Internet Revolution Strikes, Again: Both in the Streets, and on “The Street”

Every analyst on the street already seems to be on the bandwagon, and every pundit on TV believes we should be scared by so many analysts being in agreement: tech stocks are cheap. Many of them have been cheap for a decade – and they were cheap for a reason.  The explosive growth of dot.com bubble wasn’t a total farce, much of that growth was simply robbed from the future – countless companies experienced a decade of growth in 18 months……and then the wheels came off.

Less than 4,000 days later……

The growth of the internet bubble was unprecedented; with companies’ valuations sorry virtually overnight, despite an internet still in its infancy and no profits at many companies.  Companies like Global Crossing and JDS Uniphase spent billions laying fiber optic cable and acquiring companies for growth.  The result: so much bandwidth, a glut, that it would take us a decade to work off the capacity.  And so, much like the very stocks that led the boom, both the internet and it’s companies had grown wildly faster than people’s ability to connect to internet, to do so with a high-speed connection, and be able to stream content.  Much like the prices of these very stocks, these companies had grown the internet (in terms of supply of bandwidth) much faster than the growth in demand for bandwidth.

And on the market side, perhaps more than ever, valuations finally caught up to stocks.  Then the seemingly infallible Alan Greenspan (after all of his talk of ‘Irrational Exuberance’) killed the ‘Golden Goose,’ raising interest rates perhaps one too many times….and Enron was exposed as a fraud (and with it Arthur Anderson), Investment Banking and Research were flipped on their head……September 11, 2001…..the Dennis Kozlowski episode at Tyco….and sprinkle in some Sarbanes Oxley – the golden age of stocks had ended.

Accordingly, nearly the entirety of tech-land has languished for the better part of a decade (not withstanding standouts like Apple): value (cheap) companies like IBM spent an entire decade getting cheaper, and cheaper – with its stock price never surpassing $135 (for 10 years) all the while steadily growing its earnings and revenue (much like Intel, though it is nowhere near its’ highs).  Recently, in fact, IBM was finally able to break-out above that very $135 level – technically, this amounts to a break-out from a 10-year consolidation.  No wonder that only days aver surpassing $135 , IBM was able to trade north of $160 (likely on its way to north of $200).

What happened?  Many things have happened….though there are a few key factors that demonstrate that this is the break-out tech investors have been awaiting since the dawn of the internet age.

A dearth of bandwidth meets soaring data demand……

Fast forward 10 years, 4 iPhones, not even Google nows how many Androids, 3 prominent social media sites (Friendster, MySpace, then Facebook), two incarnations of high-speed mobile networks (3G & 4G), and a President elected by the social-media age, and we find ourselves in a brave new world.We finally have the streaming content, mobile access, and are so socially connected that we, as a people, have completely overrun the entire internet infrastructure.  Just weeks ago the last IP address available was used.  In New York City, where I live, my iPhone has been reduced to a paperweight during times of high data-traffic.

Governments around the world are in a race to provide the vast majority of their populations access to high-speed digital internet, while mobile carriers struggle to upgrade their networks to meet demand.  Right in the middle of at least the second worst financial catastrophe in modern civilization, we are witnessing the equivalent of a ‘digital’ New Deal.  With the world on the verge of what could be considered a long-term structural unemployment problem we are witnessing  the mass reconstruction and build-out of the entire information super highway – and many of the broken companies of the past boom are back again to reap the rewards.

Make no mistake there are, and will be losers.  Some companies did not (or not yet) adapt to the changes of the second coming of the digital age (we’ve all seen Cisco’s last few quarters).  In other areas there has been a changing of the guard; Apple is one of the rare exceptions that never skipped a beat over ten long years, and Google appears to be he new Microsoft, but better – by being the leading software provider to the ‘new’ hardware (mobile devices), all the while using their search business to literally ‘print’ money.

The Revolution will not be televised……

From President Obama to the recent uprisings in Tunisia and Egypt, we have also seen the power and scope of the internet revolution we are in the midst of.  This social revolution has created a kind of momentum, social, political, and technological, that cannot be stopped and the will forever change the course of history.  Every day we are more and more connected, and those who are unable or unwilling to adapt will be left behind; people, companies, and countries alike.  This was perhaps no  more evident than when [former] President Mubarak of Egypt spoke the world this past Thursday; he adamantly implored his people, the youth of Egypt, not to listen what the people on TV were saying/telling them what to do.  In that moment it was so obvious. This movement that began with a Google executive’s post on Facebook, a movement against a President/Dictator that, despite weeks of protests, was completely oblivious to the root of the riots and, to what the world had become.

This is a lesson not just to other nations that might rise up in peaceful democratic protest, but to all of us.  It’s been called a ‘tipping point,’ or wildfire, even cancer, but, like or not, the digital proliferation of humanity can no longer be stopped.  Perhaps more now, than ever in history, the people of the world, the masses, have the loudest voice.

The bottom line, is exponential……

This translates to a world where the most valuable infrastructure is digital, the most important security is cyber, and the majority of the world’s capital flows through fiber optic cables and is then transmitted through the air – and the rate of the proliferation of any and all of these digital trends is more rapid than anything in human history.  Faster than anything the ‘old world’ could muster other than perhaps cancer.  This past year social networking/group-coupon company, Groupon, grew from literally $0 in value to a valuation of over $1.4 billion – in less than 8 months! The company’s value literally grew at the speed of ‘word of mouth.’

Whether it’s the growth of the conservative ‘Tea Party’ or the youth of Egypt throwing their own ‘Cairo tea-party,’ we can literally see the proliferation of the internet revolution on the street.  If we look at IT spending, or at productivity, or at the growth in profits and revenues at tech companies, we can literally see the proliferation of the internet revolution on The Street.  And this time, they’re growing at almost the same rate.

Why the street is wrong about what the iPhone means to Verizon

For months and months we have speculated (and been right) that the iPhone would inevitably come to Verizon and end AT&T’s reign of exclusivity with the popular consumer device – the time seems to finally be upon us.  Yet, all of the naysayers are now trying to convince us that the iPhone may be more trouble than it’s worth for Verizon; that subsidizing (the cost of being able to offer that sexy $200 price-point) the iPhone will crush Verizon’s margins; that bandwidth consumed by iPhone users might cripple Verizon’s network; that iPhone might cannibalize Verizon’s more profitable Android sales; and that somehow the moment we’ve been waiting for since the launch of the first iPhone might not be all it’s cracked up to be as a user experience, or as an investment.

Now let’s take a look at why none of he above will prove to be much, if any, headwind to the Verizon/iPhone experience:

The cost of subsidizing the iPhone will cripple Verizon’s margins.

Perhaps, and perhaps you’re mad.  Verizon is a $100 billion company, a significant portion of which is the landline/Fios business (Verizon [VZ] only owns 50% of Verizon wireless) if you’re worried about iPhone having an extreme negative impact on margins please bring it on, because iPhone sales would have to be extraordinary to affect margins much in the short run – and the long-run it should be a non-issue.  And like most carriers, Verizon limits the number of times per year you can upgrade phones and pay the discounted price (like the $200 iPhone) – so everyone who upgraded to Android or a Blackberry within the last 12 months will have to pay full-price or wait; therefore you can try to believe that iPhone will cannibalize Android or hurt margins, but not both – you are not allowed. Even if Verizon’s margins are hurt but the subsidy of new phone sales (with new contracts) all of those customers will extend (or sign) their contracts, and the rest will be defecting from other carriers – so if we see growing revenues with a hit to margins at Verizon, we’d probably see a hit in revenues at other carriers.

iPhone users will completely over-run and/or cripple Verizon’s great network.

Imagine the iPhone is LeBron James and that Verizon is the NBA.  Now realize that Verizon has known that “free-agency” was coming for several years and they have ramped their network accordingly – like NBA teams clearing salary cap space to compete for LeBron – they have capacity, 4G has come online, they have further investments to the network scheduled, and if they really need more bandwidth they can always buy Sprint or T-Mobile.  Again, if the network is crippled short-run (which is when I’d be worried, because they’re still improving their network) I’d have to chalk it up to a ‘good problem to have’ because it would indicate that not just usage, but also sales were fantastic – you’re no crippling that network overnight.

Cannibalizing Android sales…….money out of one pocket and into the other, and at lower margins.

As we discussed, I believe this issue is overdone.  Will it occur?  I’m sure it would have to at some level, but realize this: while Android has been growing market share, that growth has been accelerating.  Therefore a disproportionate amount of Android devices are likely to have been purchased more recently, and accordingly these users will not be eligible for an upgrade to buy a $200 iPhone – and several Androids are priced well below iPhone, meaning they are not in competition.  The dominant expectation continues to be that many iPhone users will defect from AT&T, hold-outs at Verizon will finally buy the phone they want, and others will move to Verizon that wouldn’t, for one reason or another, move to AT&T.

But, is that it?

This may be just the tip of the iceberg. Verizon seems to be the leader in 4G; so we should expect to see 4G versions of the iPad and iPhone in the not to distant future.  I also believe that Verizon’s network is good enough that continued success could prompt Apple to release other phones (an Apple phone not called iPhone?) – perhaps even one with a keypad. Analysts have said that the iPhone going to Verizon was priced-in the stock after is recent move, but that the market hadn’t discounted all of the above concerns .  The fact of the matter is that the market has already discounted the above, and Verizon will not likely fall into the category of “victim of its own success” – at least not any time soon.

Trading Notes: I’m not here to say if Vodaphone (the other 50% owner of Verizon wireless) is a better play than VZ – that’s up to you.  I do happen to believe Spring will be bought, or possibly merge.  And if you’re wondering what I think of AT&T – if my friend (and account manager) ever quits there I will run, not walk, to the nearest Verizon.

To be fair: I am at the time of writing, and/or manage accounts that are,  long Apple, Verizon, and Sprint. Members of family own Google.