Selling Our Telecom Position
Several people on twitter in addition to some inwards individual have got asked me for an update on my real bullish spot on Verizon - peculiarly since the results were non equally expert equally expected terminal quarter.
I promised I would last forthcoming - but that I wanted to piece it out to our clients first. This is an extract from a client letter.
I desire to start alongside the master copy bull thesis.
The master copy thesis
The master copy thesis came from watching Randall Stephenson (the CEO of AT&T) beak at a Milken Conference inwards 2012. The master copy recording is here. The relevant portion of the video starts at close infinitesimal 18.
Randall Stevenson tells a even out of the iPhone’s introduction. The introduction of smart phones ran the society out of capacity inwards parts of country. [Apple offered the iPhone solely through AT&T inwards the USA.]
In New York the problems were intense. The electrical charge inwards New York was that the iPhone was a peachy telephone so long equally y'all accepted y'all could non usage it equally a phone. Jon Stewart mocked the coverage alongside odd brutality on the Daily Show (link).
AT&T solved this yesteryear to a greater extent than in addition to to a greater extent than upper-case alphabetic lineament expenditures. At the time, capex ran at simply about US$20 billion per annum. AT&T was – other than the authorities – the unmarried biggest upper-case alphabetic lineament spending entity inwards the US.
Stephenson (speaking inwards 2012) said that the same occupation would recur equally usage continued to grow massively. But this fourth dimension Stephenson argued it is different. He asserted that AT&T would non last able to solve this occupation yesteryear to a greater extent than upper-case alphabetic lineament equipment. Spectrum congestion was inevitable.
He saw this equally apocalyptic, but nosotros saw potential pricing powerfulness in addition to improving profitability.
We were doing uncomplicated arithmetics in addition to getting real large numbers. Most Americans if given a selection betwixt their pay-tv provider in addition to their smart telephone would remove the smart phone, but they currently pay to a greater extent than for their pay-TV.
We figured that if at that spot were a shortage of capacity in addition to then the telephone companies would larn a lot of pricing power. Our figuring was that alongside $10-15 per calendar month of extra pricing powerfulness Verizon would air current upward equally a real expert stock indeed. And nosotros did non encounter a ground to halt at $10-15. [It wasn't difficult to railroad train a model where Verizon injure upward worth to a greater extent than than Apple.]
This of class led us to exercise a lot of query into telecommunication technology scientific discipline to encounter if nosotros could verify Mr Stephenson’s claim of inevitable shortage. And equally nosotros discovered zilch inwards this infinite is ever equally uncomplicated equally Mr Stephenson’s blanket claims.
So – at the opportunity of offending people alongside deep noesis of how mobile telephony industrial plant – nosotros are going to give y'all a unsmooth agreement of the issues. We exercise it yesteryear uncomplicated analogy.
This leads us to the 3 ways telephone carriers (like AT&T or Verizon) have got managed to conduct to a greater extent than wireless data:
a). Advances inwards encoding technology scientific discipline (from 3G to 4G, for instance),
b). More jail cellular telephone partition (deploying to a greater extent than equipment) thus shrinking the number of users sharing a unmarried cell,
c). Deploying to a greater extent than “colours”, also known equally to a greater extent than spectrum.
We in addition to then spent a lot of fourth dimension researching the limits to each approach, in addition to nosotros focused on spectrum because Randall Stephenson led us there.
Not all spectrum is equivalent. Some tin top through walls (low frequency radio). Some cannot (eg visible light). But going through walls is of import if I desire to usage my mobile telephone inside.
It turns out that to a unsmooth approximation low-cal tin top through an object one-half its wavelength thick. (The physicists volition pick objections to this statement.) But low-cal at 600 MHz volition top through the walls of most buildings but low-cal at 5000 MHz (where upper-band WiFi is located) volition not.
This makes 600 MHz spectrum much to a greater extent than useful for mobile telephony. It is sometimes called “beach forepart spectrum” for this reason.
There is a lot of high frequency spectrum available, but it does non have got expert propagation characteristics. Sprint – the U.S. carrier - is unlikely to ever run out of such spectrum. There is, however, a express amount of “beach forepart spectrum” available which has real expert propagation characteristics.
Thus the high frequency players similar Sprint or T-Mobile inwards the U.S. tend to offering inexpensive unlimited packages (because they have got a lot of spectrum) but have got lousy coverage.
By contrast depression frequency players (AT&T in addition to peculiarly Verizon) tend to have got express capacity (as at that spot is express depression frequency spectrum) but peachy coverage (because it propagates well).
In this form of marketplace nosotros wanted to ain the low-frequency players, equally they ain what is express in addition to valuable. But the low-frequency players exercise non have got unlimited pricing power, because customers mightiness jump to high-frequency players offering a inexpensive – albeit inferior – product.
We purchased positions inwards shares inwards depression frequency players who nosotros believed would ain increasingly valuable spectrum. We figured all nosotros needed to exercise was wait.
And the information was largely supportive. Verizon Wireless revenue grew quite quickly, fifty-fifty when the fixed draw occupation organisation was declining. Here is a slide of Verizon Wireless revenue from the 2013 Q4 Verizon earnings presentation (slide 7):
Note 8 pct points of Wireless revenue increment – in addition to real fast EBITDA growth.
You could non encounter this inwards the Verizon accounts because the landline occupation organisation was declining, but our logic was that the landline occupation organisation would halt declining in addition to the wireless increment would continue.
The thesis was reinforced when real high in addition to increasing prices were paid for spectrum inwards recent auctions inwards many jurisdictions inwards the world.
We went so far equally to download from the Federal Communications Commission a listing of spectrum ownership yesteryear county inwards the U.S. in addition to tally that alongside the population information from the census. We used spectrum prices that nosotros saw existence used yesteryear major parties inwards large auctions. Prices are ordinarily considered inwards dollars per MHz per caput of population. We concluded that Verizon offered the best valuation in addition to that using this model owned $500 billion worth of spectrum. If the spectrum prices that nosotros observed existence paid were rational in addition to then Verizon inwards particular was really cheap.
The Verizon spot had an additional advantage: the penalization for existence incorrect appeared low. After all, if nosotros were wrong, in addition to then nosotros owned Verizon, a high-dividend paying “grandma” stock.
AT&T’s behavior
One wing inwards the ointment of our thesis was the continued bizarre demeanor of the major carriers – peculiarly AT&T. If the spectrum even out was equally expert equally nosotros thought, in addition to then if y'all ran a telephone society y'all would non dilute your stock nether whatsoever circumstances. You would largely usage spare cash to purchase dorsum your stock in addition to would bide your fourth dimension until the loot flowed inwards from rising prices.
If y'all believed Randall Stephenson’s even out that is what y'all would do.
Instead AT&T purchased DirecTV – a large satellite TV company.
At ane phase nosotros had a large AT&T position. Their demeanor convinced us to sell. Besides Verizon was meliorate on the spectrum valuation model described above.
Still this irked us. Perhaps nosotros were wrong…
The thesis broke
There were several things that, should nosotros uncovering them, would tell us nosotros were wrong. These were:
a) The cost of spectrum at major auctions or major transactions non continuing to rise;
b) Verizon, inwards particular, or depression frequency carriers inwards full general offering increasingly large bundles at lower prices; and
c) Wireless revenue increment slowing.
We were unconcerned close cost contest for small-scale information bundles (say 2GB of information per month) because nosotros figured at that spot was plenty capacity to offering everyone a few GB of data. But nosotros were real concerned if discounts were offered on large bundles of 10GB or more. Most importantly nosotros did non desire to encounter the reintroduction of unlimited bundles.
Alas our thesis broke pretty rapidly on all 3 criteria over the yesteryear vi months. The incentive auction (that is the recent U.S. spectrum auction) produced much lower spectrum prices, Verizon reintroduced unlimited bundles, in addition to revenue increment slowed--and in addition to then slowed some to a greater extent than (it is soundless positive, but only just).
The entire spot was sold.
Obviously the engineers at Verizon remember they tin handgrip all the extra usage that volition last piled on what nosotros idea was their express bandwidth.
When the thesis is incorrect it is fourth dimension to sell.
How bad could it get
We really remember it could larn quite bad at the carriers. The world’s worst occupation organisation is ane alongside high fixed costs, depression marginal costs, in addition to lots of competition. In that illustration the competitive forces volition drive prices downwardly to the depression marginal costs – in addition to it volition last impossible to recover fixed costs.
When the fixed costs are debt financed, bankruptcy ofttimes follows. That is exactly why the airlines have got been bankrupt many times. The marginal cost of filling the otherwise empty spot is real depression – in addition to contest at times drives prices to those real depression marginal costs.
If wireless telephony capacity really is unlimited in addition to the carriers insist on cost wars in addition to then the hereafter is bleak indeed. (For shareholders, if non for consumers.)
We have got gone from thinking the carriers were exceptionally expert longs to believing they mightiness last expert shorts. We are non at that spot yet: nosotros would similar to encounter falling wireless revenue first. But if spectrum
isn’t genuinely scarce this could larn ugly.
John
I promised I would last forthcoming - but that I wanted to piece it out to our clients first. This is an extract from a client letter.
I desire to start alongside the master copy bull thesis.
The master copy thesis
The master copy thesis came from watching Randall Stephenson (the CEO of AT&T) beak at a Milken Conference inwards 2012. The master copy recording is here. The relevant portion of the video starts at close infinitesimal 18.
Randall Stevenson tells a even out of the iPhone’s introduction. The introduction of smart phones ran the society out of capacity inwards parts of country. [Apple offered the iPhone solely through AT&T inwards the USA.]
In New York the problems were intense. The electrical charge inwards New York was that the iPhone was a peachy telephone so long equally y'all accepted y'all could non usage it equally a phone. Jon Stewart mocked the coverage alongside odd brutality on the Daily Show (link).
AT&T solved this yesteryear to a greater extent than in addition to to a greater extent than upper-case alphabetic lineament expenditures. At the time, capex ran at simply about US$20 billion per annum. AT&T was – other than the authorities – the unmarried biggest upper-case alphabetic lineament spending entity inwards the US.
Stephenson (speaking inwards 2012) said that the same occupation would recur equally usage continued to grow massively. But this fourth dimension Stephenson argued it is different. He asserted that AT&T would non last able to solve this occupation yesteryear to a greater extent than upper-case alphabetic lineament equipment. Spectrum congestion was inevitable.
He saw this equally apocalyptic, but nosotros saw potential pricing powerfulness in addition to improving profitability.
We were doing uncomplicated arithmetics in addition to getting real large numbers. Most Americans if given a selection betwixt their pay-tv provider in addition to their smart telephone would remove the smart phone, but they currently pay to a greater extent than for their pay-TV.
We figured that if at that spot were a shortage of capacity in addition to then the telephone companies would larn a lot of pricing power. Our figuring was that alongside $10-15 per calendar month of extra pricing powerfulness Verizon would air current upward equally a real expert stock indeed. And nosotros did non encounter a ground to halt at $10-15. [It wasn't difficult to railroad train a model where Verizon injure upward worth to a greater extent than than Apple.]
This of class led us to exercise a lot of query into telecommunication technology scientific discipline to encounter if nosotros could verify Mr Stephenson’s claim of inevitable shortage. And equally nosotros discovered zilch inwards this infinite is ever equally uncomplicated equally Mr Stephenson’s blanket claims.
So – at the opportunity of offending people alongside deep noesis of how mobile telephony industrial plant – nosotros are going to give y'all a unsmooth agreement of the issues. We exercise it yesteryear uncomplicated analogy.
Imagine us inwards a real large room (say a large indoor stadium), y'all alongside a receiver in addition to me alongside a transmitter flashing a reddish light.
I could flash y'all a signal. Morse code would do.
With Morse code I could flash things to y'all at a maximum charge per unit of measurement of close 5 characters per second. That is non real fast.
Alternatively I could usage a figurer to command my flashing low-cal in addition to y'all could usage a figurer to read it.
I could in addition to then flash signal to y'all at close the intensity of a CD player. It’s quite a lot of information. More than plenty for y'all to run the cyberspace at a reasonable speed.
The get-go in addition to most of import way inwards which nosotros have got got to a greater extent than capacity is yesteryear using meliorate in addition to meliorate signal encoding in addition to decoding. In mobile telephony, nosotros refer to the generations of transmission technology scientific discipline equally analog, 2G, 3G in addition to 4G (namely LTE). It was our assertion that this tendency had reached its natural limit.
Now imagine at that spot are 10,000 people inwards this room. I could flash a signal to all of them alongside my reddish light. And if I equipped all of them alongside a smart decoder (say a picayune figurer built into your phone) in addition to then I could flash the signal encrypted – in addition to they could decrypt it, pick out their combat of the signal in addition to discard all the residue of the signal equally white noise.
The occupation right away is that my red-light is shared betwixt 10 one k people in addition to whilst it is real fast if used for ane individual it becomes quite boring when used for 10 thousand.
There are multiple potential solutions.
One solution is to beam my reddish low-cal to every individual individually – say using a laser. This is effectively what is done inwards a fiber-optic cable. The Light Amplification by Stimulated Emission of Radiation inwards the cable goes to me, in addition to a different Light Amplification by Stimulated Emission of Radiation goes to you, in addition to they are non mixed because they top downwardly different fiber-optic cables. This offers anyone on the terminate of a fiber eye cable almost unlimited capacity. The occupation is that y'all have got to last connected to the fiber eye cable - in addition to nosotros usage these things mobile.
There are possibilities of beaming radio-waves to people too, though for the most purpose this is laboratory stuff, non materials already implemented yesteryear telephone companies. [That said – it is said yesteryear some that the ground that AT&T wants to purchase Straight Path is that their spectrum was expert for beam forming.]
Another to a greater extent than realistic solution for most purposes is jail cellular telephone division. Instead of using ane large reddish low-cal to signal everyone inwards the stadium, I could instead construct hundreds (maybe thousands) of small-scale transmitters each beaming a depression intensity beam to small-scale groups of people or fifty-fifty individuals.
There is no existent bound to the amount of jail cellular telephone partition if I brand the powerfulness of the antenna depression enough. That is, inwards part, what WiFi does. The powerfulness of a WiFi transmitter limits its attain to close xxx meters. This agency my WiFi transmitter does non interfere alongside your WiFi transmitter because they are to a greater extent than than say lx meters apart. The amounts of information that tin last carried on WiFi is enormous exactly because the transmitters are so depression powered in addition to so numerous.
When someone says that they are going to “run out of spectrum” they are inwards some feel kidding you. One tin e'er make to a greater extent than capacity yesteryear jail cellular telephone division. The only occupation is that it rapidly becomes enormously expensive. To encompass America alongside WiFi ane would demand to construct billions of transmitters.
Cell partition is expensive. Really expensive.
Then at that spot is some other alternative. Influenza A virus subtype H5N1 inexpensive one. Just usage some other colouring textile to transmit. Transmit to ane individual using reddish low-cal in addition to someone else using bluish light. If my colours are far plenty apart on the spectrum nautical chart in addition to then they volition non interfere alongside each other.
Using some other colouring textile is some other give-and-take for using to a greater extent than spectrum.
Spectrum is an option to jail cellular telephone partition in addition to thus upper-case alphabetic lineament expenditure.
Spectrum has value if it allows a carrier to avoid upper-case alphabetic lineament expenditure.
This leads us to the 3 ways telephone carriers (like AT&T or Verizon) have got managed to conduct to a greater extent than wireless data:
a). Advances inwards encoding technology scientific discipline (from 3G to 4G, for instance),
b). More jail cellular telephone partition (deploying to a greater extent than equipment) thus shrinking the number of users sharing a unmarried cell,
c). Deploying to a greater extent than “colours”, also known equally to a greater extent than spectrum.
We in addition to then spent a lot of fourth dimension researching the limits to each approach, in addition to nosotros focused on spectrum because Randall Stephenson led us there.
Not all spectrum is equivalent. Some tin top through walls (low frequency radio). Some cannot (eg visible light). But going through walls is of import if I desire to usage my mobile telephone inside.
It turns out that to a unsmooth approximation low-cal tin top through an object one-half its wavelength thick. (The physicists volition pick objections to this statement.) But low-cal at 600 MHz volition top through the walls of most buildings but low-cal at 5000 MHz (where upper-band WiFi is located) volition not.
This makes 600 MHz spectrum much to a greater extent than useful for mobile telephony. It is sometimes called “beach forepart spectrum” for this reason.
There is a lot of high frequency spectrum available, but it does non have got expert propagation characteristics. Sprint – the U.S. carrier - is unlikely to ever run out of such spectrum. There is, however, a express amount of “beach forepart spectrum” available which has real expert propagation characteristics.
Thus the high frequency players similar Sprint or T-Mobile inwards the U.S. tend to offering inexpensive unlimited packages (because they have got a lot of spectrum) but have got lousy coverage.
By contrast depression frequency players (AT&T in addition to peculiarly Verizon) tend to have got express capacity (as at that spot is express depression frequency spectrum) but peachy coverage (because it propagates well).
In this form of marketplace nosotros wanted to ain the low-frequency players, equally they ain what is express in addition to valuable. But the low-frequency players exercise non have got unlimited pricing power, because customers mightiness jump to high-frequency players offering a inexpensive – albeit inferior – product.
We purchased positions inwards shares inwards depression frequency players who nosotros believed would ain increasingly valuable spectrum. We figured all nosotros needed to exercise was wait.
And the information was largely supportive. Verizon Wireless revenue grew quite quickly, fifty-fifty when the fixed draw occupation organisation was declining. Here is a slide of Verizon Wireless revenue from the 2013 Q4 Verizon earnings presentation (slide 7):
Note 8 pct points of Wireless revenue increment – in addition to real fast EBITDA growth.
You could non encounter this inwards the Verizon accounts because the landline occupation organisation was declining, but our logic was that the landline occupation organisation would halt declining in addition to the wireless increment would continue.
The thesis was reinforced when real high in addition to increasing prices were paid for spectrum inwards recent auctions inwards many jurisdictions inwards the world.
We went so far equally to download from the Federal Communications Commission a listing of spectrum ownership yesteryear county inwards the U.S. in addition to tally that alongside the population information from the census. We used spectrum prices that nosotros saw existence used yesteryear major parties inwards large auctions. Prices are ordinarily considered inwards dollars per MHz per caput of population. We concluded that Verizon offered the best valuation in addition to that using this model owned $500 billion worth of spectrum. If the spectrum prices that nosotros observed existence paid were rational in addition to then Verizon inwards particular was really cheap.
The Verizon spot had an additional advantage: the penalization for existence incorrect appeared low. After all, if nosotros were wrong, in addition to then nosotros owned Verizon, a high-dividend paying “grandma” stock.
AT&T’s behavior
One wing inwards the ointment of our thesis was the continued bizarre demeanor of the major carriers – peculiarly AT&T. If the spectrum even out was equally expert equally nosotros thought, in addition to then if y'all ran a telephone society y'all would non dilute your stock nether whatsoever circumstances. You would largely usage spare cash to purchase dorsum your stock in addition to would bide your fourth dimension until the loot flowed inwards from rising prices.
If y'all believed Randall Stephenson’s even out that is what y'all would do.
Instead AT&T purchased DirecTV – a large satellite TV company.
At ane phase nosotros had a large AT&T position. Their demeanor convinced us to sell. Besides Verizon was meliorate on the spectrum valuation model described above.
Still this irked us. Perhaps nosotros were wrong…
The thesis broke
There were several things that, should nosotros uncovering them, would tell us nosotros were wrong. These were:
a) The cost of spectrum at major auctions or major transactions non continuing to rise;
b) Verizon, inwards particular, or depression frequency carriers inwards full general offering increasingly large bundles at lower prices; and
c) Wireless revenue increment slowing.
We were unconcerned close cost contest for small-scale information bundles (say 2GB of information per month) because nosotros figured at that spot was plenty capacity to offering everyone a few GB of data. But nosotros were real concerned if discounts were offered on large bundles of 10GB or more. Most importantly nosotros did non desire to encounter the reintroduction of unlimited bundles.
Alas our thesis broke pretty rapidly on all 3 criteria over the yesteryear vi months. The incentive auction (that is the recent U.S. spectrum auction) produced much lower spectrum prices, Verizon reintroduced unlimited bundles, in addition to revenue increment slowed--and in addition to then slowed some to a greater extent than (it is soundless positive, but only just).
The entire spot was sold.
Obviously the engineers at Verizon remember they tin handgrip all the extra usage that volition last piled on what nosotros idea was their express bandwidth.
When the thesis is incorrect it is fourth dimension to sell.
How bad could it get
We really remember it could larn quite bad at the carriers. The world’s worst occupation organisation is ane alongside high fixed costs, depression marginal costs, in addition to lots of competition. In that illustration the competitive forces volition drive prices downwardly to the depression marginal costs – in addition to it volition last impossible to recover fixed costs.
When the fixed costs are debt financed, bankruptcy ofttimes follows. That is exactly why the airlines have got been bankrupt many times. The marginal cost of filling the otherwise empty spot is real depression – in addition to contest at times drives prices to those real depression marginal costs.
If wireless telephony capacity really is unlimited in addition to the carriers insist on cost wars in addition to then the hereafter is bleak indeed. (For shareholders, if non for consumers.)
We have got gone from thinking the carriers were exceptionally expert longs to believing they mightiness last expert shorts. We are non at that spot yet: nosotros would similar to encounter falling wireless revenue first. But if spectrum
isn’t genuinely scarce this could larn ugly.
John
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