The Law of Unintended Consequences and an IPO

 
We have fun with laws all the time.  Think of the bumper sticker that says: "Gravity, It's Not Just a Good Idea, It's the Law." Or how about the law that says that your supermarket line is the one that will have the price check?  Or even the one that says that toast that falls off the table will fall buttered-side down (probably one of the many variants of Murphy's Law)?

There is, however, one law that's been a favorite of mine since I ran into it in a college history class.  It's The Law of Unintended Consequences.

The classic example of the LUC is the Treaty of Versailles that ended the First World War.  The victorious allies were somewhat peeved with Germany, and celebrated by imposing harsh reparations and economic restrictions to punish it.  (Just a bit of trivia: one of the provisions of the Treaty was that Bayer, the German pharmaceutical giant, was forced to give up two patented pain relievers.  The first was being sold under the trademark Aspirin.  The second was trademarked Heroin.  But more about that later.) 

The popular LUC theory is that the huge monetary reparations and strict industrial limitations placed on Germany created the economic chaos that allowed the Nazis to come to power and start WWII.  (Some historians disagree about this, but historians will disagree about just about anything, so they don't get a vote.) 

True or not, it's the perfect story to illustrate how ignorance, stupidity, short sightedness, malice and the vagaries of chance can turn well-meaning attempts at rule-making into a source of negative outcomes.

Prohition and Ethanol

Another classic example of bad results from good intentions is America's 13-year experiment with outlawing the sale of alcohol, known variously as the 18th Amendment to the Constitution, The Volstead Act or just plain old Prohibition. 

It's universally accepted now that Prohibition was a dismal failure, succeeding only in allowing organized crime to grow into a profitable colossus, encouraging the production of untold gallons of questionable (and sometimes dangerous) brews and liquors, and turning millions of Americans who just wanted a little drink into criminals.

My favorite current example of the Law of Unintended Consequences at work is the adoption of ethanol as the replacement for the 10% of MTBE added to U.S. gasoline supplies.  Since MTBE has been shown to be a persistent pollutant of ground water supplies, a change seemed like a good idea, and ethanol was a renewable, plant-based, U.S. product that would help farmers and reduce dependence on foreign oil.  Clearly a win/win proposition.

Well, not so much.  It turns out that the prime source of raw material for ethanol production is corn.  Corn production, in turn, is sensitive to applications of fertilizer.

As the price of corn rose in response to this new demand, the price of fertilizer skyrocketed, tripling in some cases.  Together with the diversion of massive amounts of corn from the human food chain to the automotive drive chain, rising prices for fertilizer have increased food prices worldwide, contributing to inflation, hunger and poverty. 

And the price of fertilizer is still going up.

The Law of Unintended Consequences is a serious business, but not a solemn one.  It can produce misery, and dire results, but it also yields the kind of ironic outcomes that make great stories. 

Heroic Heroin?

To get back to my bit of Bayer trivia, I like to point out that there have been two attempts to produce a non-addictive form of opium.  Everyone wants the pain relief that opium brings, but addiction is a high price to pay.  So a German pharmacist, convinced that it was the impurities in opium that made it bad, refined it and named the resulting compound for the Greek god of dreams, Morpheus.  Thus was morphine born. 

Working on the same principle of purification, Bayer further refined morphine and named the resulting compound after the German word heroisch, which means "heroic."  It's not a name most people would apply to heroin these days, but that's the way the Law of Unintended Consequences works.

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Well, it's official, China now has more wired citizens than any other country on earth. 

The Chinese government just announced that the number of Internet users in China just topped 221 million at the end of February, pushing it past the United States, which stayed firm with 215 million.

Of course, being an Internet user in China is a very different proposition from the usual practice in the U.S., where netizens can surf a virtual universe containing every imaginable opinion, service, product or sexual practice.  It's all there.

For Chinese users, things are a little different, as the government runs a small industry devoted to keeping ideas and information it doesn't like off Chinese computer screens. 

The Three T's

A lot of what it doesn't like is political, including the ominous "Three Ts" I was told not to talk about during my visit in March.  Taiwan, Tibet and Tian An Men Square are the three incendiary topics that the government is especially interested in controlling.  It uses elaborate screens and a small army of monitors (estimated variously at between 10,000 and as many as 50,000) to track people's surfing habits and block access to anything "objectionable."  As you can imagine, an ideological bureaucracy's idea of what's objectionable can cover a lot of ground.

There's no doubt that there's a lot of distasteful, disgusting and disreputable material out there on the Web, and lots of parents use software to keep objectionable content away from their kids.  And, of course, there are lots of people, including some lawmakers, who would like to take a crack at doing some access restrictions of their own.

So far, at least, the lawmakers of the United States, and the people who elected them, haven't assented to the idea that the government knows best what people ought to see on the Internet.  The American consensus is that erring on the side of too much freedom is preferable to having a government nanny to watch over us.

Accordingly, the absolute number of users may not be the most critical factor in deciding how the Internet works in (and for) a society.  China may have a neat, orderly Internet filled with only authorized thoughts and sanitized opinions.  Give me messy chaos every time.

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Rubicon Technology

One fun thing about the stock market is that a stock will occasionally pop up in an industry that you've never even heard of, much less thought about.

Hidden among the ranks of late-2007 IPOs was the coming-out party for tiny ($37 million in sales) Rubicon Technology, a company whose stock in trade is monocrystalline sapphire (and other crystalline products).  Rubicon supplies this optical-quality sapphire to all kinds of high-tech companies that use it to make LEDs, radio-frequency integrated circuits (RFICs, whatever they are), blue laser diodes, optoelectronics and the like. 

The most obvious uses for sapphire LEDs are for the displays on your hand-held phones and PDAs, camera flashes, computer backlighting, public signs, auto lights and traffic signals.

The intriguing part of Rubicon, which was founded in 2000, is that there are military, aerospace and other uses that they don't seem to talk about much.

It's not easy to gauge the prospects for a company with such a limited product line.  How many precisely-machined sapphire tubes, rods, wafers and cylinders does the world need?  The only hint we get is from Rubicon's sales, which increased 2% in 2005, 27% in 2006 and 64% in 2007, the first year the company made a profit. 

RBCN made a great run after its IPO, doubling from 14 to well over 30 before correcting back to around 22.  Most stocks need this kind of pullback after they're big going-public run loses steam.  The question will be where the stock goes from here.

Strong Q1 results on April 24 should have lifted the stock, but the company failed to lift 2008 guidance until officers were clear that planned additional manufacturing capacity would indeed come online on schedule.

The company's new facility in Bensenville, Illinois, is building capacity, including the manufacture of sapphire crystals 8 inches in diameter.

Aggressive investors looking to find a new tech stock early in its career should keep an eye on Rubicon.

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Sincerely,

Paul Goodwin
For Cabot Wealth Advisory

P.S. If you want to discuss this or any other issue of Cabot Wealth Advisory with fellow Cabot subscribers, head on over to the Cabot Forum at http://www.cabot.net/forum and start talking. The Forum is a place for like-minded investors to discuss the market, stocks or investing. Just register a unique username and password, log in and start a post or reply to one that's already been started. Check it out today!

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Paul Goodwin can be found on Google Plus.

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