TITANS OF TECH
The Return of the Queen
Morgan Stanley's Mary Meeker survived the boom and the bust. Now she's back -- as are her top stock picks.

By John Battelle, June 2004 Issue

Hailed as the "queen of the Net" by Wall Street tout sheet Barron's in 1998, held up as the poster child of the dotcom bust in 2001, Morgan Stanley (MWD) analyst Mary Meeker has lived through several lifetimes of glory and infamy. She's seen fellow analysts and a former boss indicted for fraud, and then was swept up herself in a massive investigation of Wall Street's research practices (the case was settled last year, with Meeker cleared). What kept her going through all this? The thing most people still don't get is that Mary Meeker is a true believer -- in the companies she helped take public, in the stocks she picked (and stuck with even as they nose-dived), and in the revolutionary nature of the Internet.

Her record is admittedly mixed, with flubs like her recommendation of AOL, which lost $150 billion in market cap after its merger with Time Warner (TWX) (the corporate parent of Business 2.0), and ExciteAtHome, which went from $35 billion to nothing. But in 2003, Meeker's picks were up 78 percent, thanks to stocks she'd long championed, like Amazon (AMZN), eBay (EBAY), and Yahoo (YHOO). If you'd had the fortitude to pile on in early 2001, when she reiterated her support of those companies, you'd be a damn sight richer today. And Meeker is still helping create new industries: Her prescient reports on the search market were part of why Morgan Stanley won a mandate in April to lead Google's IPO. She won't admit to more than feelings of satisfaction with her recent record, but one can sense a certain bounce in her step these days. We visited her in New York to hear what she has learned from the past and what she thinks about the future.
(full text in extended entry...)

The investment banking industry spent much of the past few years under a cloud of investigation, culminating in a billion-dollar settlement, with a prominent banker on trial and several analysts banned from the industry. Is the worst over?

I certainly hope so. It was a challenging period. It was very difficult to have everything we had done questioned in a very public way. For me, having my ethics questioned was really tough. That said, 1999 and 2000 were super-challenging too, but in a different way: 449 Internet companies went public during that period. Morgan Stanley analysts were involved with less than 10 percent of them. I was the lead analyst on seven, or less than 2 percent. We passed on the vast majority because we didn't believe in the business models or the IPO timing, and that means we passed on hundreds of millions of dollars in fees. That was not a cakewalk.

If you take a 60,000-foot view, the idea that the Internet is a business transformation tool or a change agent for society, well, it's a very big idea. And in those rare times when something as significant as the Internet comes along, history has proven that the changes create a lot of enthusiasm, fear, transitions, and volatility. Students of history could have predicted that there would be a very positive cycle followed by a very negative cycle. But, living through it ... that's quite different from knowing about it.

Did you ever want to just quit?

It's not in my DNA to punt. When you are going through what we went through, you don't have a lot of choice; you're with it until it's done. You can't wake up one day and say, "I don't feel like dealing with this anymore." It is what it is. My point of view was "Hey, the good news is that the environment for the Internet is stabilizing, getting better as a business proposition." There was always a light at the end of the tunnel. Sure, sometimes it was pretty hard to see. But I was optimistic that it would play out like we hoped.

What ended up happening to you and to Morgan Stanley? Will anything really change in your business?

We participated with nine other firms in the global settlement, and we've implemented the terms of the settlement along with the other required reforms. I still focus on the Internet and PC software companies and co-lead our global technology research group.

There were business practices on Wall Street that needed to be changed. In many respects it was a good thing that this happened. But process change is rarely as elegant as you'd want it to be.

Given that a strong case could have been made that a bust was coming by mid-2000, why didn't you revise your stock picks accordingly?

I am not happy that I did not downgrade the stocks back then. That is a disappointment. We articulated that we were in a very volatile and risky time, but we didn't appreciate the degree, speed, and power that a downturn could have. If one goes back and looks at the period from the fourth quarter of 1999 through the first quarter of 2000, that's when the Internet stocks really exploded on the upside. Living through it, it was really hard to determine the inflection point. And at the same time, many of the positive secular trends for Internet user and usage growth just kept cranking away.

You've been called a "true believer." Do you still believe in the Internet industry and the companies that lead it?

While I was and am a believer in the Internet opportunity, I was skeptical of most of the companies I saw during the late 1990s. Back then I was often quoted as saying that at least 70 percent of the Internet companies that went public would end up trading below their IPO prices. And, as of March 2004, 73 percent of the public Internet companies are trading below their IPO prices.

I still believe the wealth creation from the Internet will be greater than the value at the market peaks in early 2000. If you look at the four most highly capitalized global pure-play Internet companies -- eBay, Yahoo Japan, Yahoo, and Amazon.com -- they were worth about $220 billion in market capitalization at their respective peaks. They're worth about $155 billion now, up from the bottoms of about $16 billion in 2000 and 2001.

Your stock picks for 2003 were up 78 percent for the year. How do you feel about that performance?

I'd say satisfied, but it's just one year in a long game. 2003 was a good year, but it's an odd year when stocks are up that much. We try to focus on long-term performance, and over the past 11 years, my positively rated stocks have been up, on average, 50 percent annually. 2000 was a very bad year, and we were down 53 percent. Of course, I should add, as we always must, past performance is no guarantee of future performance.

How do you rate the prospects for Internet stocks during the next couple of years?

For the next year, we think the Internet space is moderately undervalued. For the longer term, as a group, we believe it's more undervalued. We maintain that the overall revenue and cash-flow growth outlook is still far greater than the market is giving it credit for.

Why?

There are a few basic things that many people may not fully appreciate yet about the Internet.

One is supply-and-demand chain management -- knowing how to effectively determine demand and get products to consumers and businesses. The value of that is off the charts, and the Internet is helping drive process improvements -- look at Dell (DELL).

Second, the leading Web companies have tens of millions of active customers, and their customer retention and acquisition costs are relatively low. This is allowing them, on a relative basis, to invest more in technology and user-experience improvements.

Third, the ability to connect to customers through search and e-mail and highly trafficked webpages helps weave the leading Web companies more pervasively into the fabric of everyday life, especially with broadband.

And last, North America accounts for only 29 percent of global Internet users, and that figure's declining. China, with 80 million-plus Internet users, is the second-largest market today, and will likely be the largest in five years.

So, are we entering a new era for the Web? Have the lessons of the bubble been folded into a more mature, mainstream industry?

I'd like to think so, but I'm not so sure. The same short-term-return culture still exists ... and greed never seems to disappear, though the degree and pervasiveness wax and wane. It's key to remember that the market is the true sieve -- over time, it sorts these things out.

A lesson relearned for investors is that they often make the most money when they can see the opportunity in front of them but most others don't believe them. At the end of 2002, most people did not believe in the Internet space. As we look forward today, we still think the Internet leaders should outperform the market over time.

John Battelle is a visiting professor at the University of California at Berkeley and author of "The Search" (Portfolio, late 2004).