The 737 Max, DSL Networks, and the Creeping Rot in Our Current Model of Shareholder Capitalism

Our current economic model does a lot of things well, but it reliably fails with long-lived assets.  That sounds like a pretty bloodless comment, but the consequences are – literally – murderous in some cases.  

In telecom, we are watching the slow-motion equivalent of the Boeing 737 MAX debacle.  The cancer is incremental investment in an asset (the 737 airframe, copper-based networks) that have hit the end of its useful operating life.  When the truth becomes impossible to ignore and the bill comes due, all that incremental spend gets written off with the obsolete asset.  Leaving you strapped for funds and time to replace it.  The sunk cost fallacy leading on to its logical,  self-destructive end.

Its a bit depressing if you are trying to maintain faith in shareholder capitalism.  About 20 years of pretending a totally obvious problem and need wasn’t there.  Until the creeping crisis accelerates to ramming speed.  It makes me think of the Hemingway quote: “How did you go bankrupt?” Bill asked. “Two ways,” Mike said. “Gradually and then suddenly.”

I kept going back to accounting 101 for asset-heavy businesses.  Incremental capital investment doesn’t magically generate (or demand) incremental revenues.  The whole point of asset lives and depreciation expense is to estimate how long until you need to replace that asset. At the end of that life, you must re-invest to maintain the existing revenue stream.  There is ZERO incremental return on that investment.  Just the privilege of staying in business.

  • The 737 was past its sell-by-date. Boeing knew it. But they tried to get out one more turn of the crank by slapping on new engines and using software to cancel out the resulting balance problems. Hundreds of people have died from that greedy calculus.
  • The copper network has been past its sell by date for decades now. The Telcos invested in increasingly fancy and expensive DSL gear to get a few more turns of the crank out of it. 20-30 years that could have been spent rolling out fiber at equivalent or lower total cost. Now that bill is coming due. People haven’t necessarily dies as a result, but rural and less-affluent areas lacking decent broadband are struggling to keep or attract businesses and jobs. Helping to feed the anger that is tearing away at our national fabric.
  • How many public infrastructure assets – roads, bridges, airports, subways – are creaking under endless layers of fresh paint  instead of being replaced wholesale? 

The 737 and Telecom examples aren’t the only ones. This seems to be a recurring problem with our current economic model. Managers charged with stewarding an asset loot it instead.  Shareholders cheer them on. The logic is “we’ll get all the cash flows and the next guy will be left holding the bag.” The negative externalities of that under-investment – rural blight and hundreds of people killed – are never factored into that calculus.

What follows is a more telco-specific rant. It’s what inspired this post but its a bit inside baseball.

After reading the CenturyLink and other telco transcripts. A durable, 10-20 year trend is getting underway.

  1. CTL’s prepared comments started with fiber Fiber FIBER! everywhere.  You would’ve thought it was Zayo’s call.  OR a re-run from 2000.  Most shocking was the whole “we’re going after SMB out of region” comment made in the Q&A.  Wow.   I haven’t heard a telco talk that much about building out new fiber plant since, well, last week’s Verizon call.  And the Vodafone call.  And most other recent telco calls.  Except AT&T – which only confirms the trend as T is always the dumb money.  Seriously, the shift in tone and focus was remarkable.
  2. If VZ and AT&T’s wireline business held a stand-alone call, they would sound exactly like CTL.  The voice revenue gravy train is finally grinding to a halt.  Consumer yes, but more so SMB.  The stats on the CTL call were pretty horrifying.  It’s not the revenues they need to replace, it’s the 99% gross margin profits.  Being telcos, they are reacting to the obvious at least 5-10 years too late, but they are most definitely reacting.
  3. The only hope is high-speed data delivered over a fundamentally lower cost network.  Which is what Verizon is actually doing under the cover of this 5G build.  Building out fiber for 4G backhaul and to sell real high-speed data services to businesses all the way down to SMB.  Like CTL, Verizon can see the rot in its own business.  So it might as well exploit that take-away opportunity out of region while shoring up its own.
  4. It all sums up to a wave of local network investment we haven’t seen in decades.  If they don’t invest, we have the Frontier call to remind you where things are headed.  That is worth a look.  Cutting EBITDA guidance in half because revenues are falling faster than they can cut costs.  There is no bottom to that pain on their current course.  Their path out is replacing those voice revenues with broadband.  That needs 1 GB speeds to be viable long-term. And that capex spend can’t be covered by existing (falling) cash flows.  So they’ll go bankrupts, wipe out the debt, and spend frantically to make up for 10 years of lost time.  Expect the same from Windstream.
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