Craig Moffett - A True Expert
Album art photo taken by Mike Ando.
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[The Business Brew theme]
Bill: Ladies and gentlemen, welcome to The Business Brew. I'm your host, Bill Brewster. This episode features Craig Moffett, senior managing director of MoffettNathanson, a division of SVB Securities. SVB as in Silicon Valley Bank. Craig is someone that I admire and, in my opinion, the best telecom analyst on Wall Street. I hope this conversation highlights his depth of knowledge and the level of work Craig has put into covering telecom for over 30 years now. I am very grateful to be in the position to interview Craig and hope that you find the conversation as interesting as I did.
Big thank you to Evan Lorenz for making this podcast possible via introduction. Thank you, Evan. Though the episode isn't sponsored by them, I'd also like to give a shoutout to my long-standing partner stream by AlphaSense. Access to their content library along with interviewing experts on their platform has helped me get to the place where I could have this conversation. I'd also like to thank the Lupa, which is my perception of a data/modeling company. They have given me access to their platform and I find it to be very helpful for getting fast access to KPIs that you can click through in Excel and it links directly to 10Ks. I think it's a great product. If you're at an institution that needs that kind of data, I would highly recommend that you check it out.
For the episode disclosures in the past 12 months, an affiliate of SVB Securities LLC has received compensation for providing non-security services to Comcast Corporation and Verizon Communications Incorporated. As always, none of this is financial advice. All of the information contained in this program is for entertainment purposes only. Please consult your financial advisor before making investment decisions and do your own due diligence. Enjoy the show.
All right. Well, technical difficulties aside, thanks very much for joining. I appreciate it.
Craig: My pleasure.
Bill: So, I wanted to start out a little bit talking about your career and you starting your firm. I think I first heard about you when the Verizon report came out where you did really, really deep work on what they were trying to do with fixed wireless and started paying a little bit more attention and then saw you present AT&T at Grant's and it's been a real pleasure following you. It's funny. When I was doing research, I see YouTubes of you at Congress. So, I'm just curious how you became Craig Moffett and what your career was like.
Craig: [laughs] Well, oddly enough, I started my career as an artist, as a painter and sculptor. And then went to graduate school to business school thinking that I was going to go into arts administration to be in the museum business. And then was fascinated and attracted to being a management consultant. I heard Carl Stern, who at the time was a partner and later became the CEO of Boston Consulting Group speak when I was a freshman in business school and thought I'd love, not just to do what he does. I'd love to be that guy. I really admired who he was and what he was talking about. And so, I ended up going to Boston Consulting Group for 11 years.
Like most management consultants, especially at BCG, you start as a generalist. I fought tooth and nail against getting dragged into telecom. I thought it sounded boring, but in the late 80s, I got pulled into more and more telecom work. I started to become really fascinated by it. I ended up being viewed as a telecom specialist at BCG and ended up leading the global telecom practice at BCG when I became a partner in the mid-90s. But I always thought of myself primarily as a specialist in businesses with no marginal cost. I always found the business problem and the microeconomics problem of competition in industries with no marginal cost to be really fascinating. And so, well, telecom is one of them. There are a lot of others, whether it's semiconductors, or whether it's airlines, or businesses that tend to be actually quite volatile because of their cost structure. I did that for as I said 11 years. I took a detour becoming the CEO of the internet business at Sotheby's, the Auction House going back to the art world for a little while.
Then after that decided to go back to telecom to Bernstein of equity research house that I stayed there for 10 years and then decided with a number of colleagues from Bernstein that I would start MoffettNathanson, but especially primarily with my now partner, Michael Nathanson, who had been with me at Bernstein for about 10 years. We started MoffettNathanson and after about nine years running MoffettNathanson, we were acquired by Silicon Valley back, SVB and that brings us up to the current chapter, where we are now working with SVB Securities and providing the research. They have an incredible number of relationships in Silicon Valley and with entrepreneurial companies. And so, it really is an extraordinarily good and interesting fit for us.
Bill: That would be a good fit if that's how you view your specialty. Software and tech has a lot of similarities, I would think with cost structures and leverageable cost basis, right?
Craig: It does. And by the way, they started Silicon Valley Bank acquired a company called Leerink some years ago. And Leerink was in the life sciences business doing some of the same things we do. It started as research, it also worked with small companies to bring them to the public equity markets. The life sciences business has a lot of those same characteristics. A lot of cost upfront in investing in identifying molecules and compounds, a lot of costs upfront in testing them for safety and efficacy, but the marginal cost of production is actually quite low. So, it has a lot of those same characteristics of building networks and that sort of thing.
Again, a really fascinating microeconomics challenge. Because if you think about what you learned in economics class about that price will fall to marginal cost and all that sort of thing, well, you better hope price doesn't follow to marginal cost of these businesses, because marginal cost is zero. So, pricing problems are really interesting. There isn't quite the same level of prescriptiveness in any of academia about how you actually manage in these businesses.
Bill: I feel so silly saying this after following the industry for a while, but this is got to be why people say the telecom tends to be deflationary, hah.
Craig: Or, in more colorful and less academic sounding language, it's a crappy business.
Bill: Yeah.
Craig: It's just really hard to make money in these businesses, unless you have something like somewhat protected monopoly, which you do by patent law in some of these types of businesses, the entertainment business, you own intellectual property rights. In the telecom business for a number of regulatory and policy reasons, you tend to have multiple competitors in these markets. In fact, the story of US telecom is a fascinating story to think about the history and how we got to where we stand today as a competitive market, because it's actually not entirely clear that competitive market is the only or even the best answer for how you should think about telecom.
Remember, the telecom market in the United States famously, if you go back, way, way, way back in history, American Telephone and Telegraph in the beginning of the 20th century signed what is now famously known as the Kingsbury Commitment to AT&T was going around and buying up small phone companies and threatening that if they didn't sell that they would not interconnect with them. And as they got bigger and bigger and their interconnection with AT&T became more and more necessary, eventually, they entered into an agreement with the government under the Kingsbury Commitment to say, "Let's make this a regulated monopoly business."
In some ways, it was an act of patriotism. They said it's best for the country that we stop making these excess profits and instead become a stable monopoly. That regulatory regime lasted all the way until the 1980s. So, for 75 years, this was a regulated monopoly. In the 1980s, first with the introduction of MCI and later Sprint, and creation of a competitive layer in the long-distance business primarily serving enterprises and businesses. The door got cracked open, there was there were legal decisions like the Carterfone decision that said you could connect other things to the network and the hegemony of the monopoly network started to breakdown. And suddenly, we swung all the way to a completely deregulated market with the Telecom Act of 1996. It set the stage for where we are today.
You can think about the history through a very, very long lens. And by the way, not just in the US, but in any telecom market as a pendulum that swings back and forth between regulators that swing the pendulum in the direction of competition with introducing multiple players and then the microeconomics of the business itself that sort of swung it back toward monopoly and bankruptcy for the competitors and you're always somewhere in that tension. But over very long periods of time, not three, four, five years, these technology cycles in telecom are 20 years long and the investment cycles for these entire regulatory cycles to play out can be 30, 40, 50 years long.
Bill: Now, well, AT&T had their monopoly, then you had the cable companies were building little franchises underneath everything, right? So, TCI goes back to the 1970s, right?
Craig: That's right. In fact, the cable industry in the United States goes back to the 1950s. One of the great things to know about the cable industry is that the use of hybrid fiber coax, the coaxial cable that you use today stems from the fact that there were lots of it available in army surplus stores after the Korean War. So, it was just cheap to buy. And so, these local electronics stores, the cable industry, some people you'll still see occasionally the acronym CATV. Some people think it stands for cable TV. It actually stands for community antenna television.
The way the cable industry started was community antennas. If you lived in a valley, say, or on the wrong side of a mountain from the broadcast tower, somebody in the local electronics store would put up a tower or really just a pole at the top of the mountain and then run coaxial cable down because it was cheap to run the signal down, run it down into the valley and then connect homes to it so that you could watch TV. And then later with Ted Turner and the creation of some cable specific telecom programming, it became the industry that we know today.
Let's go back to that regulatory conversation for a second, because it's really interesting because it tells you a lot about the birth of cable. There were regulatory prohibitions against the phone company being in the video business and having any proprietary interest in anything that they carried. If the phone companies had been allowed to be in the cable business, they would have built cable networks themselves and the cable industry never would have come into fruition. Instead, they weren't allowed to be in the video business and the cable companies weren't allowed to be in the phone business. So, you had these two industries that technologically could have actually been quite similar, but were prevented for regulatory reasons from ever doing what the other industry does. So, they grew up separately.
When Congress enacted the 1996 Telecom Act, it was really about trying to create competition in the local exchange. We'd had about 10 years of competition in long distance by that point. It was perceived to have worked incredibly well. The prices of long distance had come down, there turned out to be a lot of elasticity of demand in long distance. And so, usage grew dramatically. A lot of jobs were created, taxes were paid. It looked like a wonderfully successful first 10 years of deregulation of long distance. Congress said, "This is great. Let's do the same thing to the local exchange business."
Not knowing by the way that within another five years or so, every long-distance company in America would be in or on the way to bankruptcy. They did the same thing to long distance. One of the ways they did it almost as an afterthought, because it was primarily about reselling local exchange assets, so that people could ride on other people's networks. But one of the things they did almost as an afterthought, they said, "Let's let the cable companies and the telephone companies compete." At the time, the view was, well, this is a pretty lopsided battle. The phone companies have huge amounts of money. They have well established brand names, they have strong management teams, the cable companies are these rough and ready companies that are poorly managed, have lousy balance sheets, their customers hate them, you hate them, I hate them, we all hate them. The phone companies are going to easily win this war.
People ignored, but wait a second. The cable business which was built to deliver video versus the phone business which was built to deliver voice connections meant that the cable infrastructure had about 4,000 times more capacity than the phone infrastructure. So, you can hate them, I can hate them, we could all hate them, but it was pretty clear that the cable companies were actually going to win this war against what to a lot of people seemed very long odds. It didn't seem like long odds to me. In fact, when I left consulting and went to Wall Street for the first time in the early 2000s, I remember thinking, it's amazing to me that here we are already six years after the Telecom Act and people still haven't figured out that cable is going to win this war.
As an analyst early in my career, I remember thinking that my hair was on fire. I've got to get the word out that cable is going to win, because it's not going to take all that long for the market to figure it out, then the opportunity is going to be gone when the market figures it out. I never would have imagined it would take the capital markets another 10 years to figure out what should have been obvious that cable was going to win the war. And that the phone companies, again, it was simply a technology question. It was the cable infrastructure, had orders of magnitude more capacity than the phone infrastructure.
Again, if the phone companies had been allowed to build a high-capacity infrastructure or had any reason to in order to be in video business in the 1950s and 1960s and 1970s, they would have and never would have been a battle. But because they weren't allowed to, they never upgraded an infrastructure that was built in the early part of the 20th century for doing voice connections that were 9.6 Kb per second. And so, the infrastructure at the end of the day just wasn't competitive against an infrastructure that had been built to carry video.
Bill: It's interesting how last mover advantage like that can really manifest itself into a structural advantage. That's cool to listen to. Now, the question that I guess pops up is why is fiber not the logical next conclusion here? How can cable compete in a world going forward when people are laying fiber and doesn't that have a lot more capacity?
Craig: Well, you might have thought so. As it turns out, the cable infrastructure has perhaps as much by luck as by great foresight, because nobody in the 1950s and 1960s, when they started building it was thinking about the capacity required by fiber networks in 40 years. But as it turns out, the cable infrastructure has turned out to be enormously resilient to the point that-- Remember, the cable infrastructure today is not really thought of as coax infrastructure. A lot of people refer to it as HFC, meaning, hybrid fiber coax. I just yesterday had a conversation with Phil McKinney, the CEO of CableLabs. He was reminding us that 99.7% of the time that a signal travels across a cable network, it is traveling on fiber.
In reality, a cable network is almost indistinguishable from a fiber to the home network. A fiber to the home network eventually has to translate an optical signal into an electromagnetic signal at what's called an ONT or an optical networking terminal. At some point in the network, typically that happens at the side of your house in what's called FTTH or fiber to the home architecture. In a cable architecture, it happens out at the telephone pole, typically, when it comes in from the node, but you're talking about whether it comes 20-feet or 30-feet through your house or whether it comes in additional 60-feet through your house, it really doesn't make any difference whatsoever. Functionally, a cable infrastructure and a fiber to the home infrastructure are more or less functionally identical.
Bill: Interesting. So, when they talk about high splits, what exactly is a high split? For those that don't know, cable talks about upgrading their cable infrastructure with high splits and converting to DOCSIS 4.0 in order to get a little bit more speed symmetrically and to compete against fiber. I understand the words that they say, but I don't understand technically what it is.
Craig: Yeah. First, before I talk about high splits, let me talk about a different kind of splits, which are node splits, because historically what you would do is, if you had congestion in the neighborhood and the node served say, a hundred homes to make the math easy, you would split the node because a cable network is a shared infrastructure. In fact, I'm sure we'll talk about wireless. Cable is in some ways analogous to a wireless network and that it operates-- It's an RF or radio frequency network that happens to operate inside a wire. So, it doesn't need licensed spectrum or anything, but it's still architected as a radio frequency network. The capacity is shared among all the people in that node.
If you start to have too many people that are online at a given peak hour at 6 o'clock at night, or 7 o'clock at night, or at peak hours typically for a broadband network about 9:00 PM, if you have too many people online at 9 and therefore, the speed gets too slow. What you would historically do is you'd split the node and you'd say, "Okay, well, we'll split the node into two nodes, and then each person will have half as many people sharing the capacity at each node, and therefore you'll get twice the speed. Unfortunately, the name high splits use the same word splits, even though there's actually no similarity between what they do. That's what the physical splits that I was talking about before what cable operators had been doing for a very long time and still do. But high splits came along and said, "Let's think about splitting the frequencies differently and we'll allocate the frequencies to upstream versus downstream differently."
The first part of that is typically that you increase the range of frequencies within the network. If a typical cable plant was last upgraded to say 860 MHz of capacity and then the cap on the frequency was typically based on what kind of amplifiers you put in to amplify the signal along the way. The first thing you would do is say, let's replace the amplifiers and instead of passing through signals up to 860 MHz, let's pass through signals up to 1.8 GHz. Of the 860 today, an awful lot of that is still tied up with good old traditional video that hardly anybody uses anymore or that's a little bit of an overstatement. Not hardly anybody, but far fewer people use traditional linear video than used to, so that spectrum that's allocated to it is less valuably utilized than it used to be. But I may only have 200 MHz of capacity today allocated to broadband.
Suddenly with a high split, I can take that from 200 to say 1,000 MHz of capacity, or a GHz of capacity, or more, even 1.2 GHz of capacity allocated to broadband. And so, it's a 6x increase in the capacity and with the advances of what's called DOCSIS 4.0, which is the next generation of DOCSIS. DOCSIS stands for data over cable. That's the Interface Specification for data over cable. It's been a very long series of technology upgrades to the cable infrastructure.
With DOCSIS 4.0, cable plant will be able to deliver 10 gigabits per second and I can make it symmetrical if I want to. I think there's a belief right now that there's a marketing value and having a symmetrical signal of 10 gigabits symmetrically. It's not entirely clear that's the right answer. This is not clear to me, because even though everybody likes to talk about how much upstream usage there is and sending video back upstream and all that sort of thing, the reality is traffic is still very, very skewed downstream to upstream and probably will stay that way for the foreseeable future. So, it's not entirely clear the right answer is to have a symmetrical signal. But since fiber typically does that and fiber uses it as a marketing argument in favor of fiber, I suspect it may turn out that cable operators end up doing the same thing and say, "Let's have a symmetrical signal." But at 10 gigabits per second, it's really hard to look out far enough until you get to maybe holograms in the home to say that there's going to be a need for more than 10 gigabits per second symmetrically. So, the cable plant looks like it has a very long and healthy runway in front of it.
Bill: This is Tom Rutledge's 10G argument, right? I like when he talks about 10G.
Craig: That's right. Yeah.
Bill: That cracks me up.
Craig: [laughs] Exactly. Well, it's a marketing name that's probably a lot better than DOCSIS 4.0. I don't think DOCSIS 4.0 is going to sell a lot of anything.
Bill: You know what's interesting about this? As you saying this, you've got Comcast-- So, Cable One has completely abandoned video as far as I can tell as a strategy. Comcast is going to milk video for whatever margin they can get. Charter, they seem to want to invest in video a little bit for a retention tool. But if they can almost push people out of video, it opens up capacity on the network, which drives more of a value proposition for the higher margin business anyway. And now that we're all streaming, they're serving video, except they're not serving video. Do I have that right?
Craig: Yeah, that's right. Most operators today are offering an IP version of video for people that use their video app. You can have either the Xfinity app or you can have the Spectrum app, if you're Charter customer. Spectrum is their tradename, just like Xfinity is Comcast's tradename.
Bill: Soon Xumo, right?
Craig: Well, Xumo is different--
Bill: We'll see how that goes.
Craig: Yeah, we'll see. That's a video aggregation service and one that doesn't necessarily have to ride on their own infrastructure. It's more of an extension of something that they've been trying with video aggregation in the past. That's in some ways competitive with Roku. This is a moment of let a thousand flowers bloom is probably a little too optimistic. It's more throw some spaghetti against the wall and see if anything sticks, because I think all of them feel there is still a role for video to play in our customer relationships and there are still people that want video. Delivering it the old-fashioned way of a linear lineup of channels with a grid and that sort of thing is probably pretty close to over.
It's still not entirely clear what's going to take its place. People like Roku have built what are essentially gateways to a bunch of apps, but I think the most people would argue that the market is crying out for reaggregation in a sensible way. It's frustrating as hell to have to say, "Wait, is that show on Hulu or is that show on Netflix or when we had the trial period for Paramount, did we see it? I can't remember where we saw it" and then you have to google to try to figure out where it is, and then you have to try to remember your password if you're not logged in. That ugly experience is I think something that everybody is aware is not a terribly good experience, but nobody is really willing to compromise their own strategic position in order to make it better for customers. So, everybody is still arguing and battling over trying to be the one that gets to capture a bigger slice of what is, I think now self-evidently a smaller and smaller and smaller pie.
Bill: I may be in the minority here, but I think that Comcast Xfinity product is excellent. But like everyone, I don't like to pay the rental fees. So, they ended up pushing me into some beta stream product they have that's absolutely horrible.
Bill: [Craig laughs] I don't understand why they don't just maybe cut price a little bit on what I think is maybe the best product in the market and drive adoption that way. But what do I know?
Craig: Yeah, Comcast likes to fancy itself a technology company. To give them credit where credit is due, as I said, people love to hate their cable company. Saying anything good about cable usually you're taking a bit of a risk. But Comcast has actually developed some very good products along the way. Part of the problem is trying to figure out which horse do they really want to ride and push. I would have thought Comcast, by virtue of the fact that they owned NBC was going to be the last of the cable companies to let video go. It's turned out not to be the case at all, I think as you described with Charter.
Charter actually has retained video customers much more successfully than Comcast has. It's not that they've had a better strategy to retain it. It's that they tried and Comcast hasn't. Comcast came to the conclusion a while back that if customers wanted to leave the traditional video ecosystem and go somewhere else, Comcast was not going to try to convince them that they were wrong. Comcast was going to try to help them with offering them the best answer they could for how do you make it a better experience.
There used to be this view in the cable world that broadband churn would be lower if it was tied to video and if you were also a video subscriber. Comcast, I remember about four years ago or five years ago, certainly pre-pandemic told me once, in retrospect, why did we think that trying to convince people to keep a video product that they really didn't want was going to be good for the relationship? I thought that was actually a pretty evolved and sensible way to look at it.
Bill: Yeah, that is. Yeah, that makes perfect sense to me. I've always mentally thought about it like Comcast is trying to maximize their profit margin per relationship, were Charter's trying to maximize profit margin per passing, which drives a pricing strategy that's lower? But maybe I've told myself, maybe I'm conflating issues in my mind because it's felt Comcast has pushed price a little bit and that is increased the amount of video people that have left.
Craig: I do think that there is a little bit of a legacy of that. Charter led by Tom Rutledge always viewed, as you said that maximizing the profitability per passing, which as the name implies sort of starts with a view of the microeconomics of the infrastructure that the infrastructure is the asset. And so, you maximize the utilization of the infrastructure that leads you to a strategy that is drive penetration, even if it means lower price. Comcast has a little bit of a legacy of being more focused on margins and therefore, higher profitability through pricing as you said. And so, it's not a huge difference. Cable operators are inarguably a lot more alike than they are different. But on the margin, Charter is a little bit more aggressive at pushing penetration and Comcast is a little bit more aggressive at pushing price.
Bill: Yeah, that makes sense. All right, so I think we brought people today, if we haven't, I'm sorry, we've done the best that I know how to do. Now we've got the war between wireless, and cable, and potential wireless convergence. So, do we want to go into what the wireless operators look like as of today as a competitive set? Does that make sense do you think?
Craig: It does. Let's start with the observation that the wireless business is a much less attractive business than the broadband business. Why is that? For an incredibly simple reason and that there are fewer broadband players in the market than there are wireless players. At the end of the day, it is simply about the number of competitors in a business. The microeconomics of both businesses are pretty much the same. It's the marginal cost of moving around electrons, which in any case is almost zero. They're both reasonably high capital intensity. You could argue that the broadband business tends to be more capital intensive upfront and a little bit less operating costs going forward. Wireless skews a little bit lower capital intensity to get started and a little more capital intensity to be sustained. But those are again on the margin. Mostly these are telecom businesses with low marginal costs. What makes the wireless business less attractive is that we've always had a regulatory structure that keeps a lot of wireless players in the market beating each other's brains out. And so, it's much harder to make money.
Now, we've gotten to a point where the cosmetics over that where that the wireless business was growing very, very fast. For 40 years, the wireless business kept growing from what was originally going to be just a little niche product too, eventually it was going to be available in most major dense markets too, maybe it wasn't just going to be dense markets, maybe it was going to be available out in the suburbs as well too. Maybe it was going to be available almost everywhere too, its ubiquitous. Maybe it's not just a business product, but it's going to be everybody. And eventually, it got to the point where now it's a pretty saturated market. It's not really a growth market anymore. So, you've got three players after the merger of T-Mobile and Sprint down from four to three. Some speculation and debate about whether Dish Network will emerge as a wireless player. We can talk about them in a bit.
Now you've got a three-player market, whereas in broadband you typically had a one player market and the debate is whether those individual markets are going to go from one player to two, but it's still not the wireless market where there's three. The wireless operators are now trying to figure out, "Okay, well, where do we go?" They spent gobs of money buying spectrum for 5G with the expectation that all these [unintelligible [00:31:38] 5G functions and applications were going to emerge that were going to unlock all kinds of new value. People will talk about driverless cars and internet of things with millions of connections for smart cities and smart traffic lights that would control traffic flow, and all these kinds of 5G stories, none of which have really materialized.
Verizon spent $50 billion dollars buying C-band spectrum. That's $50 billion with a B to buy C-band spectrum. Imagine a company where you spend $50 billion and the next morning, no one changes their revenue forecast by one penny, because you just bought an asset for $50 billion.
Bill: It sounds little like Facebook.
Craig: [crosstalk]
Bill: For different reasons.
[laughter]
Craig: Exactly. Yeah, that's right. So, now Verizon is sitting on top of the C-band spectrum that they bought. It's pretty clear it's not going to generate a particularly meaningful amount of incremental revenue. And so, the question is, what do you do with it? T-Mobile is sitting on top of a ton of 2.5 GHz spectrum that they got in the Sprint deal. They also are thinking, in retrospect, got a much better price on it. They didn't have to spend $50 billion to get it. In fact, buying all of Sprint was less than what Verizon spent on just the C-band spectrum.
T-Mobile got a very good deal in retrospect. But T-Mobile is looking at the same thing of excess capacity. And so, they first started looking at the broadband market as a way to use some excess capacity. It's important to remember that a broadband customer that is in this case a household, because wireless operates at the individual customer level and broadband operates at the household level. But a broadband household uses about 50 to 70 times more data than a wireless phone subscriber does. And yet, they only generate about 20% more revenue. So, on a revenue per bit basis, fixed wireless broadband are serving the wireless broadband market generates about 1/50th as much revenue per bit as wireless does. It is so unattractive economically on a relative basis that you would only do it if you were just a wash in excess capacity. You couldn't think of anything else to use your capacity for.
As it turns out that's the case today, but it's not clear it's going to stay the case, which is why people have a very skeptical perspective, I would say. I certainly do about how long is the runway for using wireless spectrum for broadband. It's just a very inefficient way to deliver broadband and a very costly way to use capacity. They will do it, but probably not in urban areas, because the growth in wireless usage which has been 35% compound annual growth rate as long as anybody can remember means that the amount of traffic on the network even if you weren't adding a single subscriber would double every couple of years. And so, even if you think, "Well, I have 20 times more capacity than I had before," that may sound like a lot, but you'll burn through that in about five, six years. And so, you can't allocate all that much capacity to fix wireless broadband in denser, more urban market.
At the edges of the network in rural America, it may actually be possible that you've got a pretty long runway. And so, I think fixed wireless broadband will turn out to be pretty much a rural product and it'll have a real place in the landscape, I think, in rural America and that happens to be where arguably the greatest need is anyway. But it's going to eat cables lunch and it's going to be the way that you finally get to say goodbye to your cable company. Probably not. It's probably too much to ask of fixed wireless broadband, because again, the economics just don't really support that.
Bill: My understanding and please correct me if I'm wrong, that is T-Mobile is leaning into two and a half gig spectrum, right?
Craig: That's right.
Bill: That sacrifices speed, but you gain penetration through things like leaves, rain, whatever. AT&T and Verizon seem to be more focused on millimeter wave, which has problems getting through things like leaves and rain, but you can potentially, in theory, have a much faster connection. Is that accurate?
Craig: Yeah, that's mostly accurate. Let's go back to the basic physics of wireless, which are that the lower the frequency, the further the signal propagates. Low frequencies in the old days used to be thought of as anything under 1 GHz spectrum. So, think of 600- MHz spectrum or 700- MHz spectrum, which were spectrum bands that were used for broadcast television. They were assigned by the FCC in the 1950s. In fact, they go way back to the 1930s radio. There are old stories about a radio station in Chicago that was causing interference with a radio station in Tokyo, because its power level was too high. Those signals will propagate incredibly far. That's where wireless first started. And wireless first started in the 800 and 900- MHz band in the very early days of experimental wireless, because those signals will propagate incredibly far and therefore, they're pretty cheap for getting coverage.
In fact, old fogies like me are old enough to remember the days that a market-- Baltimore was actually the first wireless market. It could only handle one phone call at a time. You actually had a button on your phone, it was usually the size of a suitcase that would tell you when the other person in the market had made their call and was finished so that the market was available for you-
Bill: Wow, that's wild,
Craig: -to make a call. And so, those early days of propagation and that spectrum was given away to the phone companies in the 1970s because nobody thought there was real value to it and so, they thought, well, maybe these guys will be able to do something with it. Let's give that spectrum away and maybe they'll create a product that has some niche application for connecting phones, connecting people wirelessly instead of with wires and the rest as they say is history. Those signals are good for rural areas. Eventually, we ran out of that kind of spectrum. Mid-band spectrum was thought of as a compromise. Mid band spectrum was between 1 GHz and 2 GHz in the old days. You thought, well, it's not as good as low-band spectrum, it doesn't propagate as far. But in urban areas in order to be able to have multiple people making calls at once. First, they figured out multiplexing, but also, they sectorized antennas.
But a big part of the answer was just turn down the power on the antenna, and make the radius smaller, and then have multiple antennas, so that people within the radius, if it's a smaller radius area or a smaller area covered in radio propagation around the tower, you'll have fewer people sharing it and therefore more capacity and you can handle more people in the city simultaneously connecting.
Bill: Similar to the node split.
Craig: Yeah, exactly.
Bill: Yeah.
Craig: Exactly the same. And so, if you're going to turn down the power and not have a particularly long radiation from the cell anyway, there's no reason to have spectrum that could propagate really far. Why spend extra for a spectrum that could propagate further than you're going to let it propagate anyway? The mid-band spectrum became a good compromise. Well, it's cheaper, there's more of it, and we don't need it to propagate all that far anyway. So, the thinking became mid-band spectrum for cities and low-band spectrum for rural. By the way, T-Mobile didn't have any low-band spectrum. So, they were urban only. They only had mid-band spectrum, because they had not been part of the giveaways of spectrum in the 1970s that got Verizon and AT&T started in what were then different brand names of course, they weren't Verizon and AT&T yet.
When Sprint had a bunch of 2.5 GHz spectrum that ultimately is now what T-Mobile has, 2.5 was thought to be such high-frequency spectrum that it wasn't really useful for anything. And so, it wasn't terribly commercially valuable. When they were developing the specs for 5G, mostly in Europe and Asia, this is now well before any of the companies started rolling out equipment. This is 10 years before the 5G cycle started and people were developing the specs. Part of the goal was, well, it's got to be an order of magnitude faster than what we've had before or no one will care. So, how do we get really fast 5G? Well, the answer was, I don't want to get too techie here, but we're already getting reasonably close to the theoretical limits of Shannon's law, which is the bits per hertz.
Most of the capacity gains we've had in wireless over the last 20 years have come from simply what's called spectrum reuse, which is cell splitting as you said analogous to node splitting and then narrowing beams and what's called MIMO and things. Well, one way we can actually get more capacity is just throw lots of spectrum at the problem. If we historically engineered around spectrum blocks that were 20 MHz wide, because that's what had been the kinds of block lists that were available in most low and mid-band ranges.
What if we wanted to design around block widths that were 800 MHz wide? Well, if I've got 40 times wider block width, so I'm going to get 40 times higher speed. But where am I going to find block widths that are that large? Certainly not in low and mid band because that spectrum has been used for 50 years for all kinds of things. So, I can try to find a little rifle shot here and say CBRs or citizens band radio. When you used to have like the truckers and things like that signaling to each other, a lot of those markets have died. And so, you repurpose the spectrum, you find some spectrum here, you find some spectrum there. But pretty much all that spectrum has been spoken for for years and all kinds of different industries, and then government functions, and national defense index.
You had to go to incredibly high frequencies where no one was doing anything, because no one thought there was any value to the spectrum. I used to use the analogy of I'm here in New York. The famous building that tragically, John Lennon was shot in front of, the apartment building is called the Dakota. It got its name because the joke at the time it was being built in the 1800s was it's so far from the city, it might as well be in Dakota. [Bill laughs] And they decided they would take that as its name. But at the time, the city didn't reach up into the West 72nd street. That's the vision for millimeter-wave spectrum. They chose millimeter-wave spectrum, because it was fallow spectrum that no one had ever figured out a way to use it or a reason to use it before, so it's just sitting there. And so, you found big, big blocks of spectrum.
The problem is the physics of, if you thought 2.5 GHz was too high frequency to propagate far enough that it was practically useful, imagine what it's like to try to figure out a way to use 28 GHz. Because remember, these things for distance will decline exponentially as the frequency rises. So, the distance covered by millimeter wave is incredibly limited and as you said it's subject to rain fade and in layman's terms, raindrops will block signals, leaves on trees will block signals, all those kinds of things. Oddly, Verizon made a huge strategic bet on millimeter wave at a time when everybody said, "It's just not going to work." In fact, the US government actually made a pretty big bet on millimeter wave 2 in that they allocated spectrum and were much more aggressive about allocating millimeter-wave spectrum and didn't do as much about trying to free up mid-band spectrum, where most of the rest of the world came to the view that this is going to have to be a mid-band spectrum story, not a millimeter-wave spectrum story.
Today, you'll hear mid band as called sub 6. Meaning anything less than 6 GHz is considered mid band. In essence, once they started talking about millimeter wave, which was so high frequency, they had to change the nomenclature for mid band and say, "Well, if I'm talking about 6 GHz, 6 GHz 10 years ago would have been thought of as ridiculously high-frequency spectrum." But now that I'm in a conversation about 28 and 39 GHz, 6 doesn't sound that high anymore. So, let's call that mid band now and instead of mid band being 1 to 2 GHz, let's say that mid band is anything between 1 and 6. Well, as anybody listening to this podcast will immediately recognize I hope, just because you change the name it doesn't mean you change the physics. The physics are still the physics. [chuckles]
Bill: Yeah.
Craig: These things still don't propagate very well. Millimeter wave propagates terribly. I think it's now become clear, "Yeah, you may be able to build networks based on millimeter wave in arenas, and stadiums, and convention centers, and train stations, and airports and things where it's pretty well contained, and they're pretty short distances, and you can aim them really well, and all that sort of thing." But realistically, millimeter wave is not going to play a terribly large role in what an individual's experience is because it would just be too expensive to build a millimeter-wave network.
Bill: Yeah, the density would need to be insane.
Craig: Exactly. You'd have to have cell sites, literally multiple cell sites on every single block of every single city. By the way, there may be some downtown areas where the economics of that are good enough that you actually do it in downtown Manhattan or inside the loop in Chicago, but there's very few of those.
Bill: Yeah, that makes sense.
Craig: Most of the time, you're not going to be using millimeter wave. It's a really interesting strategic moment for Verizon. A lot of Verizon's troubles today are a function of having made this enormously aggressive strategic commitment to millimeter wave. AT&T was off wandering around in the woods doing all these goofball things with media, which ended terribly as everyone knows, buying direct TV and buying Time Warner. And Verizon in some ways strategically made exactly the right bet, which was, "Let's not go off and do goofball media stuff. Let's stick to our knitting in our history as the best network." And so, they got the big strategic thing right which was, "Don't go off and diversify." But then they got the execution exactly wrong and they made a giant bet on millimeter wave and blew it.
T-Mobile made the bet on mid band in part because they had it. And so, as they did the merger with Sprint, Sprint had this giant trove of 2.5. As I said, it used to be thought of as very high-frequency spectrum. But suddenly, the conversation of mid band goes all the way up to 2.6, it's thought of as lower mid band today. It's still expensive to deploy. We still need much higher density than you would need for what used to be thought of as mid band, but it's got a really large block width, they've got a lot of it, it's pretty much everywhere and they just bought some to fill in. And so, it's a really good strategic asset.
By the way, when Verizon spent that $50 billion on C-band, C-band is 3.7 GHz versus T-Mobile's 2.5 GHz. That may not sound like a big difference, but it's a huge difference. The propagation advantage of 2.5 is much better than the propagation of the C-band. And so, it will cost Verizon and AT&T also operates, it's primary 5G mid band, spectrum band will be C-band as well. They will both have to spend vastly more money than T-Mobile. And even then, I think it is fairly clear that T-Mobile will have much better network coverage by virtue of the physics of the spectrum band that they operate in.
When we say T-Mobile as we enter 5G positioned to have the best network and also the lowest prices, it's not a question of they've done a better job at densifying the network, or their engineers have done better at this, or that or the other thing, it's simple physics. The physics of the spectrum band that they own that is the backbone of the T-Mobile story, those are better physics for what they're trying to do than the physics of what Verizon has.
Bill: Meanwhile, they don't have the burden of a dividend yield. At least whatever debt they've incurred to buy Sprint is put into productive assets as opposed to Verizon and AT&T, which arguably have debt that is serving less productive assets to say it nicely.
Craig: It's a huge difference for Verizon and AT&T are very levered companies. Let's go back to some long history, in some ways, having done this now for-- I've been involved in the telecom industry for 33 years or something. One of the things that you see that recurs globally in telecom is they tend to be very slow growth businesses. They tend to pay very high dividends. The idea that phone companies are major dividend payers shouldn't actually be obvious based on any characteristic of their business. It was perfectly obvious and sensible for that 75-year period that I was talking about when they were regulated monopolies. And so, by sharing into the history, they are big dividend paying companies and that's the expectation for them in the same way that electric utilities which are still regulated monopolies are giant dividend payers.
They are big dividend payers and with slow growth and high dividends and big capital investment requirements like buying the C-band spectrum that I described, you tend to get heavier and heavier and heavier debt burdens on these companies over time. It gets harder and harder and harder to sustain the dividend and to service the debt as the debt levels get higher and higher. So, you go through these cycles that we've seen in Europe over now 30 or 40 years. We've started to see in Asia and some markets. And now, we've seen in the US, where AT&T, for example, cut its dividend a year and a half ago and then suddenly tries to make the case well. Now that we've cut the dividend, we're a growth company, and blah, blah, blah, blah, blah. But give it a little time and you're right back to the conversations about these heavily indebted companies with big dividend burdens that are back to having to entertain cutting the dividend because the economics are just really punishing over the long term for these kinds of companies. And a company like T-Mobile that has never had that legacy of having to pay a massive dividend has a huge advantage in much greater flexibility.
Bill: Now, to compound the competitive set that AT&T and Verizon are facing and I'm somewhat excluding T-Mobile from this because I think that they have a little bit more capability to compete on price. But you've got the MVNO that the cable companies have, so they're selling wireless plans at what appeared to me to be quite cheap prices relative to what your standard wireless plan is, right?
Craig: That's exactly right. I think there's this narrative that people love to entertain because it sounds like it's armchair game theory. Well, the phone companies or the wireless companies are entering fixed wireless broadband and the cable companies are therefore entering the wireless market. It's tit for tat. They're trying to signal to blah, blah, blah, blah, blah. All that's a bunch of nonsense. There is no complex game theory going on here. It is simple. The wireless companies as I described before are looking at the broadband market because they can do it with excess capacity and they think they can make some money at it. To be fair, they do hedge their bets against what if the world does go in the direction of bundled offerings and a converged offering of wireless and broadband and I'll come back to that in the microeconomic logic of that a second
The cable operators are looking at it in much the same way, they can make money in wireless. It's amazing. The MVNO which stands for mobile virtual network operator, meaning it's just a fancy way of saying they buy capacity from Verizon and resell it under their own brand name. The MVNO dates back to 2011 when Comcast and what was then, Time Warner cable and Bright House, all did a deal with Verizon that sold Verizon some spectrum. As part of the deal, they got an agreement to be able to resell Verizon service. That deal set fallow for about five years and then around 2016, the cable operators finally entered the wireless market. I think most people are dismissive of Cable Wireless, because it's "Just an MVNO." After all you're just reselling Verizon service. So, it's a low margin service.
Again, going back to the basic premise of telecom which is high fixed, low variable cost. An MVNO is not that. An MVNO is high variable cost because you're paying for each gigabyte that you use under a wholesale agreement with Verizon. The cost structure doesn't really allow you to be super competitive and blah, blah, blah. Well, guess what that's not the way the cable operators think of their business. It's not really the right way for investors or observers to think about their business. The cable operators actually have a real advantage here, which is that their ground infrastructure, terrestrial infrastructure gives them a cost advantage that can potentially mean they won't just be bit players in the wireless market. Give them time and they could actually win in the wireless market and be the dominant wireless providers in the United States. I know that's very counterintuitive to most people. But remember that a wireless network, the old adage is that a wireless network is 90% of wires and that you have these wireless endpoints, the radios propagate radially. But as soon as it hits the tower, it drops onto a wired network.
Well, as you get denser and denser and move toward 5G, wireless network that used to be 90% wires is going to be 95% wires. The wired part of the network is where the real costs are. And therefore, whoever has the advantaged cost structure of the terrestrial network ultimately wins. The cable operators have the densest and largest terrestrial network of any of the players here. So, their strategy was initially let's do a hybrid Wi-Fi cellular network and let's offload as much traffic onto Wi-Fi as we can. Now, already every cellular customer in America offloads most of their traffic onto Wi-Fi. You're on your Wi-Fi network at home and so your iPhone is sending traffic over Wi-Fi at home, and it's doing it at school, and it's doing it at Starbucks, and what have you.
A typical Verizon customer might send say 75% of the monthly traffic on that device over Wi-Fi and only 25% over the cellular network. Comcast already sends over 90% of the traffic over Wi-Fi and only about 7% or 8% of the traffic over the cellular network. If you really think about what their marginal costs are, which is just what did they pay Verizon for that piece that they send over the cellular network because what's sent over Wi-Fi is essentially free to them, it's already a fraction of what you would have thought based on if it were just a regular MVNO. So, they already have a much better cost structure than most people think and therefore they're able to offer a pricing structure that as you described is really cheap and it's a very competitive product.
Interestingly, they actually even beat Verizon in most network performance test because it is exactly Verizon network and coverage and it's exactly Verizon's network and speed wherever it's running on Verizon, but it actually runs faster than Verizon network when it's on Wi-Fi in some of these places. And so, you get a network that it is essentially, in fact, it's not just essentially, it is Verizon's network, but even better and you get it much cheaper than even-- Verizon can sell it, because again it's not that Verizon doesn't have a low enough marginal cost to sell it, they could sell at lower marginal costs if they wanted. You can't cut your prices and still support your dividend and your debt. So, you're stuck in this rock and a hard place.
The cable operators are just getting started because they're going to start moving more and more traffic on to CBRS, Citizens' Band Radio Spectrum that they bought when essentially the FCC said we don't need CBRS service anymore. And so, let's reclaim that spectrum that kept the name CBRS. But let's reclaim that spectrum and use it for something else and they sold it at auction. And now, it's going to be used for a wireless service and the cable operators bought a bunch of it. It's adjacent to a lot of unlicensed spectrum. So, they have a big, big block of spectrum between what they bought for what are called pal license or preferred access priority licenses and the unlicensed spectrum. So, they now have a big block of advanced spectrum. They'll do what are called strand mounted small cells where very, very cheap to hang these things wherever you have aerial plants strung between telephone poles. Very cheap to hang these radios and offload traffic that would otherwise go on the Verizon network that you'd have to pay for. And instead, just take it over cables own network and keep lowering your costs more and more and more. Some of that cost advantage, they will translate into their own profitability and some of that cost advantage they will translate into lower prices to take more and more market share.
I think the cable operators are just getting started in the wireless market. There's still this perception in the capital markets that this is just, I call it almost a hobby for the cable operators because again, it's viewed as well, it's just an MVNO. What I'm really worried about is the growth rate of broadband is slowing down. And so, cable is yesterday's news and it's blah, blah, blah. I think the market is grossly underestimating the runway in front of the cable operators in the wireless market.
Bill: Yeah, I also thought it was interesting. I read a Tom Rutledge's interview that he did with CNBC and he seems to say that the broadband market still has a fair amount of growth. I think the other thing that's confounding market participants is how much of what's going on currently with cables growth or lack thereof was a COVID pull forward and then you've got T-Mobile is signing up a bunch of people on their fixed wireless product that I think maybe confuses reality a little bit right now. I don't know it's hard to decipher what's reality from what I believe to be the case, I guess. I don't know if I'm saying that the right way, but that's what I think's going on.
Craig: There's a lot of debate about why the broadband market is slowing down. I think the cable operators talk about low rates and that move activity is suppressed. The capital markets have concluded that the problem is fixed wireless broadband and expanding fiber competition. We should talk about fiber competition in a minute. But expanding fiber competition are eating cable's lunch and broadband. I actually don't think any of those things are quite the right diagnosis. I think the right diagnosis is actually a lot simpler and probably a little less interesting and sexy than any of those things. The terrestrial broadband market has gotten reasonably close to saturation. There's just not a lot of growth left.
The penetration of the market as a percentage of total US households is now right around 85%. We don't know what the denominator is that is we don't really know how many of those homes have access to broadband and how many don't. We know that there is a big rural contingent in America that for whom the wired network is not available. But we don't know how large that is. The FCC has been charged with getting maps out for 30 years that we're now hopefully into the short strokes of getting those maps released and so, we'll finally get a chance to see what portion of American households don't have access to broadband. Under the JOBS Act after COVID, there was this enormous allocation of money in the Infrastructure Bill to build rural broadband without anybody really knowing how big the problem was that we were trying to solve. My intuition is, we may have allocated way more money than is actually going to be needed to solve the problem, but we'll find out.
Whatever that number is, we're probably pretty close to saturation in the parts of the country that actually do have access to broadband such that there's just not going to be a lot of growth left. It's not this terrifying story of, "Oh, my God, cable operators are suddenly getting killed by X, Y, or Z." It has become a mature product, there's still going to be some pricing growth left in it like in almost any other product, but it's not going to be a unit growth story anymore. If the cable operators didn't have wireless, I think that would be a fairly glum forecast, I guess. But they actually do have wireless. I used to describe a video was Act I for the cable operators. There was this moment in circa 2006, 2007 when the market was obsessed with the idea that, "Oh, my God, the cable operators are going to lose their video and cable is dead."
There was this wonderfully poetic bear thesis for cable called The Twilight of the Gatekeepers that was about how cord cutting, which wasn't yet called cord cutting. It was going to kill the cable operators. Remember, that goes all the way back to 2006 or so. It took people a while to figure out, wait a second, cable operators aren't media companies. Cable operators are infrastructure providers and they've got the winning infrastructure. The broadband business is going to turn out to be a much better business than the video business ever was. That became really clear and the cable stocks were off to the races and had an incredible decade as investment. I think the markets going through that same crisis of confidence again of, "Oh, my God, Act II, which was broadband is now over, time to leave theater." Instead of saying, "Well, Act II is just about over, but Act III is getting started and Act III is wireless."
Now, to be fair Act III is not as profitable as Act II was. Wireless is not as profitable a business as broadband was and has been. But it is a much bigger business than broadband. The wireless market in the United States is more than twice as big as the broadband market in the United States. If you change your lens a little bit and think the cable operators are playing around the edges for this just to be a small added product that extends their lineup a little bit to instead, "No, these guys are actually playing to be major players and potentially the winners in wireless because they have the best wired infrastructure underneath the wireless network," then I think you could imagine the cable operators actually have a pretty attractive future in front of them. And that's certainly not the way they're being viewed in the capital markets today.
Bill: Well, I think part of that to circle back to what you put a pin in is the fiber overbuilders and the perception that fiber may threaten cables Act II.
Craig: Yes, that's right. The fiber overbuilders are, it's not a new story. Everybody is probably familiar with FiOS that was the big fiber overbuild story of now more than 10 years ago. It started around 2008 or so and run its course by 2000-- It really started about 2006, 2007, I guess and then had run its course by 2010. Now, we're in this another cycle in part because cost to capital had gotten so low in the post COVID days and before inflation reared its ugly head. It was infrastructure projects of all kinds became incredibly attractive and the market was enraptured by the idea that you could build fiber networks and build a competing fiber infrastructure. And so, suddenly it went from a niche activity to a mainstream activity to everybody and their brother wanted to build fiber networks.
I am extremely skeptical. I've been looking at fiber overbuild economics for 30 some odd years now in my career. A lot of the immutable truths that are taught by time are inevitably kind of rear their head here. Not least of which is that we're going to start to run out of places where it's economically attractive to build simple economics of building a fiber network or that you cost a certain amount per mile. Now, by the way, it costs a lot less per mile where there's aerial infrastructure. Meaning, it hangs on telephone poles, where there's buried infrastructure where it has to be buried in the ground.
It's not hard to imagine that it's a lot more expensive to dig a trench in the ground, and put fiber in it, and then cover it back up, and have to repave over it, and get all the licenses and permits and that sort of thing than it is just stringing along telephone poles. Either one is expensive. But burying it under the ground is really expensive. Then it costs a certain amount per mile. And so, your cost per home passed, which is really the fundamental determinant of the economics of building wireless network. Your cost per home passed is a function of how many homes there are per mile. So, higher density is a lot cheaper to build a lower density. If you have to build a mile and there's only 10 houses, it's going to cost a lot more than if there's hundred houses along that mile. So, you naturally started building fiber in places that were primarily aerial and high density.
Well, you run out of those places eventually. When I hear people say there's going to be a competing fiber network built in 70% of the United States, the truth is, let's say we've built to about 38% of the United States today with overlapped fiber and cable networks. The density in the four densest deciles of population in the United States, that is census blocks that represent the first 40% of the US population have densities respectively of about 25,000 people per square mile, about 10,000 people per square mile, about 6,000 people per square mile, and about 4,000. So, say we're in that 4,000 people per square mile now that we're building in the fourth decile.
The seventh decile has about 400 and some odd people per square mile. I don't hear anybody saying, "Well, you better take your cost per home passed up by 10x if we're going to be building into the seventh decile." Because if the cost of building a mile is the same with 1/10th of density, it's going to start to be insanely expensive to start building. And so, I think there's been an awful lot of capital that has been directed at building fiber networks and this narrative that, "Well, we can get 50% penetration and we can do it for $1,000 per home passed and we're going to make a really attractive return." Well, guess what those business plans were built at a time when the cost to capital was 6%. It's not anymore. They were built with an expectation of labor costs rising by 2% a year. They're rising at 10% where there were no equipment supply chain challenges of getting bucket trucks and what have you to build these networks.
They were built naively on the view that I could sustain the same cost per home passed that I've been seeing in the past without just acknowledging the obvious that we're going to run out of places with sufficient density pretty quickly and we're going to be building in high-cost low-density areas and the returns are going to be absolutely awful. So, one of my personal strongly held views is that the fiber bubble will burst and burst badly over the next couple of years and there's going to be a lot of tears after some very, very poor investments.
Bill: Can we talk about what Altice is doing real quick, because I am confounded? Are they overbuilding themselves?
Craig: They are. It's really hard for most people in the industry and for me to understand why they've never articulated a very clear vision for why. Remember, they have a European legacy. Altice N.V. started as a company in Europe. They have a Portugal technology arm and they overbuilt in Portugal. They were primarily French and bought SFR and the wireless company in France. They have cable assets in Europe. So, they brought some of that European expertise if you will to the US market when they bought what had been Cablevision with another cable operator called Suddenlink and put them together as Altice and committed to overbuilding themselves with fiber.
Part of the argument was that it would be a lower cost network to operate. I don't think anybody would argue that that's not correct. It will be a lower cost network to operate. Question is, how much lower? Is it sufficiently lower that it earns a return on the capital to overbuild yourself? The answer is almost certainly not even close. You will save some money, but in the grand scheme of things, save enough that it's going to make all that much difference. Certainly, not going to pay for overbuilding your own network. They have made the argument that overbuilding their network will mean that they have faster growth and higher market share than they would otherwise have. There's no real evidence for why that would be the case. Because again, unless you believe that the capability of a fiber network is just simply greater than the capability of a cable network and while that may intuitively resonate with some people, the evidence suggests it's just not the case. You have this obvious problem of how in God's name are you going to earn a return on all the money that you're spending to overbuild your own network and why are you doing it? They've never really articulated any clear evidence for why it's a good idea.
Bill: And the inefficiency that comes from running two plants, I think I saw they have 13% penetration on the fiber product. It's like, "Okay, well, now, it seems to me that both plants are inefficient currently." I don't know, I'd always known that they wanted to go to fiber as an end state. Any interview that you read or somebody that you ask, it's pretty evident that they liked fiber. But I did not understand that this would be the strategy. I don't know it's shocking to see what happened to that stock. They bought it much higher. So, I think they must have thought that they were right.
Craig: Well, their strategy wasn't only building fiber. In some ways, it's an Icarus story of flying a little too close to the Sun, I suppose. Their strategy, they used to call it with no small measure of hubris, the Altice way, was in some ways pretty simple financial engineering. It was by a company, slash the costs, raise the prices, start buying back stock, get the stock price up by buying back stock more and more and more. It worked pretty well in France until it didn't and then it became clear. They had cut too far and raised prices too much, and it all came crashing down. Of course, they bought Cablevision and Suddenlink in the United States before it came crashing down in France. And so, there was still some view, "Well, now we're going to apply the Altice way to the US market."
They bought Cablevision and especially Cablevision was much larger of the two assets. But known I think, for most people as Long Island's cable market in the US, but it's not just Long Island. It's also a lot of New York City. It's just people tend to have a very Manhattan centric view and sort of New York City X Manhattan, it's the outer boroughs. But they slashed costs, they raised prices, and it worked for a little while until it didn't. And now, I think they are setting about the very difficult work of having to clean up some of the mess that they themselves made by pushing prices too aggressively and cutting costs too aggressively. I don't have a particularly cataclysmic view of what's going to happen. I think they just still have a lot of work in front of them. It's still at the end of the day, a pretty good asset. But it's going to be a very difficult slog to fix, especially the pricing problem that they have created. They have just pushed their pricing for broadband much too far, too fast relative to the competitive market that they're in. It has created, I think, a real overhang for them.
This is not unique to Altice in any way, the other problem they have is that it's a very levered stock. And so, rising interest rates have worked against all leveraged stocks. Remember that as the stock price falls, the debt stays the same, the equity slice on top gets smaller and smaller and smaller and therefore, the equity gets more and more and more volatile, and gets more and more sensitive, exponentially more sensitive to further changes in interest rates if it works against you. And so, in some ways that's been as much the story Altice as anything else is that levered stocks have just gotten killed in this market, because the cost to capital says all multiples come down. If the debt pile doesn't change and it hasn't, then what's left is for the equity to shrink. When the equity is just a thin slice of capital on top of a big pile of debt, it suddenly becomes incredibly volatile.
Bill: Yeah, it's been wild to watch. I think it definitely caught me off guard when Charter got a little expensive. I traded it into Altice and thankfully I got out and back into Charter. I think I'm just going to stick with management teams that I am aligned with from here on out. [chuckles]
Craig: Yeah, that's right. Charter has a heavily levered capital structure as well. So, they also have a lot of exposure to changes in interest rates irrespective of anything that's going on at the company specifically. They're just like levered companies. You are exposed to changes in prevailing interest rates and the rise of the tenure. No, but operationally I think Charter is quite a strong company and certainly much stronger and in a much stronger position than Altice. That's in large part because they have priced their broadband services much more judiciously than Altice has over the last seven or eight years.
Bill: Yeah, indeed. Well, I am out of my allotted time with you, but I want to thank you very much for coming on. You put a lot of research out. Some of it, I'm fortunate enough to see and I hope that I have reciprocated some value to you and that I'm certain that the people that listen understand why you have the reputation that you have as an analyst. If anybody has listened to this and is interested in subscribing to your research, where would they go to find you and what you do?
Craig: Well, first of all, I really appreciate those kind words. You can go to moffettnathanson.com. That's M-O-F-F-E-T-T-N-A-T-H-A-N-S-O-N dotcom. We are, as I said, a part of Silicon Valley Bank or SVB Securities. But you can go to moffettnathanson.com and then you can find on the website ways to inquire about the subscription. I really appreciate the kind words because our business was built on the idea that if we did good enough research and if we hired people with enough experience and insight that we could create research that people actually wanted to pay for, which as obvious as that sounds is not actually the way the research business historically worked. And so, it's very much about providing research that our subscribers value enough that they think is worth paying for. And so, I appreciate those kind words.
Bill: Yeah. Well, I mean it man. It's been a pleasure talking to you. Are you going to be at Liberty next week?
Craig: Yes, I will be at Liberty. And so, I look forward to meeting you in person and I want to thank you for doing this, Bill. Actually, it was a pleasure. I really enjoyed the conversation.
Bill: All right. Sounds good, Craig. Have a good one. See you next week and we'll chat soon.
Craig: Sure. You too.
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