Daily Archives: July 22, 2006

Telco Innovation: A Contradiction in Terms

An essay titled “The Phone Companies Still Don’t Get It” is featured in the July 31 edition of Business Week. It’s also available online.

Essentially, the essay contends that the telecommunications carriers charge too much, stifle competition, don’t know how to innovate, and don’t spend nearly as much as they should on research and development.

I agree that telecommunications carriers charge too much for their services, though competition from VoIP service providers and standards-based IEEE wireless technologies, such as WiFi and WiMax, have the potential to keep them somewhat honest. I’ll also agree that the telco behemoths work to discourage and prevent the market-based dynamic of competition. They’d rather just divide the market among themselves in peaceful oligopolies, like back in the old days before the anarchic Internet forced them to mend their complacent ways.

Where I diverge from the author of the essay is in relation to his next two points, namely that telcos don’t know how to innovate and that they should spend more money on research and development.

Oh, I agree that telcos don’t know how to innovate. As for as I’m concerned, that’s good. I don’t want them innovating. If they were capable of innovation, they’d charge too much for the resulting products and services and they would have a better chance of exterminating their smaller competitors. The result would be a pitiably limited range of choice for consumers and businesses, not to mention permanently high prices for offerings that inevitably would slide into mediocrity.

Similarly, I don’t want telcos spending their money on R&D. I just want them to provide me with a big fat communications pipe. For them to do that, all they need is networking gear from Cisco, Nortel, Alcatel, Juniper, and countless other network-infrastructure providers. I don’t want them devising and selling content, architecting walled-gardens, and putting up toll booths wherever they see fit. It’s okay for them to deliver basic service bundles through their pipes — say, broadband Internet access, IP TV, and VoIP — but I don’t want them restricting what I access through those pipes or applying service charges when I patronize a site that doesn’t belong to them or is outside their circle of preferred suppliers.

We don’t need vertical integration in the telecommunications supply chain. The system is more efficient, and more responsive to customer demands, when communications-equipment providers sell their gear to service providers, who then provide us with the resulting pipes, through which we decide, as consumers, what types of creative or informative content we wish to consume from the purveyors or sites of our choice. There’s plenty of room for everybody in that decentralized market model.

So, give us a pipe, telcos, and leave the technological innovation and content to people who know what they’re doing.

Weighing Pros and Cons of AMD’s Rumored Bid for ATI

A rumor has circulated for at least a couple months that Sunnyvale-based Advanced Micro Devices (AMD) would acquire Toronto-area graphics-chip designer ATI Technologies. The rumor has come and gone a few times — and now it’s back again, this time apparently with more plausibility. Neither company has acknowledged the scuttlebutt, but that could mean anything or nothing.

Speculation is rife that AMD will acquire ATI for approximately US$5.5-billion in stock. The deal, which reports indicate could be announced as early as Monday would be an immense undertaking for AMD, potentially resulting in a merged company in which ATI shareholders would own a considerable stake. After all, AMD’s market capitalization is about $8.84 billion; it has about $2.63 billion in cash and more than $658 million in debt on its balance sheet.

So, is AMD wise to take the multibillion-dollar plunge with ATI?

Before we make our judgment, let’s examine the pros and cons of the proposed acquisition from AMD”s perspective.

On the pro side:

1) Buying ATI would let AMD offer a wider array of chips at lower prices to its customers, helping it mitigate or eliminate a competitive advantage of Intel’s

2) AMD could sell stand-alone graphics chips that Intel doesn’t sell

3) ATI would allow AMD to diversify into new markets such as graphics chips for televisions, cellphones, and game consoles

4) AMD’s roadmap calls for tighter integration of chip sets with its microprocessors for better performance and improved heat dissipation

On the con side:

1) It would be an extremely dilutive acquisition, potentially weakening AMD’s ability to make future capital expenditures in R&D and next-generation foundries

2) Graphics chips are less profitable than PC microprocessors, with gross margins of 45 percent compared to 55 percent for microprocessors

3) Such an acquisition would distract ATI from its single-minded focus on competing against and beating Intel in the market for microprocessors; as a bigger company, Intel can afford more diversification, but even Intel has shown that it can’t excel at providing all the chips to all market segments and companies

4) AMD has benefited from being a neutral microprocessor vendor, able to work with both ATI and its archrival Nvidia Corporation in sourcing chip sets and graphics chips

So, where do I come down on this acquisition, presuming it happens? I have to think that the risks outweigh the rewards. The larger the acquisition, the more difficult it is to pull off. Problems relating to integration, logistics, and day-to-day operational management grow exponentially as acquisition deals scale in size. AMD is proposing to take over a company practically half its size, and, even if the strategy seems compelling in theory, the post-deal reality can be quite different in practice.

Moreover, it isn’t clear to me that at least some of the purported benefits for the deal couldn’t be achieved through existing or future partnerships rather than through the extreme measure of a multi-billlion dollar acquisition. Similarly, the development of product sets for markets such as the “digital home” could be pursued organically at less cost, and probably within a reasonable time-to-market window, than resorting to an acquisition ATI and its attendant baggage for $5.5 billion.

I think AMD has to be wary of defocusing, too. It had Intel on the run, and digesting an acquisition this big, with the potential for so many things to go wrong, could be disastrous. Intel is trying to climb back into the ring, looking to resume the battle leaner and meaner, with a renewed focus and long-lost vigor. In the end, Intel might benefit from AMD’s acquisition of ATI more than AMD would.

LA Times Explores SEC’s Focus in Stock-Options Investigations

There’s bicoastal coverage today of backdating-related stock-options scandals. Joining the New York Times in visiting the subject, the LA Times takes a different tack and explores where it believes the Justice Department and the Securities and Exchange Commission are heading with their ongoing investigations and charges.

The conclusion — with the charges filed against former Brocade Communications Systems Inc. CEO Gregory Reyes and the company’s former Human Resources Vice President Stephanie Jensen cited as evidence — is that the government will aggressively pursue acts of falsification and fraud related to stock-options transgressions, regardless of intent.

In the case of what is alleged to have transpired at Brocade, Reyes and Jensen are said to have made engaged in fraud to make options lucrative for the company’s employees and prospective employees, all in a bid to recruit and retain staff. They are not alleged to have aggrandized themselves, though there probably will be cases of that sort prosecuted before all the other stock-options investigations come to a close.

The common thread in the prosecutions will be fraud. As the LA Times article points out, stock-option backdating is not proscribed, in and of itself:

The SEC doesn’t prohibit backdating of options — or picking an exercise price that is below the stock’s market price — as long as the company discloses it and correctly accounts for the difference between the lower exercise price and the market price as an expense.

The SEC has encouraged companies to commission independent investigators to review their past and present option-award practices. If suspect practices are found, companies are advised to contact regulators immediately with their findings.

The SEC and the Justice Department are sending a message: If you don’t come forward, we will come after you; and, if that happens, it won’t be nearly as pleasant an experience as it would have been if you’d come to us first.

NY Times Examines Stock-Option Sins of the Valley

In today’s edition of the New York Times, reporters Gary Rivlin and Eric Dash examine why technology companies in general, and those in Silicon Valley in particular, were more inclined to indulge the illicit practice of stock-option backdating than were companies in other industry and in other parts of the country.

Write the article’s authors:

The practice of backdating options dates to the early 1990’s but took on momentum during the frenzied days of the Internet era, when the competition for available talent was fierce. Numerous Silicon Valley insiders described the practice as routine — so much so that the universe of technology companies ultimately placed under the microscope may well far exceed the dozens already under scrutiny by the Justice Department or the Securities and Exchange Commission, if not both.”

While that statement seems fair enough, the writers then push their luck by straying into the boggy land of questionable assumptions and hyperbolic imaginings:

There is little doubt that Silicon Valley provided the perfect setting for cutting corners. The heady days of the tech boom gave many a sense of entitlement, if not also a sense that they were the primary force keeping America strong in the world economy. It was also a maverick culture where clever ways of gaming the system were admired rather than excoriated.

I don’t disagree that cutting corners occurred and was encouraged by many executives during the boom days of technology industry. It happened, sure. I’m not as disposed to see, even in retrospect, the “sense of entitlement” or the “sense that they”(presumably the denizens of the technology industry, and particularly those in Silicon Valley) were “the primary force keeping America strong in the world economy.”

Balderdash! The people who cut corners and enriched themselves and their employees at stockholder expense did it because they could. They didn’t need grandiose rationalizations as to how they were defending the interests of the American economy. That never entered into the equation, except perhaps in a few delusional instances.

The stock-option backdating craze took hold because of two basic human emotions: greed and fear. Greed was a obvious motivator; executives saw the opportunity to pad their nests with even more money, felt it was a victimless crime (as one of those quoted in the article points out), and they grabbed with both hands. Fear also was a motivating factor, because an intense battle was being waged for technology talent in the Valley and beyond. Companies figured if they didn’t put together exceptionally compelling compensation packages, with favorable stock-options at attractive strike prices, prospective employees would work elsewhere.

For some reason, the New York Times feels the need to add an element to the story that was never there, to ascribe motives to these actors that they never would entertain, much less possess. The technology industry, from my firsthand experience, is a multinational, multiethnic, multicultural realm, and it largely is apolitical, at least in the geopolitical sense. People are in the business either because they like the technologies or because they like to make money, and some people are in it because they like both.

That said, the article is worth reading — it includes a graphic that maps 25 Valley-area companies under investigation for, or conducting their own probes into, stock-option improprieties — and it closes with a remark by an SEC official that should trigger consternation throughout the technology industry, especially in light of the recent criminal and civil charges filed against former Brocade CEO Gregory Reyes.

Linda Chatman Thomsen, chief of enforcement at the S.E.C., said in an interview that the government filed charges against Brocade first “because it was ready.’’

“It wasn’t necessarily,’’ she said, “the most egregious case.”

Who’s next? We’ll probably get that answer soon enough.