The Flip's Flop: Three Simple Lessons from Cisco's Blunder

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Apr 13, 2011
On the front page of today’s Business section in The New York Times was an article about the Flip video camera, which I believe has three key anecdotal lessons for investors. While these certainly aren’t mind-blowing conclusions, they are fundamental ideas that should be part of the credo for investors. Before we jump into them, here’s some background on the situation:


In 2007, entrepreneurs at a startup called Pure Digital Technologies started selling camcorders for digital video (called Flip Video) in the market, and were initially met with success. Over the next two years they sold more than two million of them, and introduced a smaller version called the Flip Video Mino. This caught the attention of Cisco (CSCO, Financial), which justified a $590 million acquisition outside of their core competency (enterprise networking services) by saying that it was “key to Cisco’s strategy to expand our momentum in the media-enabled home and to capture the consumer market transition to visual networking,” adding that it would take the company’s consumer business “to the next level.”


Two short years later, despite the unreserved optimism of key executives at Cisco, the Flip has flopped. Along with products like the GPS and the alarm clock, the point and shoot camera industry has been left wondering why the smartphones had to come around. As noted by Brent Bracelin, an analyst at Pacific Crest Securities, “It’s a testament to the pace of innovation in consumer electronics and smartphone technology. More and more functionality is being integrated into smartphones.” Cisco has stated that they expect to take a $300 million charge as a result of shutting down Flip.


So what are the lessons for investors? Here are three that I’m taking away from Cisco’s blunder:


Watch out for Diworsification: Peter Lynch talked about it a lot in One Up on Wall Street, and it is an illness that has struck companies across the globe. As an investor, it is your job to understand a company’s core competency, and take note when it crosses into unchartered waters. According to Alex Henderson of Miller Tabak & Company, there wasn’t an analyst “on the planet” who thought that Flip was a good acquisition for Cisco. When companies you follow are involved in M&A, make sure you understand the reason behind the deal; if you don’t see how it fits in with the current structure and culture, it might be a red flag that management has lost its way and you need to get out before the ship starts sinking.


Invest in What You Know: The same can be said about Diworsification in your own portfolio; it’s hard to tell that Cisco has made an odd acquisition if you don’t know what Cisco does. While this should go without saying, you would be surprised: During the tech bubble, some stock prices jumped unexpectedly because investors (it pains me to use that word here) accidentally bought stock in a company with a similar ticker to the “hot stock.” If people can buy a stock without even knowing the ticker, they could easily do the same without understanding the business; don’t let this be you.


Look for Tortoises, not Hares: The mistake made by Cisco’s management is a testament to the words of Warren Buffett: Invest in companies with sustainable competitive advantages, which usually can be found in boring, slow-changing businesses. Potato chips, soft drinks and cigarettes may not be as cutting edge as smart phones and digital camcorders, but they provide sustainable and reliable streams of revenue and earnings to their owners. Avoid fads and growth stocks that are priced for perfection, and instead stick with boring businesses that generate consistently strong returns for equity investors that are rarely threatened by new entrants.