These recent events highlight the lucrative nature of infrastructure investments and the persistent and controversial trend of foreign companies and sovereign wealth funds acquiring huge infrastructure assets in the United States. The political environment grows increasingly hostile as national and local politicians, including the presidential candidates, look to explain Americans’ economic struggles with a cornucopia of reasons including free trade agreements like NAFTA, a “corrupt sitting president,” and globalization generally.

This issue of foreign investment in public infrastructure has been on my radar since late 2006. Below is an essay I wrote for an investment newsletter published in January 2007 distributed to high net worth clients.

Public Infrastructure Sales: Samurais, Jihadists, and Masters of the Universe

“The Japanese are coming!” Remember when modern-day Paul Reveres shouted this refrain in the 1980s? Honda (HMC), and Toyota (TM) earnestly began their conquest of the American driver and, resultantly, Detroit’s mammoth metal benders. Would-be samurais from a nation of diminutive conformists threatened our towering sense of American exceptionalism by snatching up national treasures from our private sector like Pebble Beach, Columbia Pictures, Universal Studios, and Rockefeller Center. Although the apocalyptic visions of Japanese dominance and American indentureship have faded, the “buying of America” continues today.

Only now, the purchasers hail from different shores and their acquisition targets are of a more public flavor. In January 2006, a plan to privatize the Indiana Toll Road came to fruition when the State of Indiana entered into an agreement with Cintra (a Spanish construction firm) and Macquarie Bank (an Australian bank). The Spanish-Australian partnership paid the Indiana State Government $3.85 billion for a 75-year lease to operate and maintain the toll road. The same consortium recently entered into a $1.83 billion lease to operate the Chicago Skyway Toll Bridge. As these foreign entities begin to exact payments from beleaguered commuters, resistance to foreign ownership of public infrastructure grows.

Free trade and free markets be damned. Early this year, public sentiment derailed the proposed Dubai Ports World acquisition of U.S. ports facilities in New York, New Jersey, Philadelphia, Baltimore, New Orleans, and Miami. In a cacophonic display of bipartisan zealousness, Republican and Democratic members of Congress questioned the wisdom of selling strategic infrastructure assets to not only a foreign country, but one which two members of the 9/11 hijackers called home. The overall tone could be summed up by the mordant one-sentence letter Representative Sue Myrick (R-NC) sent to President Bush that read, “Dear Mr. President: In regards to selling American ports to the United Arab Emirates, not just NO – but HELL NO!”

Being neither knee-jerk nationalists nor adherents to Ricardian economic orthodoxy, the editors of this publication acknowledge the merits of both the free market argument and the argument for excluding strategic infrastructure from the free market. One of the tenets of free trade asserts that private industry is more efficient at delivering services than government, and experience has confirmed that theory. But, when does that precious efficiency bump up against national sovereignty and security? Pragmatic protectionists should point out that ports and roads are different species in the genus of public infrastructure; that roads are strategic but ports are more strategic.

Do we as a nation make distinctions between domestic private players and foreign entities? How do we respond to foreign companies that are not entirely private, being controlled by foreign governments? In the case of Dubai Ports World, the United Arab Emirates government owns a stake in the port operator. How do our reactions at home affect the ability of our own private companies to venture abroad and invest in and own foreign assets?

Through all this brouhaha, the editors of this publication see an opportunity for the many domestic leveraged buyout firms within our own borders. With over $175 billion raised in 2006 alone, the industry is flush with liquidity. At the risk of sounding cliché, we echo the industry’s mantra that there is “too much capital chasing too few deals.” With all the largest funds finding themselves in highly contested auction environments for companies suitable for buyouts, even the most sanguine investors admit that future returns will lag past performance. Public infrastructure as an asset class represents a potential opportunity to deploy some of that excess liquidity and to diversify LBO or private equity portfolios.Some questions beg consideration. This asset class will no doubt offer lower returns than traditional private equity investments; does the stability of returns compensate for that shortfall? What are the reasonable exit opportunities? What consequences might arise from shifting concepts of private and public property? How can the public be safeguarded from the specter of crony capitalism?

Questions notwithstanding, infrastructure investments with their super-stable revenue and profit streams offer the possibility of smoothing out the volatility of returns in portfolios otherwise dependent on the ever shifting environment for initial public offerings, mergers, and acquisitions. The promise of stable returns is causing some financial masters-of-the-universe to contemplate establishing investment pools to capture this opportunity. Goldman Sachs (GS), the Carlyle Group and other top institutions are all rumored to be pitching this idea to limited investors. We’re quite sure that hedge funds will want to get into this game too.We suspect there might even be an inefficiency here for domestic buyout firms to exploit. Public sentiment against encroachment by foreign firms might allow for lowball bids by domestic buyout firms. This compromise between public and private could placate the citizenry. The Golden Gate Bridge anyone?

The market takes a breather after several weeks of blistering recovery from last winter’s doldrums. Commodities all around saw amazing advances. Crude oil rose 8.3% last week and has more than doubled over the last year. I remember taking my first car, a Honda (HMC) Civic, out for the first time and pumping gas for about $1.18 per gallon. This was also in the notoriously gas-expensive San Francisco Bay Area. Base commodities and gold continue to follow oil’s lead in going the opposite direction of the U.S. dollar. Will the likely Democratic presidency mean a material difference to the nation’s budget policies and thus the value of our currency?

The tech-laden Nasdaq Composite took a 1.3% dive last week. Does this in any way validate my technology industry bifurcation thesis? Absolutely not. Relative to the rest of the equity markets, the Nasdaq Composite performed decently. The S&P 500 stock index saw a 1.8% decline while the Dow Jones Industrial Average (a poorly constructed index) lost 2.4% over the last week. More painfully for investors anticipating a real estate recovery, REIT stocks lost 3.2% collectively. The Nasdaq Composite (actually a very well constructed index) performed better than other equity indexes. In essence, technology stocks as a whole, large blue chips and second tier small caps, did better than the old industrial giants found in the DJIA and the big caps in the S&P 500 by a significant margin.

We have seen very little evidence of second-tier technology companies suffering from the recent slowdown in economic activity. This is particularly interesting because one of the historic catalysts for technology capital investment by enterprises, the Microsoft (MSFT) operating system upgrade cycle, is not a large factor in this market. The Vista operating system has not caught fire like previous Microsoft operating system launches. The Windows XP operating system was a blockbuster and so were earlier versions of Windows. Prior upgrading cycles resulted in renewed investment in computer equipment, computer peripherals, and secondary software products.

Macro

I’ve alluded to my concern about Ben Bernanke’s ability to display great staying power in his effort to jump start the economy by lowering interest rates. With oil and commodity prices barreling higher every week, the specter of inflation looms menacingly and hampers the Federal Reserve’s ability to continue lowering rates. The macro themes of globalization and emerging giants like China and India have been the drivers of skyrocketing prices in oil and food commodities.

However, I see imbalances developing between asset prices and the underlying supply and demand curves. Crude oil’s meteoric rise to record prices never before seen in history is rooted primarily in fundamental, systemic growth in demand. But the recent, almost parabolic rise in oil prices suggests that speculators and trend followers are piling in, hoping for continued profits flowing. Speculators and trend followers, by definition, introduce inefficiencies and imbalances to asset prices. China’s trade surplus is growing at a decelerating pace. Our diminished dollar makes our goods and services much more attractive to foreign consumers. It also makes foreign goods and services much more expensive for Americans to buy. The trade frictions caused by our historically cheap dollar might just slow down emerging markets growth and thus the demand for oil. Oil is the hot investment right now, but it could be flammable for recent riders of the bandwagon. We might be caught in what I call the “Black Bubble.”

Micro

Priceline surges on strong earnings, outlook – Priceline.com (PCLN) hit an eight-year high as both its domestic and international businesses enjoy huge demand. The company’s business model, which allows travelers to name their own prices or bids, has been attracting legions of bargain-hunting travelers. How long will this last? Priceline.com is one of the few companies thriving in the travel industry. The airlines, other online travel retailers or portals, and car rental companies have mostly seen their stocks decline over the last year.

Constant Contact’s first quarter revenue soars – Email marketing is so Web 1.0, isn’t it? Older Internet users still rely heavily on email. Early adopters and younger users of the Internet are less reliant on email. Instead, they gravitate to other services such as instant messaging, text messaging, and social networking. Twitter, is a very interesting next generation platform that further reduces the need for email communication. All these usage patterns do not bode well for Constant Contact (CTCT), a provider of software for email marketing campaigns.

The CAPS Screen: 10 Small Caps on Fire – The Motley Fool includes Interactive Intelligence (ININ) in one of their interesting screening exercises. Interactive Intelligence makes software that manages call center or contact center operations. Screens are a good way to generate investment ideas, but a formulaic investment program based on screened variables does not automatically lead to good investments. Many investors employ screens to find stocks selling cheaply. Sometimes, companies are cheap because they deserve to be cheap as the economic merits of their businesses deteriorate. An investment decision made solely by screening and without knowledge of the competitive standing of the company in question is akin to marrying a girl solely because she comes from a good family. Full Disclosure: I currently have a long or short position in ININ in one or more of my private investment partnerships.

National Oilwell Varco, Inc. Q1 2008 Earnings Call Transcript – I mentioned that oil appears to have become a speculative market surrounded by a thin film of soapy substance. Bubbles don’t fizzle out, they usually burst or pop with ferocious force. National Oilwell Varco (NOV) provides equipment and supplies to the oil and gas industries and has been a big beneficiary of the rising price of crude. The price of oil may continue its amazing ascent or it may flush out the speculative latecomers, but the imperative to keep searching and producing oil will hardly diminish.

James River Coal 1Q loss widens on higher costs, stoppage – Alternatives to oil become more attractive as black gold becomes more expensive. Thus, oil shale, ethanol, coal, solar power, and biofuels become serious considerations. I have been investing with this thesis for over a year. James River Coal (JRCC), one of the worst managed coal companies around, has seen its stock move in lockstep with the rising price of oil. So although it continues to run into management and operating gaffes, the stock market has rewarded it and its highly leveraged balance sheet with new price highs. Full Disclosure: I currently have a long or short position in JRCC in one or more of my private investment partnerships.

Social networking has thus far been primarily about connecting with lost friends, playing simple games, and gawking at strangers. Aside from the amazing ability to reconnect with buddies from middle school, the rest of social networking mirrors normal human behavior in real life. Lots of people need an avenue for rest and relaxation. Dumb games like Pirates vs. Ninjas on Facebook replaces old time-wasters like watching TV. Who hasn’t been to the mall or the park watching people pass by? We’re all voyeurs to some degree but social networks like Myspace (NWS-A) make us Peeping Toms powered by technology.

It’s been great fun, but social networks have ambitions to be more than just a digital playground. They want to be super hubs of e-commerce where people go to buy stuff. Even on that front, current efforts have been less than inspiring. Facebook has had some success getting people to spend micro amounts of money sending small digital images as gifts for their friends. This is much like the candy grams I bought for all the pretty girls in middle school, juvenile and bound to lose its novelty. Of course, new generations of kids are always going to join social networks, so the “digital dollar” gifts will always be in demand. It is a valuable business, but one that could evolve into something greater if Facebook or competitors figure out more useful applications for micropayments or “digital dollars.”

I believe that it’s perfectly fine for social networks to remain as fun hangouts but if the Zuckerbergs and DeWolfes of the world want their networks to be much more, things will have to change. The future of social networking requires much more elegant thought leadership that will lead to much more robust applications made by much more skilled developers and managers.

A big change has already begun. Corporations are slowly dipping their toes into the waters. While they’ve been big advertisers on the networks, they are beginning to interact directly with the community. Some are leveraging existing networks. Others are building their own networks so they can customize that interaction.

Let’s take a quick survey of what some grown-ups are doing today in the social networking space. This is by no means an exhaustive study, think of it more as a sampling of some of the more interesting and unique approaches. It remains to be seen which of their differing approaches will succeed, but a careful watch of their efforts might give us clues as to what that elusive future of social networking might look like.

Struggling Starbucks (SBUX) has seen its stock price fall over 40% over the past year due to slowing growth, customer apathy, and fierce competition from the likes of McDonald’s (MCD) and Dunkin’ Donuts. It recently announced the launch of its own social networking website called My Starbucks Idea. In what looks like a valiant corporate effort in crowdsourcing or leveraging the wisdom of crowds, the website attempts to engage the audience to share ideas on how to make Starbucks better. Not sure if the company has ever used fancy pants MBAs and consultants who think in terms of profit margins, market share, and brand extension, but any attempt to get the average Joe to opine about his cup of Joe makes sense. These are presumably the people who feel the strongest about their daily java fix, an emotional connection that ought to lead to insightful ideas. Therein lies a natural problem; the most passionate fans of Starbucks who share ideas are not the bulk of customers who feel that Starbucks has lost its way but wouldn’t be motivated enough to tell anyone why. While I’m at it, here’s my suggestion: brand extension usually does not work – get rid of the tastefully compiled music compact discs.

Networking giant Cisco Systems (CSCO) has always excelled in growth through acquisition. By acquiring technologies developed by small startups or budding competitors, the company has been able to keep its technology edge and maintain market leadership. However, this strategy has always been a tad expensive; after all, the venture capitalists that backed the acquisitions need to be paid off for making good bets. Now Cisco has launched a competition called I-Prize that could help the company identify good ideas long before they become pricey startups. The I-Prize competition allows the company to reach out to its community or ecosystem and motivate submission of ideas for rewards. The best idea gets funded as a new business unit and the idea generators get a big signing bonus and employment. The social networking aspects of I-Prize include the ability for entrepreneurs to comment on each other’s ideas and network with each other to form collaborative teams. Recently, Cisco released a blog post describing the demographic details of the semi-finalists in the competition. It appears Cisco is having a successful experience with this program.

Overstock.com (OSTK) has seen its stock price follow the trajectory of a roller coaster over the past year. The online retailer suffers from negative margins and a supremely competitive online landscape. It recently launched a community portal on its website that allows users to blog about their interests, write product guides and reviews, discuss auction items in online forums, and read the latest articles written by CEO Patrick Byrne. Byrne has been pilloried by the vicious financial press for his unorthodox behavior, but I love his independent, contrarian, and defiant style. I think the attempt to engage its most loyal shoppers to contribute product guides and blog about favorite products makes sense, but I would implement the strategy differently. Instead of Overstock hosting the blogs and reviews on its own website, it should attempt to build a loose network of affiliate bloggers and guides similar to blog networks such as Know More Media, b5media, and Pajamas Media. The separate network approach would result in less control but better search engine rankings, increased traffic driven by external sources, and a more active affiliate program fueled by a rewarding incentive scheme.

Dell (DELL) operates a website called IdeaStorm that resembles My Starbucks Idea. The mammoth computer manufacturer wants its customers to post and discuss ideas. One large component of the interaction design on the website involves the ability to “promote” or “demote” ideas posted by others. In this way, the site imitates the crowdsourcing methodology pioneered by Digg, the news aggregator community. For corporate executives that have been tasked with the daunting responsibility of building web communities with the potential to feed the parent company with business intelligence and game-changing ideas, check out Salesforce.com’s (CRM) Ideas platform. Dell’s IdeaStorm is built on the Ideas platform and appears to be a good implementation. My Starbucks Idea is also powered by the same platform. The platform is definitely a more cost effective solution than building a platform from scratch, but care should be given to customization and integration with existing websites or properties.

Dell has also been experimenting with innovative forms of advertising on social networks. Instead of what I call “passive advertising” on the margins such as banner ads and margin text ads, Dell is putting its name directly on web applications that social network denizens interact with. In partnership with Federated Media, Dell conducted an art competition on the Graffiti application on Facebook centered around the question “what does green mean to you” which ultimately drove traffic to another one of Dell’s social networking sites, ReGeneration. The ReGeneration campaign is an early example of what I call “appvertising,” a more direct and intimate form of advertising made possible through social networks.

Our favorite whipping boys, the American auto industry, might well need to try anything and everything to stem its losses to the relentless Japanese auto companies. In other words, in times of desperation, throw everything at the problem including the kitchen sink. General Motors Corporation (GM) has decided that social networking might be one way to persuade American consumers to buy Cadillac Escalades, Buick Enclaves, and Chevrolet Corvettes instead of Honda (HMC) Accords and Toyota (TM) Corollas. GM Next, the company’s attempt at social networking, is a content rich site that includes blogs, podcasts, and a healthy serving of videos. Unfortunately, the site feels too promotional and not focused enough on carrying a genuine conversation with car enthusiasts.

We’re witnessing the early stages of corporate involvement in social networking, both on the mass consumer social networks and on specialized corporate social networks. The operators of popular social networks desire to be more than just massive collections of frivolous games and applications. They’d like to move beyond the amateur and simple coding exercises haphazardly thrown together by weekend programmers with illusions of getting rich off their tiny applications. I think that’s a dangerous change in direction and few social networks will succeed in growing up and surviving the coming shakeout. It would behoove some savvy social network executives to heed Geoffrey the Giraffe of Toys “R” Us fame and consider that “we don’t want to grow up.”