One of the smartest people I know lost $2 million recently shorting Dell, and another good chunk shorting Excite. This is instructive, because it shows just how difficult and dangerous shorting stocks can be. (I warned you!) This fellow was not born yesterday. He made his fortune early as a Wall Street trader. He lives and breathes computers. He is not reckless. (That is, he did not short 100,000 shares and watch Dell jump 10 points; he shorted 2 shares and watched it jump a million points – what were the chances of that? – or so it feels to him.)

He points out that Dell’s $60 billion market cap now rivals that of Hewlett Packard, while competitor Gateway Computer has a market cap of more like $7 billion. Is Dell that much better than the rest? Can IBM and Compaq never threaten its growth?

One interesting advantage Dell has (my friend notes ruefully, in hindsight) is that it charges no sales tax. Because it does business only in Texas, it charges only Texas customers sales tax. (Don’t hold me to this; it is his perception; I haven’t checked it.) Gateway and the others sell through retailers throughout the country and have offices in many states, and are thus required to tack sales tax onto their mail-order sales.

Right there, through no technical brilliance other than the quirks of tax law, Dell has, typically, a 6% to 8.5% price advantage over the competition.

(Theoretically no such advantage exists. Theoretically, Dell’s customers file “use tax” forms and pay the tax that way. Dell has no responsibility to collect it, but, theoretically, its customers in most states have an obligation to pay it. But do you know anyone who ever has?)

So, as we commiserate over his loss – $2 million may not be much to you, but it is to him – we plot Dell’s downfall. We envision state sales tax authorities subpoenaing Dell’s customer lists and hitting up customers for delinquent use tax plus interest and penalties. We envision cheap foreign imports, made all the cheaper by the Asian crisis, eating into Dell’s margins and market share. We envision a tornado hitting Austin, or Michael Dell being indicted for violating the Illegal Alien Act. (Anyone who has done so phenomenally well so phenomenally young must be from another planet.)

To be honest, I don’t personally put a lot of energy into envisioning these things, because I am not short Dell. I put my energy into envisioning the things I hope befall the Internet stocks I am short.

Excite is not one of them – my friend is short Excite – but after we finish persuading the local tax authorities to go after Dell customers, it is our dream to get IBM, Compaq and the others – the companies that determine how new PCs are shipped – even Dell – to begin exercising their muscle in this area. Yahoo wants to be the default start page on Compaq-shipped browsers? Fine. Compaq should charge Yahoo $100 trillion a year for this privilege. How would that cut into Yahoo’s profits (assuming Yahoo someday were to have profits)? Excite wants this privilege on IBM Thinkpads? IBM should charge Excite $100 trillion as well. IBM and Compaq, et al, have the leverage here – they just haven’t woken up to realize it and claim their share of the pie.

This is how tough short-sellers think when the going gets rough. Because you know the old saying: When the going gets rough, the tough get … margin calls.



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