Hello my friends and colleagues,

I hope you’re well and emerging from your pandemic cave in good spirits.

It’s great to have the weather getting warmer and to be spending more time outdoors. Recently I’ve been training for an upcoming trip to the Grand Canyon where we’re hiking down and then rafting the lower canyon. I’m so excited--it looks like one of the most amazing places on this planet. After that, assuming it’s safe, Eleanor and I are looking forward to being able to travel and see our parents.

It’s funny having to learn how to socialize again...it’s been quite an insular year. I just had my first work coffee meeting this week in well over a year. And so while I enjoy connecting with you via this newsletter, hopefully we can meet face to face soon!

Best regards,

David

Friends & Family Spreadsheet Help Offer

I regularly get calls from folks who are stuck on some Excel problem. They range from very basic to quite advanced, and I enjoy helping out. I’d like to extend that offer to you, since you subscribe to the newsletter. I like hearing from people randomly and I find the issues to be like a little puzzle I get to solve before getting back to work.

Feeding the Beast: The One Critical Telecom Assumption People Miss

What’s as big an assumption as a 70% revenue drop or a 12% EBITDA margin decrease that most people barely consider in a telecom plan? Consider the NPV of a base case and three scenarios which have changed one assumption each:

The Telecom Dream
I do a lot of 10-year pro forma forecasts, and the typical plan focuses on thinking about a disruptive product, then determining the engineering dimensioning and cost for the initial build. After that we add customers and when the revenue turns into high-margin EBITDA we grow it and ride off into the sunset.

But it actually doesn’t work this way.

The Telecom Reinvestment Reality
In their wireless businesses, the results from Verizon, T-Mobile, and AT&T tell a different story. Focusing on Verizon, you can see that while there are ups and downs, over the long run they kept investing in the business (i.e. spending capex). This is the reality of telecom in the modern era: you need continuous reinvestment to thrive. Note that this period includes both heavy spending years as the industry shifted from 3G to 4G as well as times when change was more incremental.

(This is over 2010-19. In 2020 Verizon changed their segment reporting, eliminating this information. Since capex doesn’t include new spectrum licenses, these reinvestment levels are thus understated.)

It’s weird that depreciation can explain this reinvestment because depreciation is non-cash. But it turns out that depreciation is actually doing a pretty good job of explaining how quickly the previous capital expenditures are being consumed.

This reinvestment capex doesn’t get much attention in wireless models, but it’s one of the most critical assumptions because the network is a beast, and you have to feed the beast. By now I’m sure you’ve guessed that this was the mystery assumption in the chart at the beginning of the article.

Make no mistake: this capital wasn’t spent so that Verizon could enter a new business. The carriers (mainly) compete in the same wireless services market they have for the last 30 years. Sure, they used to count minutes or texts and now they might count GBs, but basically you’re buying access to a network which connects you to desirable things. When the network moved from 3G to 4G in the last decade they didn’t enter any new businesses with their wireless capex. Similarly, I count the entire move from 4G to 5G as reinvestment.

Impact of Ignoring Reinvestment
This reinvestment capex is important because failing to account for this can lead you into a modeling fallacy. The fallacy is that you think your business will continue to grow and be profitable in the final years of your plan and in the terminal value. But if you don’t have the reinvestment capex, you won’t achieve that multiple. In fact, I’d argue that the cash flows will be degraded in Years 6-10 and the terminal value (as a multiple of Y10 cash flow) will be lower.

As this article started with, ignoring reinvestment capex is the equivalent of a 70% drop in revenue. Or, changing both revenue and the terminal value, it’s equivalent to a 40% revenue drop and halving the terminal multiple. Clearly these are significant impacts which can change an investment signal or a price that you’d be willing to pay for a business.

So be sure to consider this factor upfront. It’s the rare telecom business that is able to avoid this cost.

(Full model in this Google Sheet.)

How far did you drop?

Overheard on a ski lift:

“Dude, I was in the air like five seconds!”

No, you weren’t.

I recently saw a quick “rule of thumb” on how to calculate how far you fall in n seconds. The rule was to multiply by 4 and then square the result to give the distance fallen in feet i.e. (4n)² feet. (If you prefer the metric system, then it’s 5n² meters).

So how big was the cliff that my chairlift companion hucked?

5 seconds x 4 = 20
Then 20 squared = 400

That’s right, he was claiming a 400 foot cliff drop. You can see my skepticism. The world record is 255’, and the skier landed on his head--fortunately into a deep pile of powder, so he skied away uninjured after getting dug out.

This caught my attention because I went back and relearned math during the pandemic. This distance/ velocity/acceleration stuff is really basic calculus, which is made easier by the fact that acceleration is gravity, a constant 32 feet/sec². (Yes, there’s terminal velocity from air resistance, but that doesn’t kick in until about 8 seconds, so that won’t impact our skiing air times.)

In brief, the (4t)² rule of thumb works because if acceleration is 32, then velocity is 32t and distance is 16t² = (4t)². More details in this Google Sheet.