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Family Matters and Cable’s Future

Lead picture (2)Greetings from Austin and Dallas, where high school football playoffs are underway (this week’s lead picture is of the Jesuit College Prep Rangers and Rockwall Yellowjackets).  Jesuit won by 20, and Martha and I are becoming football parents like we never dreamed before.  There is nothing like Texas high school football, especially during the playoffs.  It’s a cultural phenomenon.

Before we begin our two-part discussion of several important trends that will impact the telecommunications landscape over the next year, I want to respond to several questions posed by you on the cable consolidation rumors that surfaced this week.

As we saw with wireless consolidation and spectrum trading in 2012 and 2013 (T-Mobile + Metro PCS; Sprint + Softbank; AT&T + ATNI + Leap, US Cellular spectrum and/or customer sales to T-Mobile and Sprint), there is a logical time in any industry where a re-clustering of assets makes sense.  The drivers of this change have been varied – government mandate, capital requirements, unique distribution capabilities of the acquired company.  The result:  Greater efficiency and broader coverage driven by economies of scale.  Greater competition has made an impact on the wireless industry in 2013.  The boldness of T-Mobile, which we have written about in several Sunday Briefs, would not have had as great an impact without MetroPCS.

The cable industry has not been caught up in the waves of wireless change, with the possible exception of Clearwire.  There has been talk for years about who would acquire Cablevision and what valuation premium would be assigned.  The possible combination of Suddenlink and Mediacom (two large 2nd and 3rd tier cable providers) surfaces every six months and then is quickly squashed.  Now, the focus is on Charter and Liberty Media’s plans to acquire part or all of Time Warner Cable, perhaps with some help from Comcast.

This story has all of the drama of many of the programs broadcast over Charter and TWC’s networks.  A legendary CEO, afflicted with cancer, announces his retirement, signaling an end to his reign over a decade of impressive transformation and value creation (which was accomplished as a previously failed merger was being unwound).

tom rutledge glenn britt

Glenn Britt (left) and Tom Rutledge (second from right) prepare for Senate testimony with News Corp and Univision executives

The acquiring company is smaller, but is in the midst of its own legendary turnaround.  While growth is slowing in much of the industry, Charter has several quarters of growth left to catch up to the penetration rates of the industry leaders, including TWC and Comcast.   Charter’s stock has skyrocketed since they emerged from bankruptcy in late 2009 (CHTR began to trade in Jan 2010), delivering a 41% compounded annual return to shareholders during that period.

On top of this, the CEO of the acquiring company (Charter), used to run one of the largest divisions of the potentially acquired company.  While there is a degree of collegiality between cable companies, the Rutledge/ Britt relationship has been cool if not wintery.  Even though  the cable industry has changed, the personalities (Dolan, Roberts, Britt, Malone, Miron, Cox, Kent, Commisso) have not.  It’s familial, if not downright family, and, as we know, there’s nothing like a good family “discussion” around the Thanksgiving table.

If there’s one thing that unites a “family” in dislike, it’s having others meddle in family matters.  This includes the FCC-run Obama administration.  As the Wall Street Journal reported this weekend (subscription required), on top of valuation issues, any acquiring company faces increased regulation.  Enter Tom Wheeler, the new FCC Chairman and one-time head of the National Cable Telecommunications Association (NCTA).  Also enter the most networked cable executive in Washington, David Cohen from Comcast.

For Charter to succeed in an industry-changing cable event (as opposed to a highly leveraged transition), they will need to go through the FCC and state regulators.  Time Warner has significant operations in New York and California, the two most active Public Utility Commissions (note, there are others such as North Carolina and Texas who will also want to extract concessions).  These commissions, along with the FCC, want to regulate broadband.  Specifically, they want to prevent the prioritization of one byte of data over another, a concept commonly known as net neutrality or nondiscrimination.

The possibility of a discriminating Internet has regulators seething.  For those of you who aren’t following the story, Verizon has appears poised to win their lawsuit challenging the constitutionality of the net neutrality provisions adopted by the FCC in 2010.  (For a good background read on the story, read the InfoWorld article here).  A recently penned editorial in Wired magazine summarizes the situation as follows (the article is titled “We’re About to Lose the Internet as We Know It”):


Given how sticky this morass is, there’s one simple way for you to judge the opinion: If the court throws out the non-discrimination rule, permission-less innovation on the internet as we know it is done. If the nondiscrimination rule miraculously survives, then, for now at least, so too will freedom on the internet.

The DC Circuit Court ruling will likely set up months if not years of appeals.  Rather than have an argument with Verizon, why not bring the cable industry to the table (who have more High Speed Internet customers than Verizon, AT&T, and CenturyLink combined) and resolve net neutrality outside of the courts and Congress?  Exercising executive branch privilege is nothing new to the Obama administration, and, after the 2014 elections, it will be the primary (if not only) way they can quickly enact their agenda.

This is one reason why Comcast must be at the table.  Enter David Cohen, head of regulatory affairs for Comcast and an expert negotiator (picture left).  He’s a strong supporter of the Obama administration and also the cable industry.  If cable had a Secretary of State, it would be David Cohen.

david cohen

David Cohen of Comcast

The value generated from turning today’s broadband connection into an engineered information delivery system is enormous.  In traditional telecom speak, this is “access” redefined.  It would entail turning Netflix, YouTube, and others into payers as opposed to users of today’s broadband network.  It would likely drive up network speeds to Google Fiber levels in areas Google Fiber could not economically reach.  The value created in a discrimination-based world would be enormous – tens of billions of dollars per year.

This is one reason (and, in my opinion, the primary reason) why Comcast wants a seat at the table.  Dealing with regulators requires technique.  Regulations set precedents.  And no one is going to dictate the cable industry’s direction without Comcast’s input.

Can regulators get it right?  Can a Cohen/ Wheeler/ Rutledge/ (Rob) Marcus deal emerge that makes everyone happy?  The short answer is yes.  It will not happen overnight because the appetite for an overarching agreement is strong.  As a result, today’s cable rumors may take months if not years to fulfill.  However, the cable industry will get congestion relief and re-cluster itself, and as a result position their broadband services favorably against their wireless and telco competitors.

The family will make it through one more Thanksgiving dinner.

Next week, we’ll cover six events that will shape the fourth quarter and 2014.  Until then, if you have friends who would like to be added to The Sunday Brief, please have them drop a quick note to sundaybrief@gmail.com and we’ll subscribe them as soon as we can.  Have a terrific week!

Cable’s Satisfaction Stars

greensboro planeGreetings from Austin, Seattle, Charlotte, Greesboro (pictured), and Dallas.  Three airlines, three separate rental cars, three dinners – all in one week.  It goes without saying that I did not make it to the stunning end of the Stanford/ USC men’s football game last night.  There’s always next year, Stanford.

There were few earnings releases this week, but two bear mentioning as we discuss the overall state of the cable industry.  Wide Open West (WOW!), a cable over-builder that was created out of Ameritech’s Cable initiative (appropriately called Americast), surprised many in the analyst community with the strength of their subscriber gains (click here for a link to their earnings release).  The company has been absorbing acquisitions (including Knology), and has not been immune to the secular changes hitting the broadband industry as a whole.  However, WOW! is an excellent regional barometer (Midwest, Southeast) and an annual leader in Consumer Reports residential metrics for all products. WOW’s subscriber performance is detailed in the following chart (from their most recent 10-Q):

 There are many things to glean from this chart.  First, notice the continued strong performance of High Speed Data (HSD) customers throughout the merger/ integration quarters (WOW! completed the acquisition of Knology in 3Q 2012).  No surprises there.  But also notice the “flatness” of video, which is only down 2.5% from the post-acquisition peak.  Given the intense competition present between three broadband providers (and two satellite competitors), as well as the standard churn that occurs as a result of merger and integration activities, this is an impressive number (Comcast’s video subscribers were down close to 2.0% over the same period when adjusted for business gains, and Time Warner Cable residential video subscribers were down 6.3% over the same period).

Many have characterized WOW! as scrappy or “teaching for the (Consumer Reports) test.”  The implication that WOW! is undisciplined or intentionally focused on pleasing one particular publication could not be further from the truth (have a look at the JD Power results if you have any doubts).  Having worked with them on their voice rollout in 2004 and 2005 (Sprint was an early provider of voice services to WOW!), they are faster and more methodical than their cable competitors, and their focus on every element of customer experience is intense and thorough.  As many analysts have written off the demise of video, WOW appears to be reinventing the value equation.  If Google Fiber had franchisees, WOW would be the first (and probably only) cable company to qualify.

The other major cable company reporting results this week is Suddenlink.  I like to look at Suddenlink as a proxy for cable company performance without AT&T U-Verse and Verizon FiOS competition (Suddenlink previously disclosed that there is a minimal overlap between their service territory and U-Verse/ FiOS).  With concentration of customers in West Virginia, it’s a very rough proxy, but it’s a data point for “without telco competition” performance.  Here are the latest figures for Suddenlink (Cequel is the parent company of Suddenlink):

Note the stemming of the losses from the first and second to the third quarter.  Suddenlink is rethinking the structure of their customer relationships.  Some other statistics of interest:  27% of Suddenlink’s customer base takes all three services (“triple play” customers) as of 3Q, up from 25% a year ago.  Most impressive in this statistic is that they did it without compromising double play penetration (still at 39% of total customers).

Also, Suddenlink reported that 20% of their customer base has a non-video relationship with the company.  This is also up 2.5% from a year ago.  Given Suddenlink’s rural weighting, they are managing to supplement the traditional satellite provider relationship with High Speed Data (and perhaps phone).  Once they have established the beachhead in the home, they selectively promote advanced data services (and phone where applicable).  This is a sound and sustainable strategy considering that in the next several years all video will be carried into the home through IP feeds.

To round out the financial picture, Suddenlink’s revenues were up 6% and adjusted EBITDA (cash flow) were up 8%.  Like their larger cable peers, subscriber revenue increases were offset by political advertising decreases.  Without AT&T and Verizon (but with satellite), the industry would likely be growing revenues and profits in the mid to high single digits.  Given Time Warner Cable’s 2.6% growth and Comcast’s 5.2% revenue growth in the third quarter, it’s probably safe to say that telco competition is costing cable at least 300-400 basis points of revenue growth, and probably an equal if not greater percentage of cash flow growth.

Why focus on smaller providers as opposed to Time Warner Cable and Comcast (Suddenlink is the 11th largest video provider as measured by basic subscribers; WOW is #13)?  As we talked about earlier, they provide actual or “stretch” data on how the larger providers could perform – WOW! a proxy for metro performance with better service/ customer experience, and Suddenlink for non-metro performance.

Have a look at WOW’s performance on consumer video relative to their peers in the Great Lakes and Southeast regions here.  They not only top the triple play reviews (most valuable customers), but also tie on video with FiOS (which shows that coax can achieve a similar score as their fiber brethren).  They lead in Internet even though they do not own a Tier 1 IP backbone.  How do they do it?  The chart below from the May issue of Consumer Reports shows how:


Each element of the customer experience is pursued on an independent basis:  Bill presentation, support, pricing (note that no broadband provider in the Consumer Reports survey gets a better than average rating for service value, and that pricing, especially after the promotion has ended, inhibits a higher score from Cablevision).  The distinguishing factor, however, is service satisfaction, which represents the ability to continually exceed (low) expectations for integrated services.  When viewed through the lens of the entire business cycle – from the first installation to the final bill – WOW and Suddenlink take top honors.  Comcast and Time Warner take two of the last three spots of the top ten.

This is an important lesson for cable.  Technology will continue to change – the cable industry has many talented engineers and operations personnel.  But the changes to the technology need to be transparent to the majority of customers who view bandwidth, phone, and video as utilities.

Whether the change is Analog-to-Digital video transition, home automation service installation, or next-generation set-top boxes, the simplicity and intuitiveness of each solution must be confirmed by the customer.  Each change must build on previous one with the ultimate goal of reducing dissatisfaction with (or improving the condition of) the current state.  While this sounds easy, it will take years to perfect.  Those who focus on radically improving satisfaction (perhaps by starting with reducing dissatisfaction) will win the subscriber and earnings prize.  Those who look to tweak their existing business models will be very disappointed.

Next week, we’ll cover six events that will shape the fourth quarter and 2014.  Until then, if you have friends who would like to be added to The Sunday Brief, please have them drop a quick note to sundaybrief@gmail.com and we’ll subscribe them as soon as we can.  Have a terrific week!

T-Mobile – Just a Good Year, or a Dynasty?

manhattan beachGreetings from Los Angeles and Dallas (Texas).  It goes without saying that the lead picture is from California, and specifically Manhattan Beach where several of us reflected on a day of cable truck rolls and customer service calls.  My key takeaway from the day was that connecting bandwidth into homes is difficult and personal at the same time.  The dedication of field techs is amazing.  More on this when we get to our end of year issue where we’ll highlight what StepOne is doing with cable and telecommunications providers to redefine customer service. 

This week, many in the telecommunications community began to take T-Mobile seriously.  For the second quarter in a row, the Bellevue-based wireless carrier posted net additions of over one million subscribers.  They did this with minimal Machine-2-Machine net additions, and with only a few thousand tablets.  And in the process, they outpaced the rest of the wireless industry in (smart)phone net additions.   Full earnings release, webcast, and financial trends can be found here.

Here’s the past eleven quarters of the wireless industry’s postpaid net additions:

big four postpaid wireless net additions 3Q

Many of those who look at the industry have compared T-Mobile’s performance to Sprint, noting that the upstart is gaining on the number three wireless provider (although they are close on branded pre-paid, they lag Sprint by about seven million postpaid subscribers when you allocate a portion of T-Mobile’s 3.4 million M2M customers to retail).

Braxton in pink cowboy hat

Figure 1: Braxton Carter 3Q earnings call in Magenta Cowboy Hat (source: T-Mobile)

T-Mobile is already the third most profitable wireless carrier, generating more than $1.2 billion more in adjusted EBITDA over the past four quarters.

The real question is “Should we have been comparing T-Mobile to AT&T?”  There’s a lot of back and forth about the failed merger, and everyone winced at the thought of T-Mobile merging with a no-contract CDMA provider named Metro PCS.  Then we have the bizarre investor day in Germany with a new CEO who “didn’t even come from our industry” (an actual quote from a wireless colleague of mine who now admits he underestimated John Legere’s understanding of customer buying behaviors and handset development).

Look at the 2013 Year-to-Date (YTD) postpaid growth for T-Mobile and AT&T above.  On a purely post-paid basis, AT&T has grown 1.21 million postpaid net additions, and T-Mobile has grown 1.14 million.  A mere 73,000 net additions separate the two, and that does not include M2M for T-Mobile (340,000 net additions so far in 2013).  This is an incredible achievement for T-Mobile considering:

  1. AT&T’s network serves 55 million more of the US population (which means that in the markets where AT&T and T-Mobile compete, T-Mobile has added more customers than AT&T).
  2. AT&T has a sizable enterprise presence.  2013 has been a terrific year for enterprise customer takeaways from Sprint as they completed their iDEN transition. So long as AT&T took away 73K more iDEN customers than T-Mobile (which is highly likely), T-Mobile acquired more postpaid consumer customers than AT&T.
  3. AT&T had the iPhone for the entire year – T-Mobile did not.  It’s hard to remember a time when T-Mobile did not have the iPhone, but they have only been selling the iPhone5/ 5c/ 5s since mid-April.  They did convert a large number of AT&T iPhones to the T-Mobile network prior to selling new iPhones (1.7 million as of the December 2012 Investor Day).
  4. AT&T has been selling a lot of tablets to enterprises and consumers – T-Mobile is just getting started.  While the postpaid base does not include connected devices, AT&T’s shared plans clearly make the process of adding a tablet easier.

T-Mobile already has more prepaid customers than AT&T (15 million for T-Mobile vs. 7.4 million for AT&T).  They are clearly winning share versus AT&T in the MVNO/ Wholesale space (1.039 million gain for T-Mobile vs. 951 thousand loss for AT&T year-to-date).  They are much smaller in postpaid (AT&T is 3.3x larger in total, and probably 2.1x larger in consumer).

For the first time, however, T-Mobile is taking smartphone share from AT&T.  Barring any dramatic changes in the remaining months of this year, T-Mobile will likely take consumer share from AT&T in 2013.  That’s a huge headline that no one would have predicted at the beginning of the year.

T-Mobile should be compared to AT&T and not Sprint.  The prospects of SIM Card swaps make it easier to move networks (just ask the MetroPCS representatives who are converting customers in droves).  AT&T will soon complete the acquisition of Leap Wireless, who was once considered a MetroPCS merger partner.  Leap and MetroPCS currently go head-to-head in many markets, and it’s about to get a lot worse with MetroPCS expanding into Cincinnati, Cleveland, Denver, Phoenix, Pittsburgh and Portland (note:  with the exception of Cleveland, all of these markets are legacy Leap/ Cricket areas).  T-Mobile has the third largest LTE footprint today, and will likely end 2014 with 85% of the LTE coverage of AT&T.

Interestingly, T-Mobile has and will claim that this has been their goal all along.  In the December 2012 Investor Day, John Legere had to correct himself and correctly state “Our focus is on AT&T” (he had originally stated that T-Mobile’s focus was on Sprint).   The analyst and investment community should have taken him more seriously.

With two quarters of success as a backdrop, what part of the telecom industry is left to disrupt?  What can T-Mobile do to beat AT&T?   Here are some ideas:

  1. Win more enterprise business.  Start with Cbeyond (full disclosure: I am on the Technical Advisory Board of CBEY), then move on to tw Telecom, XO, and others.  Certify 20,000 “T-Mobile ready” buildings with superlative coverage by the end of 2014. Rally around the “Beat the Indoor Beast” mantra, which creates more cringing than any other single problem in the telecommunications industry (having both an AT&T and Sprint phone, I can attest that they cannot keep their speed promises in many buildings).  Eliminate that “Bring Your Own Data Cringe” customers feel when they enter an office building, hospital, courtroom, or packed arena.  Make the partnerships profitable for both buyer and seller, and build enterprise credibility on a building-by-building basis.
  2. Delight customers with exceptional application experiences.  Over three years ago, I wrote a Reality Check article for RCR Wireless called “The Tweet Guarantee.”    There’s a lot of value in a superior Pandora, Spotify or Rhapsody (or Netflix) experience.  No one owns the application experience in wireless – yet (Verizon is very close based on several devices I have recently tested).  T-Mobile can own this space, but it’s going to require a data center/ content management/ edge network strategy that is better than AT&T’s.  Plenty of Internet/ broadband partners willing to help here, including Level3, Cogent, Savvis, and the underlying applications providers.  And, once Sprint Spark is launched on SprintLink (one of the largest backbones in the world), low latency applications providers are going to flock to Sprint.
  3. Improve national coverage.  I know this sounds like a broken network, but Sprint is T-Mobile’s friend here.  Both lack the last 50 million POPs.  Partner with Sprint to blanket the Mississippi Valley (US Cellular spectrum) and break the small town duopoly that Verizon Wireless and AT&T currently enjoy.   Last year, we went into some depth on several areas where Sprint and T-Mobile could get started (the “Dear John” October 2012 Sunday Brief is available upon request).

While many of you want to add complex wireline/ wireless product partnerships or inorganic growth options to the list, these take a lot of time and energy.  T-Mobile is rightly focused on daily execution because it’s working.  Make gains from the current strategy throughout 2014, and then contemplate more complex activities.

As the title of this week’s Sunday Brief implies, this has been a good year for T-Mobile.  Sprint had blowout years in 2004 and 2005, right before the Nextel merger.  AT&T had a terrific wireless performance in 2009 and 2010, just as iPhone exclusivity ended.  Verizon had a blockbuster year in 2012 and is likely to replicate it again this year.  These are examples of good years, not dynasties.  T-Mobile has had a good 2013, and these typically come in pairs.  To create a dynasty, T-Mobile needs more – a lot more.

Next week, we’ll cover cable earnings in greater detail.  Until then, if you have friends who would like to be added to The Sunday Brief, please have them drop a quick note to sundaybrief@gmail.com and we’ll subscribe them as soon as we can.  Have a terrific week!

The Broadband Wars Fire Up- Sprint, Comcast, Time Warner Cable

susan g komen dallas picGreetings from Dallas (Texas), where several thousand will complete the Susan G. Komen 3-Day Breast Cancer Survivor Walk today.  First, thanks to everyone who has been patient in the many responses to the last two Sunday Briefs.  I’ve been a bit under the weather, but really appreciate the kudos and many thoughtful responses.  Frankly, I am overwhelmed by the response the newsletter/ column receives across the telecommunications community.  I went into a few details a few months ago about why this column exists – to inform, engage, debate and stimulate new thinking about the telecommunications industry.  Never thought it would get to this level.  Thanks again. 

This week, we have had earnings releases from Comcast, Time Warner Cable, US Cellular, and Sprint (as well as Facebook, Apple and Amazon).  On top of this, we had the “what can happen” announcement of Sprint Spark, an innovative and potentially competitive differentiator for Sprint.  That’s a bit more than I can cover in 1500 words, but we’ll hit the highlights of each and cover key themes in greater depth before the end of the year.

First, Sprint reported earnings that were pretty much at or below expectations (and also set the stage for a strong T-Mobile earnings announcement next Tuesday). The company lost 315,000 customers, with gains in lower ARPU prepaid and wholesale offsetting higher ARPU/ higher margin 535,000 postpaid losses (360,000 of these losses came from Sprint’s CDMA platform and 175,000 came from either the Clearwire or the purchased US Cellular properties).   Dan Hesse, Sprint’s CEO, attributed the postpaid losses to the iDEN shutdown:

…we needed to shut the iDEN network down on the June 30, and we were quite successful compared to the plan in re-capturing 40% of those, if you will, those customers but we lost 60% and most companies were mixed in that. You had iDEN subscribers, typically the over simplified, the blue collar workers, white collar workers would be on the Sprint platform. If we lost the account, Nextel or iDEN customers came off in June and then the Sprint customers come up in the second half, both Q3 and Q4. The impact on the third quarter was quite significant

This is one of many transitions that were occurring at Sprint in the third quarter.  The Sprint platform had no additional opportunity to benefit from the Nextel transition, yet the lingering negative effects of the previous quarter’s transition described above are still being felt.  Offsetting this loss, however, are the reductions in access and tower lease costs that Sprint no longer has to incur because of the Nextel platform.  Bottom line:  There are a lot of puts and takes in the Sprint results, and the US Cellular and Clearwire transactions add additional swirl to the story.  Without US Cellular and Clearwire, most metrics were flat or down.  Relatively speaking, Sprint lagged behind all of its peers in the third quarter, including T-Mobile.    You can access Sprint’s latest financial spreadsheet and management presentation here.

sprint spark logoThe question many investors are asking is “How will Sprint use its spectrum holdings to create competitive differentiation and grow profits?”  Sprint clearly assuaged many investors with their groundbreaking demonstration of Sprint Spark on October 30.   The technology fuses multiple spectrum bands (800 MHz, 1.9 GHz, and 2.5 Ghz) with different technologies (TDD LTE, FDD LTE, 8T8R radio heads in the 2.5 GHz band, Carrier Aggregation which is a part of the upgrade to LTE Release 10) to create a fast experience.

Several portable HotSpot devices already have the Sprint Spark capability, and the first Spark-enabled handsets (Samsung Galaxy S4 Mini, Samsung Galaxy Mega, HTC One Max, LG Optimus G2) are scheduled to hit the shelves on November 8.  Sprint teased participants at the Burlingame demonstration with two additional smartphone models that will receive Sprint Spark capabilities via a software upgrade.  On Friday, Google and Sprint confirmed that the Google Nexus 5 will be Spark-capable with a software upgrade in April, and it’s rumored that both the Samsung Galaxy S4 and the Samsung Galaxy Note 3 will have Sprint Spark capabilities by the summer.

Can Spark save Sprint?  It’s a worthy question both to ask and to analyze.  It will definitely kick start Sprint’s enterprise and wholesale/ M2M efforts.  Having consistent yet dynamic 20Mbps downstream capacity could enable a lot of new applications and would certainly crown Sprint “King of the Cloud.”

The issue with the last sentence is consistent.  Sprint acknowledged what many blogs have been talking about for months – Network Vision has created more than dust; it’s created havoc for many customers.  Assuming Sprint will incorporate a $20-40 monthly price hike for the faster network speeds, it needs to also carry a guarantee or at least an extended trial period.

BYOD-July8-PhoneCatAspotAlso, the technology capable with Sprint’s devices will have to be purchased – it does not have the “Bring Your Own Phone” allure that MetroPCS has been able to capitalize on this quarter with SIM Card swaps.  This will slow adoption rates in the mass market.  Finally, if my predictions are correct above, it will not be ready for an iPhone device until late 2014 (if then).  That’s troubling news for ~20% of Sprint’s postpaid base that is Apple loyal.

Sprint must deploy Spark consistently.  It cannot be a “bonus” feature (a la early versions of cable-based “burstable” data which were tied to the viewed website address), but needs to be delivered in a standard, consistent manner.  This means 50 feet inside the NYC building, 5 feet outside the building, and 5 miles away.  Because Sprint lacks a comprehensive coverage strategy (one is coming in 2014), the promise cannot be kept “in selected areas.”  Verizon and AT&T will pounce on this, especially in NYC.

Sprint Spark will cost $4-8 billion per year to deploy and grow ubiquitously.  As we saw with Verizon’s earnings release, just because they hit their initial coverage targets does not mean that capital spending will precipitously drop.  Densification and continued spectrum deployments will continue to drive additional capital, and, in Verizon’s and AT&T’s cases, corresponding double-digit revenue growth.

Does Spark become the catalyst for a new consumer-based shared data plan?  Does a Spark product wade into the eerie waters of wirleine data replacement, at least for some narrow segment (a la Clearwire), and, if they do, will this plan be capped?  If the plan is not revolutionary, how will Sprint recover the 12 million postpaid customers it has lost since the ill-fated Nextel merger?   Most importantly, how will any of these strategies benefit shareholders (vs. bondholders)?

It’s exciting to see Sprint with a spring in its step, and to see technology leadership drive innovation.  It’s also exciting to see the ecosystem (particularly Samsung and Google) rally around Sprint.  But shareholder value comes with ubiquity and consistent performance.

Following the bandwidth theme, Comcast and Time Warner Cable also released earnings this week (Comcast here and Time Warner Cable here).   For the sake of brevity, Comcast results will be confined to their Cable division only.  Here’s the brief summary of the cable subscriber performance: comcast results

It’s no surprise that Comcast grew High Speed Internet subscribers, and that growth accelerated over the third quarter of 2012.  And it’s not that surprising that Comcast is managing the growth of video, recognizing that satellite and U-Verse deployments will continue to accelerate (we will elaborate on the X1 and X2 platforms in an upcoming Sunday Brief).

What is surprising, especially compared to Time Warner Cable’s performance, is the importance of the Double and Triple Play bundles to Comcast (which drives voice additions).  Forty-three percent of Comcast’s base currently subscribes to the Triple Play (up from 39% in 3Q 2012) and 78% of the base have at least two components.

Voice is a critical part of the Triple Play profit picture.   Comcast added 169K residential voice customers in 3Q, and has grown their base to nearly 10.5 million lines or 20% of homes passed.  In contrast, AT&T lost 613K residential voice relationships in the quarter (the numbers are stark when you look at them over the past eight quarters:  1.154 million voice subscribers gained for Comcast, and 4.481 million lost for AT&T).

Why is voice important to Comcast?  On top of the “control as much of the home as possible” reason, incremental phone additions are wildly profitable.  Using the numbers provided by Time Warner Cable in their trending schedules, we’ll assume that each of the 709K voice customers added over the past year generates $34 in ARPU and a 73% gross margin (Comcast’s margin is likely higher because they did not outsource their platform operations).  Adding in a few extra dollars for installation, promotion, access costs, and other items, the 73% gross margin becomes a 35% EBITDA margin ($11.90 in cash flow per month for every residential voice customer added).

Annualize $11.90 for each of the 709K voice customers, and you get $102 million in operating cash flow growth for the next twelve months.  To put this in context, total Comcast cable OCF is growing between $160 million to $200 million per year on a rolling 4-qtr basis.  Bottom line:  The strong voice performance (which in reality is a low-bandwidth network augment to their robust Xfinity infrastructure) allows the cash flow gains from High Speed Internet to fund the foundational changes Comcast is driving in their video platform.

Next week, we’ll cover Time Warner Cable in greater detail (Charter also releases earnings).  In addition, we will have more earnings news from T-Mobile and be able to round out the total wireless and wireline pictures.   Until then, if you have friends who would like to be added to The Sunday Brief, please have them drop a quick note to sundaybrief@gmail.com and we’ll subscribe them as soon as we can.  Have a terrific week!

AT&T’s $61 Billion Promise

lead pictureGreetings from Paris (France) and Dallas (Texas).  This week has been full of news, and we will highlight the Five You May Have Missed on the website (www.mysundaybrief.com ) late Sunday evening.  However, in the interest of good articles to add to your background reading, I really liked Ars Technica’s assessment of the Android development ecosystem called “Google’s Iron Grip on Android: Controlling Open Source By Any Means Necessary.”  It’s a bit lengthy, but summarizes the differences between the Android Open Source Project and the Google-branded analog.  Open just isn’t as open as it was in 2009, and no one is surprised.

ATNI statistics through 2Q 2013Last week, we discussed the changing nature of handsets as well as Verizon’s earnings.  Late Wednesday afternoon, AT&T announced third quarter earnings.  Generally they were well received, although some analysts, searching for an “AT&T loses to T-Mobile” story, have been quick to point out that postpaid phone net additions were negative for the quarter (363K total postpaid net adds less 388K postpaid tablet net adds).  This 25K net loss includes approximately 405K postpaid customers acquired through the Atlantic Tele-Network Incorporated (ATNI) acquisition.  Bottom line:  excluding the ATNI acquisition, AT&T lost at least 425K postpaid retail customers.

AT&T was quick to explain that part of the decline was due to weakness in 2G products (the 25K loss includes 178K in smartphone net additions, meaning that there were 203K non-smartphone net losses), and that some customers may have moved from AT&T postpaid to AT&T prepaid products.  AT&T added 192K net prepaid retail customers in the quarter, ending with a 7.4 million base.  Of the 192K net additions, about 180K of them came from the acquisition of ATNI.  So it’s very unlikely that these customers went to AT&T prepaid – it is likely that they went to another provider, perhaps StraightTalk (WalMart/ Tracfone) or Virgin Mobile.  Bottom line:  AT&T lost all (or nearly all) of the postpaid base to their competitors, not to prepaid.  AT&T’s prepaid retail gain came mostly from ATNI, not from GoPhone.

As reference, here’s the historical net additions trend for the Big 4 carriers.  With Sprint and T-Mobile left to report, it’s anyone’s guess as to the ending growth for the quarter, but connected device (particularly tablet) growth is much stronger than it was in 2012: net add growth through 3Q Oct 27 version

If net additions didn’t raise enough eyebrows in the analyst community, this next table did:AT&T sequantial revenue growth picture PNG

Data revenues grew 18% annually, but only a meager 2.9% sequentially.  Voice, text, and other service revenues declined as well in the quarter.  The expectation was that sequential data would have been higher, not lower than the 2Q’s 4.5% growth.  Instead, it’s likely that AT&T’s organic data revenue was 2.5-2.7%, not the 2.9% reported.  This stands in contrast to encouraging upgrade metrics cited by John Stephens, AT&T’s Chief Financial Officer.

It’s likely that AT&T’s sequential data growth will return to the 3-4% range in the fourth quarter, but, with Verizon’s anemic 2% retail service growth, there’s a distinct possibility that we have hit a consumer ARPU wall.  This is troubling for the entire industry as LTE capital builds are based on increasing ARPU/ ARPAs.

AT&T’s wireless results clearly show a company in transition:

1)      Less voice-centric retail devices and services

2)      Less/ no 2G (GSM) services for voice or data customers

3)      More smartphones using the LTE network (40% as of 3Q)

4)      More shared data plans (see here for the announcement of the end of metered plans)

5)      Leap acquisition (see here for the pre-announcement of the death of AIO wireless brand)

6)      More connected devices (719K net additions is the best in seven quarters)

7)      Supply constraints in the third quarter for their best selling product (iPhone)

8)      Less segment income, even with the ATNI acquisition

9)      Steady churn (1.07% postpaid churn, up from 1.02% in 2Q and 1.08% in 3Q 2012)

10)   More consolidated/ total company debt ($6 billion more than the beginning of 2013).

Without the ATNI acquisition, the headlines would have been a lot different for AT&T in the third quarter.  How will AT&T pull out of this rut?

The secret is in AT&T’s $61 billion VIP promise.  When AT&T made this announcement in November 2012, we devoted an entire Sunday Brief to our analysis (see “AT&T Goes Organic.”).  While AT&T’s estimated VIP spending has dropped from an estimated $65 billion to $61 billion, the organic growth requirements have not changed.  As we said in last year’s Sunday Brief:

The returns required for this new level of invested capital are daunting.  Currently, AT&T has slightly more than $230 billion in net Property, Plant, and Equipment, Goodwill, and Spectrum License assets.  Assuming an 8% cost of capital expectation, that’s $18+ billion in net income required per year to achieve expectations (AT&T is currently earning slightly less than $15 billion on an annualized basis excluding special items).   An additional $65 billion of spending, even with depreciation of the current base, would result in a new base of at least $260 billion by the end of 2015 (re: fiber, towers are longer-lived assets), which will require an additional $2-3 billion of net income (or $20 billion in revenue growth).  Overall, after this plan has been implemented, AT&T, to achieve expectations of an 8% post-tax return on invested capital, will need to earn more than $20 billion annually and have revenues (at current profit margin levels) of more than $150 billion. 


To put the “more than $20 billion” revenue growth into context, U-Verse is now a $10 billion business.  Mobile data is now a $27 billion business.  They need to grow roughly another U-Verse and grow mobile data by 40% by the end of 2015 and preserve margins in the process. 

As an update to the original writing, AT&T has $239 billion in net PP&E + Spectrum + Licenses as of 3Q 2013.  Net PP&E has grown $3 billion since the beginning of 2013, and Licenses have grown $4 billion.     The $10 billion in data revenue growth requirement is well underway, with $3 billion of annualized growth since 3Q 2013.  U-Verse is now a $12 billion per year business, up $2 billion from the 3Q 2012 level.  There’s $45 billion or so left to spend, and AT&T has already achieved 25% of the revenue need to justify their bold project.

AT&T has clearly not chosen the easy path with Project VIP.  It would have been a lot easier to partition and sell off those assets that had not been upgraded.  Massive infrastructure upgrades are required to create an IP + LTE network, and LTE deployment resources were (and still are, to some extent) in short supply when AT&T made the VIP decision last fall.

It’s a harder but familiar road for AT&T, one that could present long-term upside for shareholders and bondholders alike.  While the company has strengths in supplier and program management (Verizon and AT&T may be the best at deploying anything at a large scale.  This is one of the reasons the President has turned to Verizon to assist in the “tech surge” effort).  However, AT&T must convince customers in these newly deployed regions that they have a more compelling video and High Speed Internet product than cable incumbents.

At the end of 2015, $61 billion in additional shareholder and bondholder monies will have been spent as a result of Project VIP.  LTE coverage will top 300 million pops covered, U-Verse will have 8.5 million additional marketable homes, and 1 million additional businesses will have fiber connectivity.  The opportunity to create sustainable competitive advantage will be significant.  Will AT&T deliver?  It’s not a leap to think it’s possible.

Next Wednesday, Comcast announces earnings and we will see how much of a dent T-Mobile had on their gross and net additions.  Until then, if you have friends who would like to be added to The Sunday Brief, please have them drop a quick note to sundaybrief@gmail.com and we’ll subscribe them as soon as we can.  Have a terrific week!

Handsets, Networks, and Verizon’s Game Plan

fishGreetings from Miami, Port Arthur (TX), Philadelphia and Dallas.  It’s been a full two weeks and I am beginning to wonder if taking a long Columbus Day weekend was a good idea.  However, as the picture on the left shows, sometimes you just need to put the smartphone/ phablet/ tablet/ laptop down and go fishing.  No application can duplicate the thrill of having a five pound redfish snatch the bait.

This week, we are covering a lot of ground, and, as a result, I will forego a review of this week’s events with one exception.  As most of you saw, on October 7 Time Warner Cable announced the purchase of DukeNet Communications (50/50 owned by Duke Energy and Alinda Partners) for $600 million cash, including the repayment of debt.  The official announcement can be seen here.  (Full disclosure: DukeNet is a previous Patterson Advisory Group client).

With their acquisition of DukeNet, TWC Business Class gets 3,500 fiber fed towers spanning more than 8,700 route miles across five states.  With Time Warner’s existing network, they become the densest fiber network for wireless carriers in Charlotte, Greensboro, Raleigh/ Durham, and Columbia (SC).

DukeNet-Communications-Logo-4cWhile most analysts saw this acquisition as a challenger move against AT&T, it also shows the difficulty TWC and other large cable providers will face with their cable brethren.  For example, TWC will now become a very large FTTT provider in Nashville (Comcast territory), and have a footprint that practically surrounds Atlanta (another Comcast territory).  Because TWC will need to maximize their return on assets, it is inevitable that these two territories will grow and that the competition for carrier business will increase.  It’s definitely a trend worth watching now that the gauntlet has been thrown.

This week marked the beginning of the third quarter earnings season for the telecommunications providers.  Leading the parade was Verizon, who posted good revenue growth and exceptional margins.

Prior to covering Verizon earnings release, let’s take a quick look at handset offerings across the industry (please reference the first page of attached PowerPoint document).  For those of you who are new to The Sunday Brief, we look at trends in handset offerings and pricing models on a semi-annual basis, usually in June and September.  Because of the iPhone 5s announcement, we decided to wait a few weeks longer to publish the Holiday season list.

A few disclaimers before analyzing the results:

  1. Pricing is determined from the website for 2-yr postpaid contracts for AT&T, Sprint, and Verizon.  For T-Mobile, Simple Choice rate plan options are used.
  2. Sprint is currently offering an instant rebate of $100 towards any phone for customers who switch to Sprint from another carrier (landline or wireless).  For current Sprint customers looking to upgrade their device, you should add $100 to the price of the devices listed (e.g., the iPhone 5s is $199 for current Sprint customers who want to upgrade their device).
  3. These prices are determined from a detailed examination of each carrier’s website, as well as conversations with carrier corporate and in-store personnel.
  4. No reconditioned device pricing is shown on the October 20, 2013 version.  Overall, it should be noted that there are fewer reconditioned choices in October than we found in June.  This is likely seasonal in nature.
  5. Previously, we had shown which devices were LTE capable.  In this edition, we are switching to show the devices which are NOT LTE capable.  On AT&T, Verizon and Sprint, we have indicated them with the term “3G” and for T-Mobile, we have shown “near LTE” or HSPA 42Mbps devices using a (42) designation.
  6. Smartphone operating systems are shown in their respective colors.  handset overview sb oct 20

For many years, we have seen brand standardization across the industry.  In June, we noted that this was the first time Apple products were offered across all four major wireless carriers.  In September, we saw the first concurrent launch of an Apple product across each of the four major carriers.

Standardization is happening with other carriers as well.  The Samsung Galaxy S4 and Note 3, HTC One, and LG G2 brands were launched across the US Wireless industry.  Exclusivity is out – simultaneous launches are in for the top selling handsets.

Fighting this trend is the four year-old Verizon Droid franchise.  Thanks to Motorola and HTC, the Droid lineup continues to make its mark across all price ranges.  Another interesting counter trend is the bevy of LG and Kyocera devices being carried by Sprint – nine of which are less than $99.  It’s going to be interesting to see how store representatives explain the intricate differences between the LTE-equipped Mach, Viper, Optimus G, and Optimus F3 to would-be new-to-Sprint customers (all four models are free if you bring a new line to Sprint).

verizon_logoWith this backdrop, handset plans and pricing and consistent network performance become important.  Those are the core values of Verizon, who reported earnings this week.  Most of you have seen their top line performance metrics, which were extremely strong:  927,000 retail postpaid additions; 0.97% monthly churn; 8.0% retail service growth; 51.1% EBITDA margin.  Here are few additional items that are worth attention:

  1. Verizon LTE statisticsVerizon’s post-paid upgrades and gross additions would have been higher in the second quarter if there had been greater iPhone quantities available.  Verizon had 2.2 million smartphone gross additions and another 5.4 million upgrades.  Of the 5.4 million upgrades, 3.6 million came from existing smartphone customers and 1.8 million were first time smartphone users.  Revenue from equipment sales was actually down one percent on a quarterly basis ($1.924 billion in 3Q vs. $1.953 billion in 2Q).   Against these figures, Fran Shammo indicated that Verizon “did encounter iPhone supply constraints that created a backlog at the end of September which resulted in some carryover to the fourth quarter.”  Higher iPhone 5s availability would have depressed margins and had little effect on current quarter revenues.
  2. Verizon had a blockbuster quarter with tablets.  One of the greatest differences between the top two providers (Verizon, AT&T) and the bottom two providers (Sprint, T-Mobile) is the growth of connected (non-dialer) devices.  Verizon had one million non-phone (tablet, HotSpot, M2M) gross adds in the quarter.  I would not be surprised if AT&T surpassed this number when they announce earnings.  Over one quarter of Verizon retail gross additions were non-phone devices.  Most of these devices do not carry heavy subsidies, and nearly all of the one million were LTE-equipped.  Before the advent of shared pricing plans, adding tablets would have been difficult.  With pooled data, it’s easier to justify incremental expenses, and with LTE profit margins, it’s easier for Verizon to promote and subsidize.
  3. No excess 3G capacity is going to waste.  Verizon’s 3Q results clearly show that they are back in the wholesale game.  After Shammo’s first quarter comments (where they all but announced they were the network behind Walmart’s iPhone launch), and the disclosure that 64% of the total data traffic is carried on the LTE network, it should be no surprise that Verizon is aggressively pursuing wholesale deals.  However, of the $423 million in quarterly revenue growth, $84 million or 20% came from the wholesale organization (my estimate is that it was at least $70 million of the $435 million quarterly EBITDA growth).  These are small numbers in the bigger scheme of things, but give an indication of Verizon’s disciplined asset utilization.  In full bloom, the wholesale network could easily provide $400 million in EBITDA growth in 2014.

There’s more to cover on Verizon (specifically their comments on capital expenditures), especially in comparison to AT&T.  Growing account usage and revenues (especially through non-phone products), managing inventory and working capital levels, augmenting network indoors and outside, and managing the utilization of invested capital is Verizon’s game plan.  It’s clearly working.

Next Wednesday, AT&T announces earnings and we will see how much of a dent T-Mobile had on their gross and net additions.  Until then, if you have friends who would like to be added to The Sunday Brief, please have them drop a quick note to sundaybrief@gmail.com and we’ll subscribe them as soon as we can.  Have a terrific week!