Editor’s Note: Welcome to our weekly Reality Check column. We’ve gathered a group of visionaries and veterans in the mobile industry to give their insights into the marketplace.
Many publications are offering their “top 10 for 2010” assessments this week. We have had a bunch of suggestions for our top 10, and are incorporating our assessment of this year into an assessment of “Who’s got the momentum?” heading into 2011. First up, the Federal Communications Commission.
1. The FCC (for now), followed by the Republican Congress (in February), followed by the courts. This was quite a week in the telecom industry with the release of the 194-page Report & Order surrounding net neutrality. The current ruling provides the FCC with new powers of definition, specifically reasonable network management practices, specialized broadband services, and unreasonable discrimination. The FCC generated a crisis (that lawful sites were being blocked by Internet service providers), claimed Congressional authority, then proclaimed that these steps are necessary to foster more innovation and job creation.
Since the fall of 2009, we have had the rise of Netflix Inc. (NFLX) streaming, the single largest source of bandwidth growth and definitely the largest threat to both the traditional cable/fiber investments. If there were one stock that would have taken a hit from blocking, slowing, or otherwise inhibiting the free flow of information on the Internet, it would have been Netflix. (Netflix’s stock is up more than 200% for the year.)
Netflix, rightfully so, has enjoyed the benefits of the expansion of cable modem speeds and advanced telco/fiber services. As a result, they have changed their entire business around video streaming. By their own admission, they entered 2008 as a DVD-by-mail distribution company. 2008 was a year of transition for the entire market, with 2009 and 2010 representing the largest gains for the market, including Comcast Corp. and Netflix. Where’s the crisis, the nervous investors shying away from this stock that is as much a play on a “free and open Internet” as any? Where’s the hit to the stock in 2009 from unreasonable network practices from the carrier community? The crisis does not exist.
The rules the FCC has proposed create more jobs for auditors. They assume that software development practices are efficient (they aren’t), and that network management practices are discriminatory (for the most part, they aren’t). But the threat to Netflix and equally dependent content distributors’ price/earnings multiples (Netflix now at 70-times earnings) has generated such hysteria that it was time for the FCC to intervene. In short, Comcast and Verizon Communications Inc. shareholders, you’ve been un-friended by the FCC. They have picked the winners, and it’s not you.
However, we have the incoming Republican Congress to the rescue, with the latest from Politico signaling that they may invoke the Congressional Review Act to overturn the FCC rules, or, worse yet, cut the FCC budget to levels that would limit their ability to hire all of the compliance auditors required to enforce the new rules in any meaningful way. The process of checks and balances at work – James Madison must be smiling.
This puts it into the hands of the courts, and ultimately the Supreme Court. That’s where the momentum has resided for the past five years, and, thanks to the current administration, will reside for the next five. A lot of attorneys get billable hours, and we all feel protected against the evildoer carrier community. Meanwhile, Wi-Fi is clogged, application interfaces remain closed (try getting access to the call control path on Apple Inc./AT&T Mobility), wireless investments proceed with caution, and uncertainty about additional regulation persists.
2. Apple. As we have noted in this column, the Apple machine keeps on churning out great products and cash for their shareholders. At the end of this fiscal year, Apple had over $51 billion in cash and investments on their balance sheet (about two-thirds of their total assets). This represents a $17 billion growth of cash in one year (interestingly enough, that cash would nearly double AT&T Inc.’s total network investment).
Sales are growing across the product line (including laptops and notebooks), but the star performers are the iPhone and the iPad. Apple has hit the mark through a careful balance of innovation and price. They have no qualms whatsoever about the average selling price of the Mac line decreasing from $1,478 to $1,279 in two years, as unit sales have risen 41% over the same period (the economic principle of elasticity at work).
Where is all of the money going? Well, in Apple’s 10-K they tell us (page 59 of 116 in their 10-K for those of you who want to research more diligently). Half of the $17 billion increase went into the purchase of other companies’ debt. Overall, nearly $20 billion of the $51 billion in cash and marketable securities is some sort of corporate debt (including commercial paper). Apple is their own VC, and they are funding the suppliers that stand to benefit the most from Apple’s strategy. It’s a positive cycle.
The world economy recovers slightly in 2011, led by U.S. disposable income growth and the thirst for consumer 2003/2004 leverage levels. The iPad 2 is launched. The iPhone is launched across additional global carriers. The Apple iOS selects partners to build a stronger franchise (see article below on potential partnership with Skype). And, as a result, Apple generates another $20 billion in cash flow in 2011 (minimum). If that isn’t a definition of momentum, I’m not sure what is.
Rather than owning a network, Apple invests in the debt of a network. They are not network operators, but have learned a lot from AT&T Mobility and Verizon Wireless and they love control. Google Inc.’s Nexus launch shows that concept devices can exist alongside of the mass market Droid and Evo franchises. So Google has a showcase phone, and Apple quietly funds a showcase network.
Is the above scenario plausible? To prevent a network from falling into Chinese or other non-Western ownership, could it happen? The short answer is: possibly, but only if it led to a) a vastly superior customer experience; b) a fast lane to premium services outlined above; and c) continued growth in small business and enterprise sales. It must have both a backbone as well as a last mile component. (BTW – this is why I love writing these at the end of the year – craft your own scenario – read up on the Apple history for some justification for increased vertical control, and do your own scenario planning.)
Apple determines the fate of competition in the telecom industry. And they have lots of cash and no debts or pension obligations. A recipe for disruption.
3. Verizon. It’s hard to make the case for any carrier, and I want to pick Comcast, but I can’t until the FCC restrictions are firmly defined. Here’s why Verizon gets the tip:
–Effective succession planning. No confusion on who is in charge and what they are going to focus on. It’s wireless, global, and FiOS – end of story.
–The Google relationship. Add to this the Motorola relationship, and you have a U.S.-based recipe for success. Top engineers working together for you and not AT&T. This is a focused strategy, not the broad-based one espoused by AT&T (Torch, Windows 7 advertising coupled with in-store Apple training).
–Apple iPhone brand
association. Sorry for the religious connotation so shortly after the Christmas holiday, but the anticipation of the iPhone on Verizon Wireless is nearly Messianic. IPhone on Verizon Wireless’ terms? No, but definitely more control, and perhaps a shut out of Sprint Nextel Corp., T-Mobile USA Inc., Leap Wireless Communications Inc. and MetroPCS Communications Inc.
–The Wal-Mart Stores Inc. relationship. Verizon Wireless has the Straight Talk relationship. That’s what Wal-Mart sells when a customer is unsure of what they want. Wal-Mart will have over five million Straight Talk customers by the end of 2011. That’s over a billion dollars in revenue growth since the summer of 2009 with minimal (if any) incremental capital investment.
–The Frontier Communications Corp. transaction. I was a skeptic, but now believe that Verizon (and Frontier) got it right. There’s a lot of work to do here, and Verizon learned from past relationships and remains involved, but it looks like this transaction will be a success for both sides. As this column has mentioned previously, AT&T should take note and contemplate sales/ spins of their own.
–Institutional knowledge of in-building issues. The new management team knows that some (but not all) of tomorrow’s wireless issues must be solved from the “inside out.” Even with the 700 MHz band, the data demands of individual phones (One to two gigabytes per device before Wi-Fi hotspot volumes) are significant. Verizon knows the construction materials used for every building from Boston to Washington, D.C. They also are the incumbent fiber provider for most of these buildings. As a result, the stage is set for not only improved speeds, but in-building consistency without messy Wi-Fi handoffs.
–LTE. Momentum defined. Playing on the Droid success, they are going to storm the country with LTE. It’s perception today, and, if they can translate speed into value ($200 to $250 of additional disposable income per year for tens of millions of Americans), it will be sustainable and their first mover advantage will be the subject of case studies for years to come. Verizon Wireless is aggressively leading with a speedier network in an app-hungry America, and they lead in network quality. A recipe for success.
There’s a lot of reasons to be negative on Verizon, namely the inability to create meaningful shareholder value for the past decade. This, however, is their breakout year.
Happy New Year to everyone!
Jim Patterson is CEO & co-founder of Mobile Symmetry, a start-up created for carriers to solve the problems of an increasingly mobile-only society. He was most recently President – Wholesale Services for Sprint and has a career that spans over eighteen years in telecom and technology. He welcomes your commentsatjim@mobilesymmetry.com.
