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This is a Bubble

Written by Briton Ryle
Posted February 15, 2017

A good investment bubble needs three things: a really good plausible growth story with some basis in reality, some real excitement about that growth, and plenty of liquidity.

Each of these elements works together. Any good story has to have an element of truth. Otherwise it's not believable. And if it's a good story — one where easy fortunes are right around the corner — it will generate excitement amongst investors.

At that point, the story starts to grow and change. Excited investors retell the story. They downplay risks and embellish the positives. The story evolves.  

Then comes the liquidity. Without a doubt, if you can tell a good story, you can raise some cash. Banks will raise lines of credit. They'll be glad to accept the fees to underwrite bonds. Investors will flock to secondary offerings of stocks.

And when it comes to bubbles, the companies themselves know this. They will perpetuate the evolved bubble growth story. Because the companies get financing, the stock prices rise, management gets raises, and their stock options get more valuable. 

Everybody's making money, everybody's happy. Until the music stops. Conventional wisdom says it's always the individual investor that's left holding the bag. But that's not completely true. You'll recall everybody went down when the housing bubble popped. Of course, only the banks and the insurance companies got bailed out...

There have been a lot of good bubbles that we can look back on and learn from. But it's that element of truth in the story that gets us every time. My favorite is still the Internet bubble. Maybe it's because I started in this biz in 1998, just as that bubble was getting going...

The Best Bubble Ever

I started in the newsletter business as a researcher. Of course, the company had computers and Internet. But I still had to go the library and scroll through back issues of the Wall Street Journal and Financial Times on microfiche. 

It was a phenomenal time to be learning about companies, technology, and the Internet. I read books on fiber-optic networks, cell phone networks... anything to be able to understand what Cisco, Nokia, and the other Nasdaq tech stocks were doing.

My favorite bubble stock story, however, is Global Crossing. 

Global Crossing's plan was to build the very backbone of the Internet. It planned to lay 100,000 miles of high-speed fiber-optic cable across the Atlantic and Pacific Oceans. And it would eventually connect four continents, 27 countries, and 200 cities.

The founder was an investment banker named Gary Winnick. He had no experience running a company. But he told a great story. Banks and investors threw money at him — he raised $700 million and on August 14, 1998, a company called Global Crossing went public at $19 a share. That valued the company at around $3.8 billion.

The potential for leasing space on its vast network to telecom companies seemed like a great idea, and by February 16, 2000, Global Crossing stock hit $61.82, valuing the company at nearly $47 billion.

Only it wasn't a great idea at all. Global Crossing spent something like $20 billion on its network and had $14 billion in debt. And there wasn't enough revenue coming in. The company never showed a profit. 

The stock was trading for a measly six pennies a share when it filed for bankruptcy in February 2002. That $47 billion valuation had fallen to around $70 million.

But here's the thing: While it failed miserably as a company, Global Crossing did indeed make a significant contribution to the evolution of the Internet. Sure, it was a charitable contribution, as the shareholders basically got zero return on billions invested.

But this is the part where there's a basis in reality for bubble stories. Because the network it built was real. And Global Crossing emerged from bankruptcy in 2003 and was a viable company until Level 3 Communications bought it out in 2011. 

The problem is that in bubbles, cash gets invested poorly. This happened during the Panic of 1857. Railroads were the hot companies. And the California Gold Rush was on, too. Lots of money went right down the tubes. But railroads did get laid. And new owners bought bankrupt assets on the cheap. That's what happens after a bubble pops. Think of all the foreclosed homes that were bought up by Wall Street firms after the housing bubble popped...

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Today's Bubble

So, the bubble I see today is one not many people are looking at. But it has all the hallmarks: it is a foregone conclusion that it will happen, it will revolutionize several sectors (the biggest being the automotive sector), revenues will skyrocket for the companies involved as million of people adopt this new technology, and companies are already rebranding themselves to emphasize their involvement...

Do you know what it is?

Here's another hint: 5 billion devices will connect to it over the next five years...

Got it now? 

Yeah, I'm talking about the Internet of Things. IoT. 

The idea is that we will have this super-fast mobile Internet that will allow all kinds of devices to give real-time feedback and allow remote monitoring that will increase efficiency and save money.

And much of that is realistic. Driverless cars are the best example. To have huge fleets of cars that are sending signals to each so they don't all crash, you can't have any downtime on the network. There just can't be dropped calls...

Even now, you can monitor your home with your phone, using the Internet to adjust temperature and turn lights on and off — not necessary, but pretty cool. 

The problem as I see it is: who's gonna pay for this new network? I've seen estimates that the Internet of Things will cost $100 billion to build. I guess that's a good deal. But where's the money coming from? If you say the big wireless companies, Verizon, Sprint, AT&T, think again. These companies are still up to their eyeballs in debt from the last network upgrades. And current cell phone business models are not working.

Sprint never makes money. It is valued at $37 billion, and it has $37 billion in debt. Verizon is a $200 billion company, and it has $108 billion in debt. To grow, Verizon is buying Yahoo. AT&T ($123 billion in debt) just bought Direct TV and wants to buy Time Warner. And they're gonna fund a massive network upgrade in the next few years? 

The plan is the same as it was with Global Crossing. Build it, and new subscribers will flock to pay for the devices to be connected. But do you want your wireless bill to go up? Are you willing to pay to remotely monitor your home? I know my cell phone bill seems stupid high. I'm not going to actively try to make it higher. 

There are security issues, too. It's already way too easy for hackers to get into networks. More devices means more opportunity. What happens when all the connected devices are infected with some kind of chaos virus all at once — your toaster is shooting flaming slices of bread at you, your car takes off and runs into a tree, your heat goes up to 100 and the AC comes on at 50, and your phone is live streaming it all...

No thanks. 

Now, I will tell you, some of the underlying story of the Internet of Things is 100% viable. I've recommended a couple different data center REITs to take advantage of increased mobile traffic (up 68% and 175%), and I've recommended a network stock (up 20%) and a chip stock (up 14%).

But I'm also keeping a watchful eye. The Internet of Things hasn't gone into full bubble mode yet, but it has a good chance to at some point. Keep your eyes open, and stay a bit skeptical. 

Until next time,

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Briton Ryle

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An 18-year veteran of the newsletter business, Briton Ryle is the editor of The Wealth Advisory income stock newsletter, with a focus on top-quality dividend growth stocks and REITs. Briton also manages the Real Income Trader advisory service, where his readers take regular cash payouts using a low-risk covered call option strategy. He also contributes a weekly column to the Wealth Daily e-letter. To learn more about Briton, click here.

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