The Telecom Killer
Dave Schaeffer is known as “the most hated man in telecom,” and it’s not hard to see why.
Schaeffer is the CEO and founder of a scrappy outfit called Cogent Communications. His vision is to sell a single, all-purpose connection meant to serve all of a customer’s digital needs — telephone, TV, Internet — at prices as much as 98% lower than the likes of AT&T, Verizon and Comcast.
It’s bad enough when a competitor comes in and cuts your profit margins in half. But when they want to drop your prices by 98%, what do you do (other than curse up a blue streak)?
Global telecom is still a $1.8 trillion industry, according to Forbes. While companies like AT&T and Verizon want to keep it that size, Schaeffer is happy to see the dollar value of the industry implode… as long as his company can grab a big piece of the far smaller pie.
The guy is just ruthless. “When Cogent got into the business in 2001,” Forbes reports, “the going rate for high-capacity data transport was $300 per megabit per second. Cogent started charging $10.” Ouch! No wonder they hate his guts.
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You Want a Good Moat
So, what’s the point here: to invest in Cogent, and short AT&T and Verizon? Not exactly. Schaeffer’s stock has been beaten up as badly as his competitors in recent months.
No, the point is more to keep an eye out for “moat” problems — and to highlight the hidden potential in tough industry conditions.
For starters, the simple fact that Schaeffer can undercut his rivals by 50% to 98%, and still stay in business, points out a huge vulnerability in the likes of the big telecom players.
The fact that a scrappy rival could drop prices through the floor and scoop up 17% of all Internet traffic in just a few years shows that the incumbents had no “moat,” as Warren Buffett likes to say… no way to protect their huge profit margins.
After all, if the first guy is charging $300 and the second guy charges $10, what was the justification for $300 in the first place?
MLPs, in contrast, have much more daunting “moats” in the form of physical infrastructure. No one can pop out of the blue, lay thousands of miles of steel pipe across the rural Midwest and start charging prices lower than anyone else. It’s a simple business, but a darn near impossible one to break into. The “moat” is deep and vast.
Pain Versus Gain
The other thing to keep in mind is that hard times can lead to long-term advantages for well-positioned companies… even companies in the middle of what appears to be contracting or collapsing industries.
When prices are falling and credit dries up (a double whammy that just hit the energy sector), the weaker players are the ones who go belly up first.
You can almost think of it like the TV show Survivor — every time another competitor gets voted off the island (or out of the industry), the remaining players see their prospects improve.
A Healthy Cycle
At the end of a tough business cycle, the surviving companies win by heading into the new upswing with fewer competitors than before. (It’s a great thing to surf a rising demand trend with plenty of elbow room.) The payoffs for making it through the pain include more demand for services, more ability to raise prices and more opportunity to expand.
We’re really seeing this dynamic play out now in hard asset businesses: miners, drillers, commodity producers and the like. Hard times are winnowing out the weak. But the kind of companies we’re focused on in Safe Haven Investor are set to benefit from all this turmoil.
The companies we invest in have the strong balance sheets to weather the storm. They have the “moats” necessary to protect profit margins and keep churning out cash flow, even when prices are down. And they have plenty of strategic options — like putting more pressure on their competitors, conserving cash for the next upswing, or snapping up distressed assets on the cheap.
So, fear not the “telecom killer,” but heed his lesson — look for good moats, and stick with hardy survivors, especially in times like these.
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