SMART Letter #39
May 11, 2000

!@#$%^&*()!@#$%^&*()!@#$%^&*()!@#$%^&*()!@#$%^&*()!@#$%^&*() ------------------------------------------------------------      SMART Letter #39 - May 11, 2000 Copyright 2000 by David S. Isenberg -- "the living company" -- -- 1-888-isen-com ------------------------------------------------------------ !@#$%^&*()!@#$%^&*()!@#$%^&*()!@#$%^&*()!@#$%^&*()!@#$%^&*() CONTENTS > Quote of Note: C. Michael Armstrong > AT&T Circles the Drain > AT&T Had it Coming, by Don Luskin > Conferences on my Calendar, Copyright Notice, Administrivia ------- Quote of Note: C. Michael Armstrong "The sky has not fallen. We forecast a 5% reduction from our previous Earnings Per Share estimate for 2000. "In a sense, we are victims of our own success. Wireless is taking business away from consumer long distance . . . High value customers are moving to our One Rate calling plans. Services like Net2Phone, in which we have a significant stake, are growing in popularity. As we focus our marketing on heavy long distance users, we're losing share at the low end of the consumer market. All of this was expected, but it's all happening faster than anyone could have predicted." C. Michael Armstrong, letter to AT&T employees, May 8, 2000 [CONTEST ANNOUNCEMENT: Find the quote in "The Innovator's Dilemma" that most directly relates to C. Mike's quote above. Make your case as to *why* it relates. All non-trivial answers win. Winning entries will be published in The SMART Letter. The decision of the judge is final. -- David I] ------- AT&T CIRCLES THE DRAIN by David S Isenberg There is no joy in my heart to watch the slow-motion debacle at AT&T. I had too many good times there. I learnt too much at Ma Bell's skirts while she nurtured me and helped me grow. I wanted to see -- indeed, I still want to see AT&T succeed. But alas, it is not to be. Loyalty is a strong emotion, albeit maladaptive sometimes, especially when things go south. Some of my good friends who still work at AT&T are held in its sway. They continue to devote their lives to making AT&T a great company, and I grieve for them. I also feel for the ex-AT&T people whose quality of retirement is tied to the price of AT&T stock. When I joined AT&T, we felt superior because we could complete calls a few hundred milliseconds faster than the competition. Then, for a few short years we had a superior brand. We broke ground with a fee-less credit card and flat-rate cellular service. We had oodles of patents and a few Nobel Prize winners. Once, briefly, we even had the best retail Internet service. Now what? AT&T, with the help of a billion dollars of lawyers and lobbyists (and the pro-competitive folks at the FCC) has succeeded in holding off RBOC entry into long distance longer than I'd have ever thought. Yet today long distance revenues are eroding faster than a Basking Ridge. It is time for AT&T to go. They got it wrong so many times -- in cellular telephony, in PC hardware and operating systems, in next-generation switches, in Internet services, in Internet backbones, in credit cards, in on-line music, in global business services, at NCR. Now they're getting it dreadfully wrong in broadband access -- and even in plain old telephony! There is no longer any room in the new economy for it's top-heavy, culture-encrusted, patrimonial bureaucracy. C. Michael Armstrong is a product of this culture -- the values that got him to the top are the same ones that drag AT&T down -- so don't expect C. Mike to fix things. Imagination and greed drive the new economy. The AT&T employees whose imagination and greed exceeded their loyalty are long gone. Dan Hesse's left-behind $50 million is only the latest public example. For sixteen years of demoralizing reorganization and fat force-reduction packages, the great intellects of the new network uprooted their AT&T-honed intellectual assets to find their fortune elsewhere. What's left? There are probably several hundred tech-savvy folks who, unencumbered by AT&T's legacy, would make a great "end-to-end solutions" consulting firm. There are many AT&T people who could enter the academy -- humanity needs good researchers and teachers at every level. There are people who, once the cord were cut, would be a strong asset to new network service firms: firms that sell pans to the miners; CLECs, DLECs and ELECs; data centers and dot.coms; B2Bs, B2Cs and the X2Ys of the future. And there'd be the losers who continue to eke refuge in the folds of AT&T's residual fat -- fortunately for them, AT&T's retirement fund still has assets. Then there's AT&T's infrastructure. You'd think there'd be some value in AT&T's rights of way. If so, AT&T could overbuild then with new technology to join tomorrow's networking giants like Qwest, Level3, Global Crossing and Metromedia Fiber Networks. But AT&T's right of way, like its network, is a historically accreted patchwork that is much too expensive to maintain, let alone modify. AT&T's new cable TV assets are still salvageable if they bring Leo Hindery back in time to save the video entertainment piece of the business. Quick, though, before TCI becomes another NCR. AT&T's buildings would make great Internet data centers, once the obsolete scrap metal that used to switch calls is hauled away. And the huge AT&T headquarters building at Basking Ridge could then reveal its true identity as a conference center and country club. Goodbye AT&T. You helped bring modern communications to Planet Earth. I'll miss you. But it is time to go. ------- AT&T HAD IT COMING by Donald L. Luskin, CBS MarketWatch, May 10, 2000 ?source=htx/http2_mw SAN FRANCISCO (CBS.MW) -- Why were investors so surprised last week when AT&T warned of lower earnings and sales growth for the rest of the year? And don't tell me they weren't surprised! Why else would the stock of this venerable bluest of the blue chips fall more than 14% in a single day, and an additional 7% by the end of the week? Investors were surprised because they've been listening to simplistic analysis coming out of Wall Street and the traditional media-- superficial measurements like price/earnings ratios that made AT&T seem like a bargain compared to high- flying technology stocks. But not everyone was surprised. There are a few people -- who work far from Wall Street -- who really understand the technology that drives AT&T and its competition, and those people were warning that AT&T was in deep trouble. The earliest and most provocative warnings came from David Isenberg, formerly a network scientist with AT&T's Bell Labs. In 1998 Isenberg wrote a paper called "The Rise of the Stupid Network." The paper was scathingly critical of AT&T's network architecture and corporate culture. So when he posted it on the Internet and it ended up with a cult following among the digerati, Isenberg was ostracized by the TelCo establishment. Today he's an independent consultant, a self-described "telecom heretic," and a member of's Think Tank of technology visionaries. Isenberg's key insight was that AT&T's "intelligent network" is optimized to mastermind traditional voice traffic between simple devices like telephones. But in the age of the Internet, voice traffic isn't growing nearly as rapidly as data traffic. And data traffic is best served by "stupid networks" like the Internet: just pure bandwidth designed to do nothing but "deliver the bits" between intelligent computers. The data-oriented structure of "stupid networks" like the Internet can easily carry voice traffic too, and at far lower cost than AT&T's intelligent network. And a single bundle of Lucent's state-of-the-art fiber can now carry all the voice traffic in America on Mother's Day -- the busiest phone day of the year. So the price of voice traffic is destined to fall to nearly zero, while all the revenue migrates to broadband data traffic. That's going to be fatal for AT&T, because it gets the vast majority of its revenue from voice traffic. Last September, Isenberg wrote on our discussion boards on the website, "The predominant discount residential long distance rate has fallen from 15 cents to five over three years. Extrapolating, that puts it under two cents by 2002. In a world like that, AT&T will be breaking even at best, if it scurries to accelerate its ongoing cost cutting regime . . . " That was enough to convince me. As adviser to a $35 million mutual fund, last October I took a short position in AT&T in the mid 40's, which the fund still holds. When AT&T announced its AT&T Wireless Services tracking stock, AT&T's stock soared to above 60 -- and I came in for a lot of criticism for the position. A typical message on our discussion boards: "Beware any short position in T! This short position should be tossed out just like any other position that just ain't working." Another said, "This stock will break above 100 before it sees 40 again..." And still another said, "It seems like you are obsessed by the T demon and want to be proven right." For a while it seemed that the Wireless spin-off might be the answer to all of AT&T's problems -- unlocking value in what many people thought was an undervalued corporate crown jewel. In March, a site visitor who calls himself "brightness" wrote, "Sprint PCS has a market cap of $62 billion and rising with considerable momentum, and AT&T wireless has a subscription base that is roughly four times . . . as large." But when the Wireless tracking stock transaction was completed, AT&T had still to come to terms with deeper weaknesses. Indeed, last September Isenberg had warned that such maneuvers would be a tip-off: "We could see significant AT&T restructuring -- acquisitions, break-offs, etc., if the core business isn't making it." And Isenberg turned out to be exactly right. Last week, when AT&T lowered its forecasts for earnings and revenue in its core long distance business, Isenberg's technology vision was vindicated. AT&T shares closed Tuesday at 37 11/16. There are three morals to this story, lessons in successful investing in our age of rapidly evolving technology. One is that the companies that seem the safest are often the most at risk. The second is that to find the truth, you have to look beyond traditional financial data, and really understand the dynamics of the underlying technologies. And the third is that when you are convinced that you understand the technology story behind an investment, stick to your guns. --- [Don got three little things wrong in this article. First, Mother's Day is the busiest *holiday* for telephoning. Lots of weekdays are busier. Second, the U.S. voice busy hour can run through a single *fiber*, not, as Don said, a fiber bundle. Third, I may have been "exactly right" but that wouldn't have made me rich. I wouldn't have had the cojones to short AT&T in the mid- 40s, and I'd be covering now in the 30s, because I'm certain that C. Mike is 24x7 on the next desperation move to get T to bounce again. Maybe that's why Don calls the market moves and I wave my arms on the sidelines. -- David I] --- [Don Luskin is the CEO of, the home of, the first interactive mutual fund. I'm on the MetaMarkets ThinkTank with Lori Andrews, Reuven Brenner, Nolan Bushnell, Peter Leyden, Nicholas Negroponte, and Peter Sprague. Don warns me that I can't say anything that looks like an advertisement for MetaMarkets without incurring the SEC's wrath, so you'll have to go to the website and find out about it for yourself. -- David I] ------- CONFERENCES ON MY CALENDAR May 23-26, 2000. Laguna Niguel CA. VORTEX. I'll be co- kibitzing the VC panel with Bob Metcalfe, then appearing on stage with a mystery guest (and SMART Person) -- but I can't tell you any more because the latest schedule says, "TOP SECRET -- FOR YOUR EYES ONLY". For the OFFICIAL story, see May 27, 2000. San Diego CA. Porter Stansberry's Pirate Investor Conference. Avast me hearties! The bucko tar can sail to windward. Don Luskin (CEO MetaMarkets) will be aboard too! Sign the log at (, or call 800-433-1528. Pre-registration $99, or register at the gangplank for $149. June 7-10, 2000. Toronto ON. TED CITY. My only role here is as a paying member of the audience, but I think that Richard Saul Wurman does a real job with his TED conferences -- every one I have been to has had deep lasting impact. June 26-27, 2000. New York City. Entertainment Internet 2000. I'll be on a panel with some of my favorite fiber and bandwidth companies. The website is thin, but there's info there -- or call 212-336-6000. September 13-15, 2000. Lake Tahoe CA. TELECOSM. Featuring George Gilder, Clayton Christensen, yours truly, and a cast of geniuses, troublemakers, and people who got rich by listening to George. This thing sells out, folks -- a word to the SMART. September 22-24, 2000. Woods Hole MA. An equinoctial weekend of deliberation for SMART People here beside the rising tide. Details soon -- but mark your calendars now. ------- COPYRIGHT NOTICE: Redistribution of this document, or any part of it, is permitted for non-commercial purposes, provided that the two lines below are reproduced with it: Copyright 2000 by David S. Isenberg -- -- 1-888-isen-com ------- [to subscribe to the SMART Letter, please send a brief, PERSONAL statement to (put "SMART" in the Subject field) saying who you are, what you do, maybe who you work for, maybe how you see your work connecting to mine, and why you are interested in joining the SMART List.] [to unsubscribe to the SMART List, send a brief unsubscribe message to] [for past SMART Letters, see] [Policy on reader contributions: Write to me. I won't quote you without your explicitly stated permission. If you're writing to me for inclusion in the SMART Letter, *please* say so. I'll probably edit your writing for brevity and clarity. If you ask for anonymity, you'll get it. ] ** David S. Isenberg, inc. 888-isen-com 908-654-0772 ** -- The brains behind the Stupid Network -- **