One of the best illustrations of the many ways a business valuation can go wrong is the pre-bankruptcy story of mobile satellite service Iridium. Some firms always passed on buying Iridium no matter how low the price dropped. The potential upside of buying Iridium even for $1 was tiny, but the potential downside (especially the opportunity cost) was massive. Some firms already had enough wholesale transfer pricing and other problems with Motorola related to Nextel.
There is a recent book about Iridium, but that account does not identify why such colossal mistakes were made in assessing the potential value of the business. The common narrative is:
“John Bloom, an investigative journalist and author of the book Eccentric Orbits: The Iridium Story. “It did what it was supposed to do. It was an engineering miracle. It’s just that not enough people needed a phone at all longitudes and latitudes.”
That’s true only in that not enough people valued the product at the price point. But there are deeper explanations of why this happened. The common explanation is that “cellular spread faster than people imagined.” That wasn’t the root cause.
The root cause of Iridium’s valuation failure was what I call goal seek bias which is a special case of confirmation bias and incentive caused bias. The goal seek function in a spreadsheet allows a modeler to use the desired result of a formula to find the possible input value necessary to achieve that result. To understand how the biases played out in the case of Iridium you must know a few background facts.
Motorola was a satellite subcontractor. It wanted to be a prime contractor, but it did not have a customer. The best way around that problem was to create the customer for Motorola satellites from scratch. Iridium was born for that reason. In order to raise the billions of dollars needed to pay for the system a credible business model was required. Naturally spreadsheets were created and it was necessary to goal seek a total addressable market (TAM) to financially justify building and operating the system to investors. The outcome of that financial modeling was a case of what Warren Buffett calls the institutional imperative at work: “Any business craving, however foolish, will be quickly supported by detailed rate-of-return and strategic studies.” The result of the goal seek bias in the case of Iridium was preposterous on its face, if the assumptions were carefully examined.
The phone did not work indoors
The phones did not work in a car
The phones did not work without line of sight to the satellite (buildings and even trees are a problem)
The phones were very big, heavy and expensive
The service was expensive
What did the market researchers ask potential consumers about the Iridium service? A classic leading question of course: “Would you value a mobile phone that you could use anywhere?” Who wouldn’t say yes to that question? But it wasn’t even close to the right question to ask. Whenever you receive a spreadsheet valuing a business, it is wise to focus on the assumptions. And as Bill Gurley points out that is particularly true of a young company. But people make emotional mistakes:
“Ed Staiano, formerly a senior executive at Motorola and the CEO of Iridium at the time of commercial activation, knew in intimate detail how the Iridium system actually functioned and was well aware of its various technical limitations, including the fact that the Iridium telephone would not work dependably indoors or in the urban canyons of central business districts, but he made the decision, nonetheless, to invest $500,000 of his own money in Iridium securities in March 1999”
“Multiple witnesses indicated that they were familiar with the “line-of-sight” nature of the system, and, despite that, they appear to have assumed that the service still would be acceptable to users.”
Iridium was purchased by an investment group for very little cash and today is both an operating business and a listed company. The business is very different than originally envisioned (r.g., they are chasing non voice markets) and the link to Motorola that would have created huge wholesale transfer pricing problems is gone (Iridium has multiple suppliers). The prospects of that new business is not a subject covered in this post since this is about what happened pre-bankruptcy.“Some of the worst business decisions I’ve seen came with detailed analysis. The higher math was false precision. They do that in business schools, because they’ve got to do something.” Charlie Munger.