Jubak's Journal
Pie in the sky for satellite wireless
Think the technology was tough? Wait until Iridium and Globalstar try to market their phone service.
By Jim Jubak
Excited by Iridium World Communications, Globalstar Telecommunications, the still-private Teledesic or any of the other companies building satellite-based wireless phone networks?
After all, if Bell Atlantic (BEL) was willing to pay $45 billion for AirTouch just to build a coast-to-coast network in the United States, what's the stock of a company that owns a global wireless network worth?
If you want to play any uptick that these stocks will get when they get their technology working this year and next, go ahead. But if you're thinking out longer than six months, I think you'd be wise to cool your jets. Marketing realities are likely to bring these technology companies back to earth at least once this year -- well before any of these stocks start a sustained upward move.
Marketing, rather than science, is the key to these technology companies. I certainly don't think that makes these companies unique. In fact, I think there are lessons here for any investor who is thinking about backing a stock that's trading on the promise of future earnings.
It's easy to overlook the mundane facts of marketing when the technology has been as difficult to execute as it has been in this industry. The big failures have been spectacular. For example, when a rocket with 12 satellites on board blows up, as happened in late 1998 at a Globalstar (GSTRF) launch, you can be sure everybody notices.
But the nitty-gritty details haven't exactly been a piece of cake either. Think it's easy to build a small wireless phone that will talk to a satellite? Iridium (IRIDF) missed its well-publicized Nov. 1 launch when a series of software glitches took down the network unexpectedly.
After overcoming problems like these, it only seems fair that getting the birds into the air and talking to the ground stations and individual wireless phones should guarantee success.
But it doesn't. The real, tough work of identifying customers and selling them on the product has really just started.
Iridium's ambitious goals
Iridium is the company closest to launching service and since it has actually started to sell phones, investors can actually get a pretty good handle on the company's cost structure and some of its assumptions. Let's use Iridium as an example and see how the marketing numbers play out.
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At the end of 1998, Iridium had about 3,000 customers. The company is counting on finishing 1999 with 500,000 to 600,000 customers. If it can reach that goal, the company believes it would become profitable in early 2000. How likely is that and how expensive would it be?
A good place to start to answer those questions is with the cost of the product. At a time when the price of a minute on a land-based wireless phone is dropping toward a dime and companies are selling phones for $50 or even a penny, the cost of an Iridium phone seems shockingly high. A handset costs around $2,500 -- before such add-ons as a pager. The price of airtime varies depending on where the call begins and ends. In November, charges ranged from $2.50 a minute from a point in Japan to another point in Japan to $10.20 a minute from Latin America to China.
Those costs are important not because they argue that no one will use the service -- there's definitely a market for Iridium -- but because they help determine how time-consuming and expensive it will be for the company to find its customers. At $2,500 for a phone and at an average $5 a minute, Iridium service isn't for everyone. It makes sense for the oil company executive who travels to Azerbaijan or for the Hewlett-Packard manager setting up a plant in Hunan, but it probably doesn't make sense for you and me.
So how will Iridium market its products? Certainly not by mailing out millions of CDs to every U.S. home, as America Online (AOL) does. That works when half of the addresses in the country house computers and are owned by potential customers. If Iridium had to rely on mass marketing to find the customers lurking out there like needles in the haystack, the company would go broke.
There simply isn't any way to mass-market an expensive niche product and make a profit. America Online spent $95 million in the most-recent quarter -- an annualized $380 million -- on marketing. That only works for America Online because, with its mass-market product, it was able to add 1.6 million new customers in the quarter. Cost: About $60 each.
Fortunately, Iridium doesn't have to do this. (But that doesn't mean that it won't anyway; the company is now running prime-time television ads.) In its original prospectus, Iridium claimed that its customers were the 42 million traveling professionals in the world. Well, that's a neat number if you're trying to raise money from investors, but all of us who travel for our jobs know that only a very small percentage of our peers are really potential Iridium customers. In reality, almost all of Iridium's potential customers work at the 8,000 companies in the world with more than 1,000 traveling professionals in their employ. To make its sales, Iridium needs to get its foot in just a few thousand front doors. The sales model isn't America Online-style direct marketing or Coca-Cola (KO)-style mass-media advertising, but the kind of intense relationship building that drug companies such as Pfizer (PFE) and Warner-Lambert (WLA) practice.
Appealing to business travelers
Here's the trade-off, though, and it's an important one. Mass marketing is expensive, but it isn't time-consuming. A company using tactics like mass-media advertising or mass-mailings of promotional samples doesn't have to train a huge sales force and then put it out on the street. For example, America Online has 8,500 employees. Pfizer, the owner of the biggest marketing force in the drug industry, has 14,500 salespeople. Iridium has around 490 employees.
I don't think that either a reorganization in headquarters or a deal for mindshare on airliners is going to get Iridium from 3,000 phones now to 500,000 phones by the end of 1999.
Iridium is so lean because it's a consortium of 18 companies. Members such as Stet Hellas Telecommunications (STHLY), the second-largest mobile-phone company in Greece, and Sprint (FON) are supposed to provide sales and service for Iridium.
There are signs that this decentralized marketing effort hasn't worked well so far. Iridium recently has reorganized its internal Washington D.C.-based sales force in an effort to pick up the pace. The company recently bought Claircom, an operator of a digital air-to-ground phone network that has access to 100,000 phones in airplanes, for $65 million. I see that deal as a smart marketing play since it will help get Iridium's product in front of business- and first-class travelers, the company's prime market.
But I don't think that either a reorganization in headquarters or a deal for mindshare on airliners is going to get Iridium from 3,000 phones now to 500,000 phones by the end of 1999. Call this a year for seeding the phones into the biggest companies in the world.
Nothing wrong with that. And Iridium will get some mileage out of being the first satellite communications company that can actually sell service. Globalstar, for example, isn't expected to start selling service until late in 1999 or early 2000. Iridium will have pretty much a whole year to open doors without having to fend off competing vendors.
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Rivals at the flank
What does all this mean for the stocks of Iridium and Globalstar, the next company likely out of the chute with service? In the short run, I think the implications are actually pretty perverse. Iridium's stock should rally when the company finally rolls out full-scale service. The stock has been depressed lately on news of various technical problems that have produced high levels of dropped calls, for example. Getting issues like that fixed can only help the stock. But I think Iridium is likely to miss Wall Street expectations badly for customers and sales this year. If customer numbers in the first quarter don't look likely to result in the 500,000 the company has led Wall Street to expect, look out.
Globalstar, on the other hand, is a year away from launching service. Technical problems at the network have been so visible that I don't think anyone on Wall Street is even taking a second to think about marketing. With recent progress in circulating enough satellites to begin service, Globalstar has outperformed Iridium recently. I think that pattern could continue in 1999 as Globalstar solves its technology problems and Iridium begins visibly to wrestle with the marketing problems that its competitor won't face fully until 2000.
In the long run, this one will be won in the marketing trenches. But we're still a year away from the beginning of that game.
Frankly, I'd worry less about this if the satellite wireless companies weren't swimming against some strong trends in the larger wireless industry. The trends there are for universal service (right now, that means national rather than global networks) priced at a level competitive with traditional long-distance using increasingly standardized hardware rather than proprietary systems. AT&T (T), the company that's driving the industry in the U.S., is a good example -- the company's bundled service offers consumers a single price for wireless and traditional long-distance minutes and combines those services on one bill with AT&T's Internet service. We're clearly headed for the time when we'll use just one phone number for calls, no matter what device we're using.
I'd rather ride that trend for the next year than bet on the untried marketing prowess of Iridium and Globalstar. My picks in wireless right now would be Nextel Communications (NXTL), one of just three national wireless service providers in the U.S., and Nokia (NOK.A), currently the No. 1 maker of wireless phones in the world. I think either of these stocks is a good long-term holding, and they also both promise enough of a return within the 12-18 month time horizon of Jubak's Picks for me to add them to that portfolio.
My 12-month price target on Nextel is $42.50, a potential 31% gain. Nokia has pulled back recently on fears of a slowdown in the company's global markets. I think that's a good buying opportunity. My 12-month price target for Nokia is $178, a potential 27% return.
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Saville Systems (SAVLY) dropped on what I think was actually good news in its fourth-quarter earnings report. The company beat analyst estimates but cautioned that marketing expenses would be climbing in the first quarter. I say, "Hooray!" Companies that don't have anything new to sell don't plan on increasing their spending on marketing. Saville has a major new product release set for the first quarter -- an improved Unix version of its billing software -- and the company will be pushing sales hard. I think the recent dip was a buying opportunity; even the analyst at ING Baring Furman Selz who downgraded the stock still has a $31 price target for shares in 12 months. That's a potential 34% return from the bad news bear.
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Drop Union Pacific (UNP)
Union Pacific has climbed faster than I thought it would when I added it to Jubak's Picks on Oct. 6 at $44.50 a share. The company fixed the worst of its traffic problems faster than analysts expected; the company reported fourth-quarter earnings 30% above expectations. That positive surprise reversed some recent skepticism about the company. Projected earnings for 1999 had declined from $2.46 a share in October to $2.35 just a few weeks ago. Now, estimates are back up to $2.41. And given the unexpectedly strong growth reported for the economy in the last quarter of 1998, I think that Union Pacific should reach my original $2.46 a share. Still, after a 17% run-up in the stock since October 1998, I think investors are likely to see slower appreciation ahead. I don't see a sound reason to raise my target price of $58 for October and that projects out to just a 12% gain over the next nine months, less than I require for a stock in this market. So I'm selling Union Pacific out of Jubak's Picks with a 17% gain.
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Nokia
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Profit Margins Add Nokia (NOK.A)
Nokia blew away the earnings estimates for its fourth quarter by 11%. Revenue climbed 63% and earnings soared 75% over the fourth quarter of 1997. And still the stock tumbled -- as of Feb. 1, shares were down $17, or 11%, from the recent 52-week high. I think this has created a buying opportunity. Shares have sold off on the company's cautious comments about a possible slowdown in China, a 2.5 percentage-point decline in gross margins from the third quarter, and a lack of new product announcements. The last two aren't significant problems -- margins fell because the company sold more low-end handsets but new low-end models coming in 1999 should increase margins there, and Nokia, by nature very conservative about announcing new products, has major new models set to roll out in March. With Brazil continuing to implode, I think the company was only right to flag its China exposure. But at current prices, I think investors are getting enough potential upside to offset that possibility. I'm adding shares of the No. 1 maker of wireless handsets in the world to Jubak's Picks with a 12-month price target of $178.
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Add Nextel Communications (NXTL)
You certainly can't value Nextel Communications on earnings. The company is still building out its national wireless network and is looking at years of red ink. But that buildout will give Nextel something only Sprint, PCS Group and AT&T have now: a wireless system that spans the U.S. Within three years, Nextel and Nextel Partners will be able to offer service to 90% of the U.S. population. That puts Nextel at the cutting edge in the drive to provide seamless service to domestic customers. And as the owner of a national network, Nextel won't have to pay other carriers for off-system calls by its customers. That should help Nextel keep up with the price cuts by AT&T while adding new customers at the recent torrid rate. On Jan. 6 and 7, the company introduced its new national service plan and cut long-distance rates to 9 cents a minute. I'm adding Nextel to Jubak's Picks with a 12-month price target of $42.50.
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