Horseman Global Fund Investment Manager Russell Clark has placed long-term bets on events that are difficult to get the timing right. He likens it to hunting wolves, according to a November letter to investors reviewed by ValueWalk. You can’t stalk a wolf; you have to let them come to you, which requires patience. But aside from Clark’s well-known stance ongoing long emerging markets and short developed markets, there is an investment he has made in the wireless arena that points to a potential industry disruption that is mostly off the mainstream consensus radar.
Legacy cell phone carriers are dinosaurs; they just don't know it yet
When Clark watches the Showtime original series “Billions” with his wife, he finds authentic hedge fund manager “Bobby Axelrod’s” interaction with investment managers constantly grilling him to be the most accurate. The overly chatty legal character, Maggie Siff, isn’t quite as believable; it is unnatural, much like a compliance officer becoming friendly with the brokerage sales force. Legal folk is typically chatty with a purpose, not on a random basis.
But the oddities in the world are not limited to cable TV. What he also finds unusual is a potential disruption that could be in the future for wireless carriers. The goliaths of Verizon Communications Inc. (NYSE:VZ), AT&T Inc. (NYSE:T), and Sprint Corp (NYSE:S) are likely to be met, head on, by a democratizing force of technology.
In the future, thanks to cloud-computing and “virtual telecom networks,” a cell phone carrier won’t be necessary to make cell phone calls.
As The Economist recently explained, virtual telecom networks transform cell phone connectivity, moving away from physical switches and boxes that are operated by a narrow corporate group. What is rapidly replacing this is the ability to connect to a wi-fi hotspot and use software, some of it off the shelf, to make cell phone calls – all without the traditional cell phone carrier.
The legacy cell phone system is the dinosaur, but no one realizes it yet.
I tend to look 5 years into the future whenever I do anything, and I am naturally drawn to areas that no one else is looking at. They also know that I tend to complain about markets and my lack of money making ability at turning points (I am my own reverse indicator apparently). Maybe they are right, as the sort of lead indicators that I focus on are all turning my way. Chinese steel prices were up 17% in November, oil was up 20% in the last three months, and the biggest high yield borrower was down 59% last month. In 2011, the fund had lacklustre returns, even though I had two great trades on, short mining and long Irish bonds. It just took some time for the other parts of the portfolio to catch up.
In the episode of Billions that my wife and I just watched, Chuck Rhoades, the attorney chasing Bobby Axelrod, gives some advice to his junior. When he was younger he went hunting wolves with his father, and for three days they tried everything, and did not even see a wolf. They then met an old hunter, who had bagged a wolf. They asked his advice, and the next day they successfully followed it. The old hunter’s advice was to stop moving and wait. Let the wolf come to you. The signals are there, but everyone is making too much money to care. Your fund remains long emerging markets, short developed markets.
Tech giants Google, Facebook and Microsoft, might dominate the cellular market
“Start-ups such as FreedomPop and Republic Wireless already offer ‘Wi-Fi-first’ mobile services, which send most calls, texts and data via Wi-Fi hotspots, relegating the conventional cellular network to the status of a back-up,” Clark noted in a letter to investors where his -3.11% performance year to date might sting to a degree.
On the surface, the battle might be framed from the perspective of the disruptive start-up challenging the stodgy incumbent. But this only looks at the surface. With Google, Facebook and Microsoft financing optic cables around the world, it is the tech giants who are also looking to disrupt Verizon, AT&T and Sprint. As a result, tomorrow’s cell phone landscape could be very different, as Clark notes:
Current large mobile phone manufacturers do not offer models that allow users to switch between networks without manually replacing the SIM cards inside the phones. However, some Chinese manufacturers offer dual SIM card phones and the software technology for switching between networks already exist, Android can discern which carrier offers the strongest signal in any given location, allowing the user to move seamlessly between Wi-Fi and the two carriers depending on signal strength. This could lead to a situation in which the carrier is essentially invisible, and the user is paying Google (or another broker) to connect to the network with the strongest signal, which could be a national carrier or a local Wi-Fi provider (source: Wired).
Over the past 5 years, the average revenue per user in the wireless telecom sector fell 6% per annum in Western Europe, 2% in North America, and by 1% in Asia (source: PWC). Since earlier this year, in Europe, large telecoms companies have to comply with the new “roam like at home” rule set by the regulator, which states that operators cannot levy extra fees for using a mobile abroad.
Telecom stocks can be perceived as defensive because of their relatively high dividends and historical high barriers to entry in the sector. This has allowed companies to leverage their balance sheets extensively, for example the combined long term debt of ATT and Verizon rose from about $115bn in 2011 to close to $270bn in the third quarter of this year. In a rising interest rate environment and as technology shifts and large internet companies are willing to challenge legacy firms, we have taken a negative view on highly indebted legacy telecoms firms. The fund has a 13.6% short position.
The world is changing, and the legacy firms that don’t adapt are likely to perish. Clark is placing his bets on the future, and this is one. They just take time to payout.