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Monthly Archives: September 2013

Earnings Drivers for the Third Quarter (Part 1)

2013-09-20 16.35.30Greetings from Ashcroft, Colorado, (picture left) and Dallas.  This has been an action-packed week for the telecom industry, with AT&T announcing that they are in discussions with J.P. Morgan and TAP Advisers to sell their tower portfolio for up to $5 billion, Sprint revealing the very attractive One Up pricing plan,  Republic Wireless selecting the MotoX for their next device (Sprint is the MVNO’s underlying network), Blackberry axing 4,500 employees (40% of the base) and the FCC approving the AT&T/ Atlantic Tele-Network’s retail wireless purchase with conditions (see more here).

The big news, however, was the launch of the latest Apple iPhones – the 5C and the 5S. Depending on the news outlet (see conflicting reports here and here), the limited launch will be judged as either a raging success or a miserable failure.  Below is Sprint’s statement as of Sunday afternoon regarding the availability of Apple devices:

sprint iphone availability

It’s important to note that the writers and customers in these stories are current iPhone users looking to upgrade their current iPhone models (likely an Apple 4S if they were on a two-year contract).  It was impossible to find reports from new iPhone users, or even less likely, new smartphone users.  To the wireless carriers, the Apple iPhone launch has become a retention as opposed to a smartphone acquisition event.  There will be some upgrades to shared data plans, but it is generally a way to keep the Apple faithful happy.

It’s also important to note that there are no iPhone launches this weekend for Virgin Mobile, Leap Wireless, Straight Talk Wireless (Walmart) or any other discount carrier except for T-Mobile.  The full effect of the iPhone 5C (good processor, iOS7 operating system, right price) has yet to be fully realized.  This is going to be a significant event to track during the fourth quarter, but the iPhone 5C and iPhone 5S launches are not going to be denting third quarter earnings.

If not the iPhone launch, what’s on the minds of the carriers as the quarter comes to a close?  Here’re some observations from recent wireless company CFO investor presentations:

  1. The “new new” metric is devices per account/ customer.  While there are other products that will matter over the long run (such as last week’s topic – watches, or perhaps connected automobiles), the main objective is to have the next LTE-enabled tablet connect to either a Wi-Fi Hotspot or directly to the carriers’ network.  Verizon and AT&T are starting to master this, but Sprint and T-Mobile have a long way to go.  As reference, Verizon ended 2Q 2013 with 2.70 accounts per customer, and average revenue per account of $152.50. While AT&T does not disclose revenue per account, it’s readily apparent that ARPU is steadily rising with data ARPUs up $2.36 or 17% annually.

With AT&T, look for greater discussion on the strategic importance of Digital Life to the future success of the company.  John Donovan, in his recent discussion at an investor conference, made the following statement:

john-donovan-attSo if you look at the enhanced services that we’re stacking on to our all IP network end-to-end with digital life. The digital life, an extension of U-verse or is it an extension of mobile. Its IP based, it’s in the home. You roll a truck. But it’s all over wireless.

So the more of these sorts of services connected car, digital life that we begin to stack on, that’s where I think the industry itself is going to move from, I have a network, it’s fast, it’s where I need it, to how is my life get different and I do think that our emphasis in these new growth areas will provide for us a significant growth opportunity as people move from just simply carrying devices for communication and applications to managing a digital home and kind of the whole life management.

Turning the page from “How the network performs” to “How the network improves productivity” is not going to happen overnight.  But clearly telecommunications executives are thinking about ensconcing their brands in places in the home where they have not been traditionally associated.

  1. With smartphone growth slowing, look for the carriers to talk more about Machine-2-Machine opportunities, particularly for business customers.  This is going to be the case with all of the carriers, but particularly Verizon.  While there will be some 4G LTE M2M applications (think better video surveillance), there is also going to be an increasing need for utilization of the predecessor networks.  Many M2M applications are perfect candidates for this network – they need hundreds of kilobits per second transmission speeds, not multi megabits per second.

The other reason for the focus on M2M is that the traditional “Corporate paid” device is quickly becoming obsolete.  As a result, the buzzword is “Bring Your Own Device” or BYOD.  Fewer corporate-sourced devices results in fewer upgrades (and their associated expense).  And, if the carrier’s appeal to consumers is greater than its business market share, it’s a “back door” market share gain against the traditional “two vendor” supply chain selection process.

Without growth in devices, where do salespeople turn?  They go to business applications.  This is why Verizon invested in Hughes Telecommunications.  As their CFO Fran Shammo explained at an investor conference in August:

Fran-Shammo

If you then take the next step, though, the value is really in the data in the cloud and how you can utilize data to do the analytics behind that. If you look at Hughes Telematics and what they are doing with the contract we have with Mbrace, it’s not the transport through Verizon Wireless that really creates if you will the ARPU increment on that machine to machine. It’s all of the other analytics behind that. And if you look at that, the ARPU on that is $20 to $30 higher than what it would be on a machine-to-machine type application for just transport.  So there is a difference in machine-to-machine application and it comes down to specifically what is that that device going to do and then also what kind of analytics behind that are we going to feed back to say the vendor who wanted us to provide that information to them in the current?

As we have advocated in many Sunday Brief columns, the carrier’s value is shifting in enterprise from reliable transport to “thoughtful bytes.”  I would call them smartbytes, but I was told that someone had already trademarked the term.

Thoughtful bytes help commercial customers drive more safely, arrive on-time more consistently, and inform their customers more thoroughly.  They integrate into systems easily, and can be modified quickly.

I doubt any telecom exec will talk about the transition from reliable transport to thoughtful  bytes (or their cousin “ThoughtBits”) but you will know which column they read if they do.

  1. Finally, look for the wireless carriers to talk about decreased capital spending relative to revenues.  The LTE spending revolution has been underway for five full years, new spectrum auctions are on the horizon, and LTE Carrier Aggregation (a function of the next LTE release) really works.  Voice over LTE is going to be launched by Verizon later this year.  AT&T still has billions left to spend on Project VIP.  Sprint and T-Mobile have between 6 and 12 months of spending just to get to 200-240 million LTE POPs covered.  When does the capital craziness end?

This is the most important question facing the largest wireless carriers.  They have had a very accommodating interest rate environment and friendly capital markets.  However, for 60-75% of the US population, four carriers will be offering speeds in excess of most of the servers they will access (especially for web page refreshes and email synchronization).

This is where scale efficiencies, largely through purchasing power, come into play.  Fran Shammo disclosed (in the August investor presentation quoted earlier) that “They have just begun to see the customer service efficiencies of having unlimited voice and text (Share Everything) plans.”  Product simplification and resource allocation has to be disciplined.  And some “in house” products need to be dropped altogether.

Each carrier will have a timeline for improved asset utilization.  It will correspond to increases in total customers as well as total data volumes.  The focus on efficiency may not translate into lower capital expenditures, however, if interest rates stay low and lending interest remains high.

That’s it for this week’s Brief.  If any of you will be at COMPTEL this week, let’s connect on Tuesday.  Until then, thanks as always for your subscriber referrals.   If you have friends who would like to be added, please have them drop a quick note to sundaybrief@gmail.com and we’ll subscribe them as soon as practicable.  Have a terrific week!

Plastic Apple Meets Samsung’s Smartwatch. Who Wins?

cookGreetings from Charlotte and Dallas, where summer is still hanging around.  This week, the Sunday Brief is devoted to the different strategies of Apple and Samsung.  The iPhone 5S and the plastic-backed iPhone 5C represent two significant announcements for the company, and signify Apple’s prioritization of global standardization and market share over innovation.  While this is not the beginning of the end for Apple, as some analysts have predicted, it is the beginning of a significant change in Apple’s strategy, and one which could be extremely valuable for Apple’s shareholders.

Many analyses have been completed on the features of the latest Apple devices (here’s the Engadget review to get you started).  Late in the week, however, each of the US carriers and Walmart announced their introductory pricing for the iPhone 4S (old Apple), the iPhone 5C, and the iPhone 5S:

iphone pricing comparison

While it seems like all four carriers have had the iPhone forever, this actually is the first simultaneous launch of a new iPhone product across the United States.

It is not difficult to see that AT&T and Verizon, the coverage leaders, have fully stuck with the Apple script and are following the $0/$99/$199 iPhone pricing formula.  Customers who are renewing their contracts can save $10-20 by upgrading their devices at Walmart instead of going to the AT&T and Verizon retail stores.  Whether that makes a big difference in store traffic at either the carriers or Walmart remains to be seen.  However, it was interesting that Walmart was prompt in announcing their iPhone pricing.

It is also interesting to see Sprint aggressively marketing the iPhone 5C and the 5S to switchers (defined by Sprint as landline or wireless customers who bring a ported number with the order).  For a “port” the customer will receive $100 off the price of the phone.  In their offer, Sprint describes this as an instant credit as opposed to a service credit which would be applied to one or more billing cycles.  Also, the offer language clearly states that this could be used in an “add a line” scenario where the home phone is ported from a landline to a mobile device.  I do not know if it will survive the “elevator pitch” but I am sure Sprint will use this promotion heavily this week.

Then there’s T-Mobile.  No contract pricing (although you need to pay off the phone balance if you leave prior to 24 months), combined with an aggressive 4 lines for $100 service plan offer could be the formula for an iPhone bonanza.

The most interesting thing about T-Mobile’s pricing is the gradations between the iPhone 4S, 5C and 5S plans.  Will customers really balk at $0 down and $18.75/ mo. vs. $0 down and $22/ mo, especially if the latter includes a faster processor and LTE network capability?  It’s not hard to see that T-Mobile will be a strong seller of the 5C.  In fact, they may as well call it the 5T because that is exactly where it will sell the most.

What does the chart tell us about Apple?  Not much.  They have less control over retail prices than ever before – that was expected (see the June 2 Sunday Brief for more details).  The result will not only be volatile (and lower) pricing for any remaining legacy iPhone5 inventory, as well as promotional pricing for the iPhone 5C by the end of the year.

By next year, we will have two Apple phone categories – the “Plastic” Apple used to attract new customers into the category, and the “Platinum” (or Golden) Apple used to showcase the latest technologies from Cupertino.  What goes inside each model will change, but the composition of the back of the phone will enable lower pricing and greater worldwide distribution.

Eventually, two phone categories will lead to two models.  Let’s face it – no phone model will succeed in between the “free” and the “newest” lines in a retail store environment.  To use a gasoline example, being the “silver” grade of fuel is a tough place to be.  This will place a lot of pressure on the iPhone 5C model in the retail environment, sandwiched between the iPhone 5S (LTE network, fingerprint scanner, gold coloring) and the iPhone 4S (iOS7 capable, HSPA network, good camera).

plastic apple

Will Apple’s plastic strategy help the carriers?  Yes, but not in traditional ways.  First, Apple has found a way to bring a broader LTE chipset to market faster.  It catches up to LTE deployments abroad.   Second, the iPhone 5C pairs well with Virgin Mobile (Sprint), All in One Mobile (AT&T), and T-Mobile.  It keeps the cost-conscious customers of these brands from going to the refurbished market first.

Finally, it gets the carriers focused.  With Google’s MotoX introducing a much broader color palette (and the feel of a “custom” phone) and the Samsung Galaxy 4 providing a host of camera features (including slo-mo video and the ability to capture a photo within a video stream), Apple’s differentiation was getting harder to explain.

Bottom line:  For the Apple faithful, the iPhone 5S will satisfy but not deliver a mind-blowing experience.  For new to Apple (or at least new to iPhone), the 5C will deliver affordability (especially with T-Mobile pricing plans).   The 5C is a step in the right direction – one that focuses on Apple’s product breadth and software integration and less on unique model functionality.

While Apple delivers some new technology in the iPhone 5S, Samsung goes all out with a new Note 3 and the Galaxy Gear.  The Note 3 is a slimmer, lighter, and faster version of the Note 2 (which happens to be my phone of choice at the moment).  It has a better S Pen integration, touts a 5.7 inch screen, and has improved battery life thanks to Qualcomm’s envelope tracker technology (more on the technology from GigaOM by clicking here).

samsung-galaxy-gear-smartwatch-3-537x402

From a price perspective, the Note 3 is the “Premium” device in the lineup.  Samsung took this a step further by introducing the Galaxy Gear smartwatch (shown in picture), which pairs with the Note 3 and will be able to pair with the Galaxy S3 and S4 shortly.

Pairing is tough, even when both devices are made by the same manufacturer and are using the latest version of Bluetooth.  Fitting applications into 4GB of the Galaxy Gear storage is also incredibly tough, and too much memory consumption will lead to sluggishness – and no one likes a slow watch.  A 1.9 Megapixel camera and “about a day” worth of use is tough because consumers expect the battery life on their watches (if they still wear one) to be months, not hours.

But Samsung got the watch party started.  Imagine the privacy issues that will emerge with a wrist-based recording device (sound and motion).  Unlike Google Glasses, it’s barely distinguishable.  At $299, it’s comparable to a mid-range chronograph.  While there are a lot of drawbacks to the Galaxy Gear smartwatch, I eagerly await the developer community’s innovative responses to its introduction.  A good review of the Galaxy Gear from Engadget can be found here.

That’s it for this week’s content.  Next week, we’ll start to look at factors that will drive first quarter earnings and the wireless selling season.  Until then, please take some time to browse this week’s Five You May Have Missed:

  1. From Ars Technica, the latest in the Newegg patent victory over patent trolls.
  2. From CNET, the latest unfunny spoof from Microsoft.  Don’t spoof Steve Jobs.  Poor taste.
  3. From AT&T, the launch of the Famigo app (kudos to Q Beck and Douglas Ferguson for their turnaround leadership).
  4. From the Wall Street Journal, a summary of the last week’s Verizon bond offering (subscription required).
  5. From Fierce Wireless, an analysis of the latest Dish FCC filing outlining how they will use the 700 MHz E block and their AWS-4 holdings to build their LTE network.

Thanks for your subscriber referrals.   If you have friends who would like to be added, please have them drop a quick note to sundaybrief@gmail.com and we’ll subscribe them as soon as practicable.  Have a terrific week!

Get Ready for the Integration Era

andy reid chiefsGreetings from Kansas City and Dallas, two cities immensely interested in the start of the NFL season this weekend.  It’s been a really full week of telecom-related events, and merely mentioning them in some sort of order would do it an injustice.  However, there is a rhyme and reason each of them, and we’ll demystify each of them this week.

While not surprising, the magnitude of Verizon’s purchase of Vodaphone’s 45% stake in Verizon Wireless was significant.  Starting this week, Verizon will be floating over $20 billion of what will ultimately be $50 billion in bonds to cover part of the purchase price.  The Financial Times is reporting that Verizon will even test the idea of 100-year terms for some types of bonds.

The largest new bond issuance to date was $17 billion by Apple in late April.  For longer maturities, Apple sold 30-year bonds with a coupon of 3.883%.  At the time of the offering, Apple had over $140 billion in cash and marketable securities on their balance sheet.  Verizon, as of June 30, has $2.3 billion in cash and marketable securities.

Many have speculated on the underlying interest rate, with several new outlets and analysts suggesting that Verizon will actually achieve a lower coupon on the upcoming debt than they have on some of their other outstanding issuances.  For the record, here is what Yahoo! Finance shows as the current Verizon long-term bond schedule (this is only a partial schedule of Verizon’s debt):

Verizon debt schedule

Based on this chart, Verizon’s current debt holders appear to very comfortable with a 30-year term. The longer the financing term, the greater the flexibility Verizon will have in upcoming 600 MHz wireless spectrum auctions.   One thing to watch – a 30-year bond yield priced at or below 6% would be very significant for Verizon and Vodaphone shareholders who still need to approve the transaction.

Speaking of shareholder approval, one of the more interesting headlines lost amid other telecom news of the week was the magnitude of the breakup fees should either Verizon or Vodaphone back out of the deal.  A good summary of the fees can be found here.  I found the “materially-adverse” clause to be particularly interesting (from The Wall Street Journal article):

If either the U.K. or the U.S. introduces new laws that would impact Vodafone’s tax bill, a “materially-adverse clause” could be triggered, the filings show. That could allow Vodafone to walk away for the $1.55 billion fee.

 

Vodafone expects to pay $5 billion in U.S. taxes on the deal, but has structured it to pay no taxes in the U.K. That is expected to raise some eyebrows in the U.K., where corporate taxes have already been under the spotlight.

I can imagine that UK lawmakers are not happy that Vodaphone has structured a deal that allows them to escape the taxman.  Outside of the syndication of the debt, there are few things that can derail this deal, but Vodaphone still has veto rights should Parliament decide to enact a special tax.

Several of you asked me to explain the near-term impacts of a heavily-indebted Verizon.  As many long-time readers know, we have been tracking Verizon’s debt load for over four years.  At the end of 2009, total debt exceeded $62 billion – that figure has since dropped to below $50 billion.  An incremental $50 billion of debt at a weighted average coupon rate of 6% = $3 billion in increased annual interest payments, against a backdrop of ~$40 billion in annualized cash flow.  Even with a capital budget of $17+ billion and $8 billion in dividends, it’s hard to make the case that increasing leverage is a bad one, especially if the long-term rate is around 6%.

Far bigger risks existed for Verizon prior to the announcement.  The Terremark acquisition ($1.4 billion in cash – 2011) was good but not a blockbuster.  The Hughes Telematics acquisition ($612 million in cash – 2012) has produced less than stellar results.  Despite the tremendous growth in wireless, wireline is sick – very sick.

To make the recapitalization of Verizon a success, they need to solve wireline’s problems:  Aging infrastructure, legacy maintenance and other operations costs, and “cloud cred” with large enterprise IT departments are but three of many issues Verizon management needs to tackle.  Verizon Wireline needs to replace hips, knees, and shoulders that have atrophied over the past decade as Verizon Wireless gained dominance.  Integration is not going to be easy – success starts with an integrated management team.

(As an aside, I have to wonder what AT&T executives are thinking right now.  They have been pursuing an integrated strategy for years, culminating in the Project Velocity IP (VIP) $20 billion announcement last November.  In many respects, AT&T is leading Verizon in balance sheet optimization against the backdrop of a low-interest rate environment.  It will be interesting to hear what comments they have, if any, when they host their earnings conference call in October).

motox.2x299

Verizon was not the only one making headlines this week.  In a surprise move, Microsoft purchased the mobility/ handset assets of Nokia.  When Google bought Motorola (and their 24,500 pending or approved patents) in 2012, I said it was only a matter of time before the Nokia and Microsoft relationship deepened.  Just after a year later, Google introduced the Moto X, the most integrated device in the Android world.  For a terrific behind the scenes look at the crafting of the Moto X, read Steven Levy’s story that appeared in Wired.

The Moto X exposed a multitude of flaws in the current Windows/ Nokia design:  virtual ears, active display, quick capture photos, hands free authentication that leverages NFC, and a customizable design process that one would expect to see from Nokia, not Moto.

Microsoft had no choice but to buy Nokia.  They are seeing some traction from Nokia 1020 (41 Megapixel) sales, but that’s only with one carrier in the US (AT&T) for now.  Given changes in Microsoft’s overall strategy that we discussed in several Sunday Briefs this summer, they need to capitalize on their ability to do what Google and Motorola just did.  Frankly, it had to have been an embarrassment to Microsoft when the Moto X launched as the features they implemented in just over a year are the same ones described by Nokia and Microsoft when they decided to join forces in February 2011.

Surprisingly, the transaction was made even easier by the current US tax code.  As a result of double taxation on foreign earnings, many companies, including Microsoft and Apple, have substantial overseas cash holdings (Microsoft has about $60 billion as of June 30).  The Nokia handset price of $5 billion today + $2.2 billion in future licensing revenues is a small dent Microsoft’s foreign reserves.  (For more on the tax code situation, Business Insider did a fairly detailed piece on foreign reserves last December.  The full article can be found here).

Integration is the new buzzword.  Wireline/ wireless integration.  Hardware/ software integration.  Global integration.  We are about to be integrated to death.  While it sounds so easy, we are about to enter the most difficult part of any business transition, one where competing models (ad-based, licensed, transactional, subscription) collide.  The resulting product tends to be a mutation that even Frankenstein would be ashamed of.  When integration is done right, we get the iPhone and the Moto X.  When it’s done wrong, we get the Nokia Lumia 900 (the link is to Jushua Topolsky’s review in The Verge).  Here’s to more iPhones.

Speaking of the iPhone, there’s an announcement next week in case you have not heard.  We’ll be comparing and contrasting it to Samsung’s lengthy presentation this week in next week’s Sunday Brief.  Over the past two weeks, we have had 29 referrals to receive the email edition of Sunday Brief (and 10 address changes).  Thanks for passing it on and staying current.  If you have friends who would like to be added, please have them drop a quick note to sundaybrief@gmail.com and we’ll subscribe them as soon as practicable.  Have a terrific week!