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.

On Probability, Risk, & Outliers; Fantasy Sleepers, Exogenous Events, Upsets,and The Next Big Thing

In a ‘streaming’ world of trending-now topics, flash crashes, upsets,underdogs, hurricanes, earthquakes, and tsunamis, many of should be questioning; “what is it exactly that we ‘actually’ do know?”  In short, the answer is not much.  But that does very little to help any of us get out of bed with anymore certainty about what to expect ‘today,’ as opposed to any other day.  The issue, I believe, is that the one thing that has eluded us, after a century of rapid innovation, is that we don’t really know all that much.

We are conditioned to look at past events, statistics and forecasts and draw some kind of conclusion about what the future of may hold, based on that information.  I am here to tell you a number of things, not the least of which is that what you think is ‘information’ often isn’t.  Nassim Nicholas Taleb has discussed this at length in his books (‘Fooled by Randomness’ and ‘The Black Swan’), but some of  the reasons his books are so profound are that: 1, they are so in-depth and intellectual that the majority of society will never derive any benefit from them and, 2, that those who can derive benefit from them are unlikely to comprehend the vast applications of this knowledge in their day-to-day life.

This is primarily a consequence of ‘what we think we know’ as opposed to ‘what we know,’ the difference between information and noise, and the notion that what we do ‘know’ about is that history can mean little to nothing as it pertains to ‘predicting’ our future. Secondarily, our failure to understand the difference between ‘low probability’ and ‘low risk’ is perhaps the greatest flaw, and the defining characteristic, of mankind. And, thirdly, our problem of assuming low probability/high impact events are somehow more likely once we’ve experienced them (think 9/11), when the likelihood of them occurring again may actually be remote even as compared to their original probability (The notion that, by virtue of having happened, a repeat of 9/11 occurring is far less likely than the probability of it having occurred in the first place – originally we couldn’t imagine it, now that we can imagine it, it would be harder to surprise us; because we can now actually contemplate that type of attack now.  Think to yourself – Given what we know now, would someone in ‘intelligence’ again dismiss the chances of such an attack if they had a warning?  Of-course not, but the first time they did).

Probability versus Risk:

People have a habit of confusing an events’ probability (The likelihood of an occurrence) with the risk of said event (the impact of its’ affect).  As human beings, we seem hard-wired to associate low-probability events as having low risk – because, there is less ‘risk’ of that event coming to pass.  Unfortunately, however, the reality is; that which we do not expect usually ends up defining our lives.

Now, for a more practical (or philosophical) description of these concepts I will defer to Taleb but, I want to broaden the scope of areas to which we typically attribute this phenomena.  Some of the obvious areas we might expect to find low probability events that carry tremendous impact are:

  • Weather (Hurricanes, Tornadoes)
  • Geological (Earthquakes, Tsunamis, Volcanoes)
  • Financial (Crashes, Depressions, Bankruptcies, Bubbles, and the occasional Divorce [See Tiger Woods])
  • Social (Facebook, Twitter, Civil Rights, Prohibition, and the LA Riots)

There are, however, an ever-growing number of additional areas where we can be increasingly (or world is accelerating faster than we are) clueless as to the impact of what we don’t expect:

  • Financial (Counter-Party Risk, Layoffs, Leverage, and the occasional Divorce [See Tiger Woods])
  • Consumer (Penicillin, Blood-Letting, Viagra, Napster, Laser-Disk, 3-D (The 1st time), Brandy, LSD, Teflon, and 8-Track tapes)
    • Note: I include not just accidental discoveries and unforeseen successes, but also ‘the next big thing’ that wasn’t.
  • Sports (Fantasy ‘Sleepers,’ 2008 NY Giants, Tom Brady, Kirk Gibson, and the 1980 USA Men’s Hockey Team)
  • Political (Elliot Spitzer, the ‘Tea-party,’ Barack Obama, and Marxist Communism)
  • Geopolitical (The Roman Empire, Christopher Columbus can’t drive, Mussolini, Hitler, Fidel Castro, and Osama Bin Laden)
  • Media (Radio, the Phonograph, Napster, the iTunes store, Howard Stern, Mary Tyler Moore, ‘The Jeffersons,” YouTube, and the Internet)
  • Religion (the very fact that this looks like it doesn’t belong here is why it does – we’re human beings, we blame everything on religion – if a highly unlikely, cataclysmic event occurred, that was man-made, a substantial portion of the population would attribute it to religion [or rather, God]; either to blame it on or to justify it)
  • Social (the 1960’s, Disco, Google, the Beatles, and Paris [Perez] Hilton)
  • And, I’m certain, many more

What we must realize is that in a world where we can derive a measurable benefit from ‘predicting’ a fairly likely event (Super Bowl Winner, company earnings, or next week’s weather) based on observation/study of past events, that we would derive an immeasurable benefit by being able to understand that the most important events [trends, catastrophes, plagues, or inventions] in our lives will be relatively unpredictable. My fiancée told me a few months ago that on our Wedding Day the sun would be setting at precisely 6:29pm, and that pictures needed to be complete before then. Today I learned that, 4 days before my Wedding, that a computer error had somehow left us without a suite for the eve of our Wedding, and that our florist/decor-person somehow did not recall on what day of the week our Wedding is to take place.  The point is, no matter how much you plan, that whatever can go wrong will go wrong (Murphy’s Law) and, more importantly, is what you least expect (e.g. something you thought you planned for).  What I am more concerned with, however, are those things so ‘random’ that they cannot possibly be expected from our past experience. (e.g.  ‘The sun never rises on my Wedding Day.)

Final Thoughts:

We have been conditioned, in part by our very nature to conform and by the globalization of our minds, to over-expect that which we can conceive of (my friend was in a car accident, so I ride in anything with wheels) and under-expect  that which we have no reason to contemplate (the Bubonic Plague, 1929, Dec 7th, 1942, JFK, 9/11, flash-crash, stock prices in late 90’s, real estate prices in mid 2000’s, our opinions of newly elected officials, and the 2008 Giants – what can I say? I bleed blue).  What does second category have in common?  They were things that, for those who were/are most affected, were barely imaginable to most people before the fact – some could have been foreseen, and some not.  What we should consider is that if we could conceive that any of the events I mentioned were even plausible before the fact, that even if they were to occur the ramifications would be reduced by virtue of the fact that we were able to contemplate such a thing.

We did not understand disease at the time of the plague, had we understood how sickness spread then the effect of the outbreak likely would have been reduced.

On the morning of Pearl Harbor some people knew that there were planes inbound, but no one believed there was a way foreign aircraft could have had enough fuel to reach that outpost let alone launch an attack.

Yes, market crashes have happened famously a few times but, it’s always the speed that surprises – we always convince ourselves we know what to look for, and the reason we crash is partly because we didn’t think it could happen that way.

I won’t try to discuss Kennedy, but I will say this:

When the NY Giants met the New England Patriots in the Super Bowl most pundits favored the Pats in a veritable landslide. Bookies across the country fielded odds grossly favoring the unbeaten Pats over the upstart G-Men.  I was baffled.  While I saw that the Pats were far superior, and I knew that if they met 10 times, with those rosters, that the Giants would be lucky to win more than once.  But what I also knew was this: As far as I was concerned there was an extremely low probability that one NFL team could beat another 3 times in one season. The Giants had played and lost to the Patriots not only in the epic Week 17 the clinched an undefeated season for the Pats, but they also were defeated by  the Patriots in the preseason that year.

  • If you viewed that game as a lone event –  a best of one series, then you would not likely contemplate that the odds of the Super Bowl weren’t ‘will the Patriots beat the Giants today?’ But rather, ‘Can the same Patriots coaches, players, and playbook beat this Giants team for a 3rd time in 3 games (in one season)?’
  • Having extra information, such as knowledge of the ‘odds’, seems to prove to be only a danger to ourselves and others.

A Moving Precipice, Creator of Black Swans, and Bubble Popper

A loosely defined phenomena which we are seeing pervade all manner of life is something I am calling, moving precipices.  This phenomenon is pervading nearly every aspect of our lives –  typically media, it now transcends society through politics, disease, terror, technology, and investing.  What I am describing is, in our globalized world, is not unlike what was described in “The Tipping Point” by Malcolm Gladwell; that singular moment when an idea, trend, or social behavior reaches a given point, and simply explodes.

The point of contention is, however, the acceleration of the ever so opaque and difficult to predict moment.  Take Google for example, a company that, by virtue of what it was, was virtually at a ‘tipping point’ at its’ inception; achieving a market capitalization of over $150 billion within a decade.  I have no doubt in my mind that due to the ever-increasing interconnectedness of things, coupled with innovation, that in our lives we will see companies that grow from venture-stage to over $200 billion market-caps within 5 years.  Again, the precipices are moving closer and, their effects are multiplying exponentially.

Evidence of this has been seen in the medical arena, take swine flu for example.  Now you can take the other side of the argument, saying that it was overblown by the media and a non-event; but that too is the point.  The rapidity of the spread of sickness has certainly accelerated with innovation in travel, and continues to accelerate as more and more of the world becomes industrialized, but the hysteria that accompanies a potential, say pandemic, now spreads at the speed of sound.  From a business perspective, it is just as important to be able to effectively position yourself for the hysteria as much as the reality; many winners were crowned in the stock market if a company was perceived to have a ‘cure’ or viable treatment.  We saw this recently with companies that had ‘swine flu’ treatments, or years ago if you happened to have a stockpile of “Cipro” during the anthrax scare.  The point is, even in medicine, we are seeing a sort of ‘critical mass’ reached ever earlier in the life-cycle of a particular trend.

This week, for example, I believe we may have seen the pronounced effect on social networking on Andy Reid of the Philadelphia Eagles.  Laugh if you like, but think of years passed when Coach Reid was virtually oblivious to calls for his head (and his job) whilst making questionable coaching decisions.  Simply put, today the shear onslaught of backlash that is possible from the twitter’s and Facebook’s of the world (not to forget Word Press) is such that the wave of public opinion is cresting virtually moments after it initially swells.  This week, it took Andy Reid less than 24 hours to completely change his mind about his quarterback and, essentially, the direction of his entire franchise.   Also this week, an Australian boy singlehandedly (and inadvertently) caused Twitter to be hacked by exploiting a tiny bit of coding error – within seconds his maneuver had been exploited, automatic posts began redirecting users to porn sites!!  I remember the days of AOL when it took days for a virus to spread to that number of people.  But, guess what?  Now there are a lot more of us plugged in, and we’re all streaming!

For years we have seen this effect in media, and it has accelerated with every major new innovation in media since the phonograph.  Today, media darlings are crowned almost over night.  It spreads like a virus and does not just pervade music, for example, but also sports, writers/bloggers, and even with popular Twitter pages being made into TV shows.  We live an in ‘Trending Now’ world, and we have to be prepared for it because we have not evolved enough to increase our potential to process this information as fast as the speed of this information can multiply.  What am I saying? Life, much like today’s markets, happens in real-time but it is not necessarily efficient; it can be wrong.  That is perhaps the greatest difficulty navigating this type of environment; knowing when and if to act on information (that may in fact be noise, not information) that occurs in  real-time, and at any moment critical mass can be reached.

We have also seen this phenomenon in politics.  I’m sure we all have a sense of how Obama was the first Presidential candidate to reach the masses with Tweets and social-networking sites, but that’s not it entirely.  Take the Tea Party movement, a viral political movement sweeping the nation because a nation wanted it and, more importantly, it moved it the speed of  sound.  And we wonder why China wants to restrict Google, and limit the flow of information.  They realize that in this day and age that information is a contagious as it ever was; an idea can spread like wildfire and grip a nation in absurdly short periods of time.

How does this relate to finance you might ask?  Does anyone remember My 6th, 2010?  Oh yeah, the flash crash.  Well what I am saying is that this is a direct result of this phenomena.  Do I have evidence? About as much as the anyone (probably more, which is to say none at all), and I think if we had any meaningful volume since May we would’ve had another one.  But, let’s take a step back.  What were talking about here, in essence, is the confluence of three very popular schools of thought that we will call: tipping points, black swans, and bubbles.  As we continue we will delve into all manner of mania, trends, fads, epidemics, pop-culture phenomena, asset bubbles, and identifying those critical moments when an idea or trend catches like wildfire and, as I like to put it, when ‘cancer spontaneously cures itself’ (and disco dies overnight).