Ever wonder why fund managers can’t beat the S&P 500? ‘Cause they’re sheep — and the sheep get slaughtered. I been in the business since ’69. Most of these high paid MBAs from Harvard never make it. You need a system, discipline, good people, no deal junkies, no toreadores, the deal flow burns most people out by 35. Give me PSHs — poor, smart and hungry. And no feelings. You don’t win ‘em all, you don’t love ‘em all, you keep on fighting . . . and if you need a friend, get a dog . . . it’s trench warfare out there sport and in here too. — Gordon GeckoI built a much better model with more realistic constraints available here
Outside of generating new information or product, risk, diversity and time horizon are only variables I’m convinced an investor can control. This means invest broadly over long time horizons and keep taxes and expenses low. If you want outsized returns, you must take on more risk or make something people want to buy. Most wealth is created by businesses making real products, but wealth can still accumulate from appreciating assets (real estate, land, gold, internet domain names, etc). However, both these methods take a lot of time and effort. Can you make a lot more quickly through selling VOIP services, posting internet ads and joining a Brazilian-focused multi-level marketing (MLM) club called TelexFree?Over Christmas break this business came up for discussion and caused a lot of confusion. Is this a business? An investment? Either way, what is the basic product and what is the associated demand? And finally, what is the downside risk?The basic value proposition is straightforward. You put in a fixed amount of money, post internet ads, sell voice over IP telephony and recruit new members. From this you receive multiple cash flows which quickly return your initial investment: bonus incentives for bringing in new recruits into the system and some fractional return of telephony services sold. However, from the company and its members there is almost no discussion of the underlying supply and demand of the business and the whole value proposition quickly becomes . . . the return! The cash flow kept getting all the emphasis, not the product. This post is to get at the question: is there a population ready to pay real cash for a product they want and no one else can give them, or are a whole lot of people getting scammed?The complexity of myriad cash flows initially obscured my ability to get to the core of the business. The different services sounded like an odd mix. What exactly are “internet ads”? What telephony services could provide high MLM overhead and still compete with Google Voice, Skype or international rates from major carriers? VOIP services in particular benefit from very large scale with a small non-recurring infrastructure, all based on leveraging the very low cost of internet bandwidth. I can’t think of anything with thinner profit margins, except for perhaps internet ads, which tend to cost from a fraction of a cent for a page view to around several dollars for impressions which lead to a sale. In fact, VOIP is pretty much a buzz word. Almost all telephony is at least partially carried by VOIP today.So, bundle two very low margin businesses and add in a high upfront cost for membership and you get a business? Something didn’t seem right. In particular I wanted to know: (1) is there a legitimate telephony business, (2) is there a legitimate internet marketing business and (3) how can the initial membership fee produce such an insane return (roughly 300% per annum) in a sustainable way?
The telephony business
The telexFree VOIP business is very simple. The product is named “99TelexFree” and is a telephone service that costs $49.99 a month and provides:
- free calls between mobiles on the carriers “Vivo-claro-tim” and “Oi”
- free calls to any landline or the aforementioned carriers in Brazil from your computer
- free calls to mobiles and landlines in the US and Canada from your computer
As mentioned previously, VOIP is a very low margin (and low overhead) business with a lot of competition from large companies. If the market is for Brazillian expats living in the US, you would have to convince these folks to pay for a service when they can use Google Voice or Skype for free (what all the expats I know do). Also, you would have to convince these folks that they should install software from Disk a Vontade (99TelexFree’s provider), as opposed to free software available from large companies with established infrastructure for VOIP services, which benefit from scale.While not exhaustive, I wanted to pick two, established companies for a cost comparison if someone specifically wants to use a computer to call a land or mobile line from America to Brazil.
Google Voice costs 3 cents a minute if calling a land-line in Brazil or 15 cents a minute if calling any mobile operator in Brazil from a US computer. In order for the 99TelexFree plan to be cost effective, one would need to make more than 1,667 minutes of calls to a land-line or 333 minutes to “Vivo-claro-tim” or “Oi” mobile phone carriers. While a very niche market, there is an advantage over Google Voice (if you make over 27 hours of calls monthly from the US to Brazil, for example).
On the other hand, Skype has plans to call mobile phones or land lines. Their land-line based plans are much more cost effective than 99TelexFree. Skype costs $9.99/month to call any land-line in Latin America or $44.49 for 400 minutes to call any land-line or mobile line in Latin America. Here, 99TelexFree only makes sense if you would place greater than 400 minutes to their two supported mobile carriers.These quick comparisons tell me that the potential market is going to be very small subset of total users: Brazilians in America who want to talk > 400 minutes on “Vivo-claro-tim” or “Oi” mobile phones. This segment of the market must also reject the very good options of calling computers for free or the ability to call a land-line at very low rates.
Anyway, the money you are supposed to make doesn’t come from commissions sold for the VOIP service (which are very small $5 for the first tier of your “downstream” and get smaller ($0.99) as the pyramid expands. The big money comes from “investing” or posting unsolicited internet ads (i.e. what is commonly called spam). You need to post ad one a day to get a $20 weekly return from a $299 membership. The value proposition here is that TelexFree is paying you $2.85 for each ad you post. Since this is roughly 300 times more expensive than a pageView ad cost from Google, Yahoo or Bing, this has led many to speculate that TelexFree AdCentral is the heart of a Ponzi scheme. See supporting articles here and here, here, here, here and here.Again, the math is revealing. In order to produce an annuity that would return 20 per week on $300 present value, you would need to be guaranteed a 6.5% weekly return, or an annual return of 247%. Unsolicited internet ads can be posted by bots for fractions of a cent, so there is clearly an external source for funding the AdCentral payback. There are only two options for this: new memberships (aka Ponzi profits), or profits from VOIP sales which have a niche, but legitimate product.
Warning, I probably get this section wrong. The membership specifics seem to change, the information seems correct as of several months ago, but some current sites have the same idea but in different formats.
TelexFree advertises itself as a MLM pyramid compensation plan (one that increases upstream compensation). For TelexFree, the pyramid takes the form of a binary compensation structure to pay out commissions on the recruitment of new members and their payment of membership fees.A binary compensation structure starts with you at the top and branches out into two legs. The first two members placed in your binary compensation structure form the basis of two teams (your “left” and “right”) which have to be balanced for payout computations. You have to recruit the first two new members in order to qualify for TelexFree’s binary commissions but thereafter any new members recruited by those below you are in your downstream for commissions.The first of the binary commissions paid out by TelexFree is a flat 40 cents a week commission per member under you (regardless of which side they are on). This is a recurring reward. The second binary commission offered is based on the pairing of new memberships on both your left and right binary sides. For example, if you recruited 6 new members and 3 fell on your right team and 3 your left, you’d earn a $60 (3 * $20) paired binary commission that day. If however, you have more on one side only the lesser amounts match up. Paired binary commissions are capped at 22 cycles a day ($440), you will see why later when I do the math.This is a brilliant strategy by TelexFree as it creates an incentive structure to get both sides to match and aggressively recruit.
Long Term Prospects
The fundamental reality is that when you don’t have a product or service with an active demand that is the foundation of your business, the money is going to disappear, it is just a matter of time. The trick for the owners/founders is to quickly convert their earnings into accounts which can’t be clawed back. As long as leadership can create enough confusion regarding where the money is coming from and keep the money coming, they can keep the whole system in place while they increase their overall take. Regulatory bodies are slow to act and schemes such as this can take years to work their way through the courts. In that time, the owners can keep turning out new products to keep their “investors” thinking the business is going to take a new direction and the money will not dry up. The brilliance of a combined ponzi and pyramid business structure is that if you start early, you are going to make a lot of money for a good period of time.If you search the internet for TelexFree there are 1000s of You Tube videos mostly filled with a discussion of the compensation scheme and reiterated emphasis on the fact that the money is flowing. The issue is not wether payouts are occurring, but if there is a sustainable (“real”) business that is unique and better than the competition. Since any potential legitimate business TelexFree might be engaged in are in the highly competitive, scale advantaged, and highly automated VOIP and internet advertising business, I’m not surprised there is no technical or even economic discussion of a viable business model that I could find anywhere on the internet. So let’s turn to math to make this more concrete . . .
In order to make this real, I’m created a financial simulation to show how this system works (email me if you want the spreadsheet). In reality, there are a lot of complications that slow things down for the member and I’ve left out a lot of the details, but I have enough in the model to show how the system works for three different categories of participants: owners, winners and losers.If you assume you buy one membership ($299) and that you are able to recruit 1 out of every attempted 20 sales and you try to sell TelexFree to 10 people a week, then you will (on average) sell one membership every two weeks. If you assume your recruits are this successful as well on both your left and right at equal rates, you will break even in 11 weeks and start making a profit (with $30 in your pocket!). At this point, there would be about 20 people in your binary. Also, assume you sell one VOIP plan every 10 weeks and 1 out of every 100 new members downstream buys a VOIP plan. At this point the company has made $5,971 in membership fees off of you, but is committed to paying $420 a week in AdCentral fees. Not bad deal for them, and it is about to get a lot better!If you fast forward with these assumptions to the end of the year (everyone you recruit, recruits 1 person every two weeks), things start to get crazy. At this point you have made a lot of cash, you are now up $63,000 (and getting $216.76 in downstream VOIP commissions and the absolute max of $3,080.00 in weekly membership commissions) and TelexFree has now grossed $65,622,212.40 from you and your downstream memberships alone. Your downstream has grown to 218,951 people. Without their $440 a day cap you would have made many millions by now. However, TelexFree now has weekly commitments to pay $4,379,020 a week in AdCentral fees. If growth doesn’t increase the company can get by for 15 weeks before 209,324 members lose an average of around $250.Clearly, this would have been an exciting ride and you would have pocketed enough cash for a nice car or down-payment on a house, and odds are that you will never meet any of those poor 209,324 people, since (in this simulation) everyone four levels down from you still profited. Naturally, very few telexFree members would recruit a new member every two weeks. In reality, people buy numerous memberships and go “all in” and the majority of new recruits never recruit anyone, which causes the same effect except with a smaller pool of people to share the risk. (This means a lot less people are going to lose a lot more money.) Despite the generalizations I’ve made, this should be a good peek at the dynamics of the system: the owner makes roughly 1000 times what the most profitable members make and those at the top do very well. The rest pay to play. The big difference is that the owner knows when the game is up and has had time to protect their earnings.
How will this play out?
There are only two scenarios for an endgame of this scenario for US TelexFree participants: (1) the system collapses and payouts cease (cf. Zeek Rewards) or (2) The US Department of Justice bans TelexFree operations in the US (which Peru and Brazil have already done). see this warning posted last week Right now the race is on. If this plays out like previous Ponzi collapses have, TelexFree will have to turn over all of their electronic records. The owners will declare bankruptcy and turn to laundered cash. If participants have benefited substantially, their earnings are subject to clawback (the government will require you to pay back your earnings) and the goverment will have your exact compensation on their subpoenaed records. If you have been/ or are a participant, I would set aside your earnings in a separate account and wait to see how this plays out over the next several years. Unlike the owners, you are clear before the law as long as you pay back your earnings if required (assuming you have claimed all earnings on your taxes).You can see through this Google trends report that TelexFree interest has peaked and is in a significant downtrend. Looking very similar to ZeekRewards several years ago. If you are wondering how to go forward and if you should trust me, I strongly recommend that you don’t. Ask the hard questions: Is there a fundamentally unique product or service? Do the math yourself. Just don’t get greedy and follow the herd, because the sheep get slaughtered.
I built a much better model with more realistic constraints available here