NYT: Hot Stocks and Vice Precedence

Should you care if the companies you invest in have a dark side, if they make money in ways that might end conversations at cocktail parties or operate in the same slop bucket as the seamy underworld you’d rather not have your name associated with?

Back 10 years ago in my hedge fund days, one of our greatest investments was this tiny little tech company that made laser diode drivers. The stock was $3 a share and no one cared about it – heck, I had to look up what a laser diode driver even was. These little devices could turn read-only DVD drives into ones that could also record. Pretty cool. We figured that someday, VCRs would be obsolete. We were way too early on that, but sometimes, you just have to be in the right neighborhood. These $2 lasers also enabled the CD drive on your computer to record onto read/write CDs. But big deal. No one cared — until Napster came along and everyone and their uncle began illegally downloading music and buying CD-RW drives so they could burn discs for their car or portable CD players.

At the time, maybe 1 percent of PCs shipped with these read/write drives, but a few years later, 95 percent of PCs had them. Sales boomed, profits went through the roof and we sold the stock between $150 and $200 (makes up for all the $3 stocks that went to $1), all because law-abiding citizens like me (and admit it, you) didn’t feel all that bad ripping off music companies – maybe because we figured they have been ripping us off for years.

Did I feel bad that we made money because of (gulp) stealing? Should the Chicago Violin Case company feel bad because Al Capone used its product to help hold up banks? Or Ford for making the getaway car? Should the General Pencil Company feel bad because Andrew Fastow used one of its products, and come to think of it, Microsoft Excel, to fudge Enron’s numbers? Still, I feel guilty enough to think about it once every 10 years. All these products have legal uses that criminals employ for their devious purposes, like copying pages of a book with a Xerox machine.

Apple’s Steve Jobs dresses in black like a cat burglar for a reason. His stock has gone from $9 to $90 in the last four years, creating almost $70 billion in new wealth in the process, lots of it for Steve Jobs, on the back of the best-ever device for the transport of stolen material — the iPod.

Remember the Apple marketing message: Rip, mix, burn. More like rip, share, steal, enjoy. O.K., Jobs has made some amends by actually selling music on Apple’s iTunes service, but run the numbers – by far the majority of music downloaded to iPods has not been purchased online. Where is Dog the Bounty Hunter when you need him?

Vice has a long history on Wall Street. I refused to invest in tobacco companies like Philip Morris. Shame on me, they would have been great investments. Same for Wynn Resorts or MGM Mirage, huge gambling enterprises that, as the saying goes, prey on suckers who don’t understand statistics. Come to think of it, it’s not just Vegas. Yahoo makes money running N.C.A.A. brackets. You gotta have some action on these games else lose your place at the water cooler.

Playboy Enterprises is a vice precedence. But what about Comcast and TimeWarner? A nice chunk of their cash flow comes from flesh tone, er, adult cable channels. Same for DirecTV and Echostar. Glistening anatomy is an extraordinarily profitable business. Anyone else making illicit gains from this stuff? Well, there are Hilton and Marriott; some 70 percent of their in-room entertainment dollars comes from stuff that’s not for children. Google and Yahoo refuse to release how much of their revenue and profits come from keywords such as “XXX.” Most investors don’t want to know – it’s bigger than you think.

O.K., lifestyle vices like smoking and gambling are one thing, but stealing is right there in the Ten Commandments. Sadly, a five finger/click discount of Bono or Beyoncé pop tunes is old hat. Many consumers already value them at zero. But what about movies? They are $10 at the theater and close to $20 for a DVD. Stealing them is big business, and I don’t mean sneaking into the dodecaplex or a DVD down your pants. Instead, look at Netflix. Some 7 million customers pay $15 to have two DVDs sent to them at a time. A large number of them return the movies the next day so they can get two more. Did they watch them? I doubt it. A piece of free software called DVD43 breaks the security of the DVD so you can read its video files onto your hard drive. Another called DVD Shrink copies the movie and then writes it back to a DVD-R disk on a recordable DVD drive (Hey, I knew those laser diode drivers would work in DVDs eventually!). Kids, don’t try this at home.

Of course, a shiny disk with “The Departed” written in magic marker is a sure sign of stolen material. No worries. The Web site cdcovers.cc has almost every DVD cover and case artwork ready to download. My guess (how would I know personally?) that between the Netflix subscription fee, blank DVD, case, circular label, heavy paper especially made for DVD covers and ink, those Netflix Al Capones are out $3.50 instead of the $28.98 suggested retail ($15.99 on Amazon) that studios clip us for.

I’m not passing judgment. I’m neither looking down my nose nor condoning piracy, hot stocks or sleazy vice businesses. This stuff is going to happen - its part of the world. But money is blind; it chases profits. As long as laws and social norms allow it, don’t let your own morals get in the way of a good investment.

http://kessler.blogs.nytimes.com/2007/04/16/hot-stocks-and-vice-precedence/

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