Strategic Logic Case Study Part 2 Global Crossing

 

If you think nobody cares about you, try missing a couple of payments. –S. Wright

Everything has been said before, but since nobody listens we have to keep going back and beginning all over again.” –Andre Gide

Part 1 of this case was presented yesterday here: http://wp.me/p1PgpH-hj

If readers don’t grasp the significance of this case then I will QUIT posting and join them: http://www.youtube.com/watch?v=J_kRDcfTKrg

Invest in Global Crossing February 2000

Part 2: You are about to meet the fund manager in 30 minutes to give your recommendation.  Take a glance at Global Crossing’s 10-K. http://www.scribd.com/doc/77824423/Global-Crossing-1999-10-K What’s it worth?  The price is near $61 or about $37 billion in market cap.

Forget the financials you think, after reading Gilder’s Technology Report (background on George Gilder, the Guru of the Telecosm: http://www.wired.com/wired/archive/10.07/gilder_pr.html) on the telecosmic Global Grossing, your confidence increases because growth will double every 100 days.

Since you leave nothing to chance, you call up David Cleevely, the managing director of Analysys, in Cambridge, England. Cleevely is a well-regarded observer of the new telecommunications economics.  He tells you, “The key thing to understand is the huge advantage of the fat pipe (or high-capacity fiber optic channels).  Remember that the cost of laying fiber is mainly the cost of right-of-way and digging or of laying it under the ocean. Recent advances let companies install enormous capacity at no more cost than building a narrow pipe. The economies of scale of the fat pipe are decisive. The fat pipe wins.”

Next you pull a slide from the company’s power point presentation on Where is the Company is Going.

The company will be in a market with EXPLOSIVE growth, competition, capacity on demand, no capital required from telecom carriers, and responsive to market demands.

Your secretary knocks on the door and asks whether you want to read about strategic logic from csinvesing?  You are handed some papers, and you immediately slam dunk the research into the circular file (waste-basket). “Who needs this bullsh@t,” you mutter.

Riches?

You are thinking of the riches you will make and what you will do with your new car: http://www.youtube.com/watch?v=uo5E-2_2mgg&feature=related

You know that economies of scale are important. The logic seems simple—the fat pipes of the new-wave telecom builders and operators gave them much lower average unit costs (Think about how average cost curves are formed). I sat back and thought a moment about fat pipes, scale economies, and telephone calls. What was the “cost” of moving one telephone call, or one megabyte of date, under the Atlantic Ocean?

But the thoughts of massive wealth kept interrupting my thoughts. “Would putting in a fur-lined sink be in bad taste?” I wondered.

What critical aspect of analysis is missing here? If you need a hint go back to the connection between industry structure and profit.

The time is late February 2000 and with your supporting materials and 10-K you wait here for the big boss to arrive. http://www.youtube.com/watch?v=TulxjdKsROI

4 responses to “Strategic Logic Case Study Part 2 Global Crossing

  1. Unstable industry structure is not a recipe for high profits! With a fast growth industry (and rapid change), it’s hard to understand what the industry structure/market share, profitability or ROIC will be when the industry matures. For example, there are many transatlantic cable competitors including: TAT-14 (consortium of British Telecom, AT&T, FranceTelecom and Deutsche Telekom ), Flag Atlantic-1 (Flag Telecom and Global Telesystems Group Inc), and Gemini (MCI WorldCom, Inc. and Cable & Wireless).

  2. Nelson Christian

    If someone were to tell me that the demand for a particular product/service originally estimated at 10 times current value is actually closer to 1000 times, one question that naturally comes to mind is what about the supply situation. Any industry having such potential growth rates is an open invitation for truckloads of competition. What prevents companies from entering this industry? Is there a moat in place so as to speak?

    The interaction of demand and supply leads to price determination. In this case there are two potential risks. If the demand falls short of expectations/estimates on a sustained basis there will be oversupply and hence lower prices. On the other hand if demand meets or exceeds estimates, there will be a rush of competition in the industry. While it may take time to build the system, it will result in oversupply few years down the line and hence lower prices. Since it is a capital intensive industry, profit realization will take time. Market skimming is obviously not going to work when you pitch yourself as a low cost alternative and want to play on volumes.
    The way to beat this is to be in industries where the supply cannot be built up easily due to presence of moats.

    “Recent advances let companies install enormous capacity at no more cost than building a narrow pipe”. This statement tells me that the barriers to entry are extremely feeble.

    As prices fall, the cost of production or the equivalent of services has to fall faster to ensure increasing profitability. When there are only fixed costs, marginal cost will be zero: any increase of production does not change costs. In this case study increase of production translates into increasing not capacity per se but increasing the usage of the system. Since every company will look to expand the usage of their cable systems, it takes a heavy toll on pricing. I would not like to invest in a company where there are lot of sellers in the same industry chasing limited buyers and there is no differentiation or USP involved. Its loaded in favor of the buyers, not the sellers. The buyers’ bargaining power automatically increases a lot.

    • Good job–I could almost copy this for completing the discussion of this case study–to be posted this weekend.

      What is interesting is that technology improvements devastated profitability of the companies. Remember Buffett’s discussion of the Textile industry when his CFO said to him, we can lower our costs by XX% with the purchase of a new loom? Buffett replied, “That is TERRIBLE news, because nothing will stick to our ribs; all will go to the customers.” Returns on capital will be NEGATIVE in other words.

      Think of Air-Conditioning. Did that invention make air-conditioning manufacturers rich or Real Estate owners in the South rich? Where are the competitive advantages/barriers to entry.

      Thanks for the thoughtful analysis. This is not taught in many business schools and this case has so much to offer investors. Gilder got the technology right but the economics wrong for the detriment of his poor subscribers/investors.

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