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The Importance of Capital Structure
Forbes ASAP
March 25, 2002

By Michael Milken

The market for technology-related companies since the late 1990s has been déja vu for me and perhaps for many others who began their careers in the 1960s. This isn't the first time we've seen these stocks have huge run-ups and then collapse. It happened more than 30 years ago.

In 1967, long before Microsoft, Oracle, Sun and Apple were launched, Merrill Lynch published a research report correctly predicting that the computer industry would be one of the great growth stories of the next generation. The report listed 25 leading companies in the hardware and software business. Industry revenues, of course, have grown tremendously since 1967, yet remarkably, 24 of the 25 companies have disappeared or stopped selling computer and software products.

When your business depends on technology — whether it's aerospace, computer and electronics firms in the 1960s or Internet, telecom and networking companies in the 1990s — volatility is a fact of life. Unlike slower-changing industries like supermarkets, which can appropriately assemble a balance sheet with more debt, technology is an inherently risky business and needs a strong balance sheet to survive. In fact, risk in capital structure should vary inversely with business risk. The lesson of the 1960s that was lost on many technology executives and investors in recent years is that balance sheets need staying power. Smart management teams raise more capital than they require in good times — selling stock, for example, when the market is receptive — so they have sufficient liquidity to see them through the excesses of optimism and pessimism that occur in every business cycle.

Many of the successful startups of the 1960s, '70s and '80s that I had the opportunity to work with, such as MCI, McCaw Cellular, Turner/CNN and TCI, competed against much bigger companies and went through plenty of ups and downs. But because this group ultimately had the right capital structure, the companies had the staying power to survive and were later sold for a total of well over $100 billion.

Over the last few years, as business slowed and the NASDAQ sank, companies that had too little liquidity to match changing conditions were hit hard. Many didn't make it and others are barely hanging on. Those that created a capital structure that matched their business risk have survived and positioned themselves for future success.

Mr. Milken is Chairman of the Milken Institute, an economic think tank in Santa Monica, Calif.