Imagine starting a business by investing $5 billion and then watching it all fall apart because you couldn’t come up with $5 million. In the crudest sense, that’s what’s happened to Iridium, the would-be satellite-telephone service that saw its last hope for salvation die Friday when Craig McCaw, the cell-phone pioneer who was contemplating acquiring Iridium, said he was no longer interested in the company. Today, the company lost access to $5 million in emergency financing it had gotten as part of a bankruptcy-court deal, and unless something happens very soon, there are going to be a lot of completely useless satellites orbiting the earth.
Of course, even the $5 million wouldn’t have saved Iridium. It needed to be bought by McCaw, but even at a fire-sale price he apparently couldn’t figure out how to make the business work. What’s startling about that is that the initial investors in Iridium, above all Motorola, which designed and built most of the system and still owns a sizable chunk of the company, thought the satellite-phone business was so good that it could justify that initial $5 billion investment. And now McCaw is essentially saying that he doesn’t think it can justify even a couple of hundred million dollars (which is a rough guess of what he would have had to pay).
The picture may be a little more complicated than this, since if Iridium does finally get put to sleep, it will sell off its assets, including the satellites and the ground stations with which they communicate, and McCaw may end up bidding on those. But what happened to Iridium is an example of how a good story cannot make up for a bad business model, and also evidence that hard assets really are sometimes worth almost less than nothing.
The Iridium story, after all, was a terrific one. You were going to be able to talk from anywhere in the world to anywhere in the world. This was a global phone for a global economy. Iridium’s ads showed people taking calls while tramping through the Arctic and sailing in the Pacific. The big problem was that even today there are very few people tramping through the Arctic, and even those that are aren’t placing lots of calls. Iridium initially projected that it would have more than a million subscribers by this point. It now has about 50,000.
And the 50,000 subscribers are not by any stretch all happy, either, since one of the interesting things Iridium discovered is that even the preposterously rich don’t like paying preposterous prices–like the $7 a minute they were paying in some places when the service launched–for a product like phone service. It’s difficult to understand why Iridium had to discover this at a time when calling prices are dropping all over the globe. But the company built its business model around a completely unrealistic set of prices and a completely unrealistic set of projections about how many people would be willing to pay those prices. As a result–and unlike its chief competitor, Globalstar–Iridium built a system that was economically unjustifiable, because all of the assumptions that had gone into it were flawed. Actually, “flawed” isn’t really the right word. “Wrong” is.
Even now, it seems hard to believe that people can actually make $5 billion mistakes, but that is precisely what the investors in Iridium did. At the same time, there’s something telling about McCaw’s decision to walk away. As the stock prices of many New Economy companies have soared while the stocks of companies in old-line businesses have stayed flat, one of the recurring criticisms of the way the market is valuing companies is that investors no longer understand the value of hard assets. How can all of General Motors’ factories, the argument goes, be worth less than JDS Uniphase’s technology?
On the one hand, there’s something just empirically flawed about this take on the New Economy, since in fact capital investment and spending are at historically high levels and have been for most of this decade. So, in one sense what we really need is probably just a redefinition of the word “hard.” But in another sense, it is of course true that New Economy companies have more invested in intellectual/technological capital than in assembly lines. The mistake is believing that because the assets seem “soft,” so too are the stock-market valuations. Because the central fact that’s at issue here is that factories are expensive. Not just expensive to build but also expensive to keep running. So, too, are Iridium’s satellites. In other words, you have to keep investing a lot of money in hard assets in order to make profits, and that means they are less valuable–because less productive–than a soft asset like, say, the code for Microsoft Word. This doesn’t mean that all hard assets are bad. (Just take a look at Intel’s performance, or Toyota’s for that matter, to see that.) But it does mean that the mere fact of their existence does not make them valuable. It may be hard to believe that you could have satellites in the sky that no one wants. But just drive by the steel mills of Gary, Ind., and this will all make a lot more sense.
