of converting “communication into computation,” as Hillis puts it, they would never have hired him. Disney may be ready to think out of the box. Again.

Everyone has been proclaiming “content” as the one true king, waiting to take its place in the circle of Internet life. As Tom and David Gardner point out in the April issue of SmartMoney magazine, investor excitement has been progressively trained on higher and higher levels of the Internet value stack. The first winners were the router manufacturers like Cisco and Bay Networks, followed by the ISPs such as UUNET and, for argument’s sake, America Online. Throw in the mandatory nod toward Netscape, and look at the recent financial press heralding the IPOs of indexing leaders Lycos and Yahoo. Forget the cover of Business Week, the Yahoo gang is on the cover of Wired. The time is right for all eyes to turn to content providers. Pumping existing profits back into new revenue-producing areas sets up another wave of long-term, above-average growth. Successful leverage of the Internet craze may be the magic feather that makes the Mouse fly even higher.

ENDNOTE: Note: See the new JavaWorld Portfolio for quotes on a number of noteworthy stocks. :END_ENDNOTE