Greetings 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.
Last 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:
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 firstname.lastname@example.org and we’ll subscribe them as soon as we can. Have a terrific week!
Greetings 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).
While 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:
- 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.
- 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).
- These prices are determined from a detailed examination of each carrier’s website, as well as conversations with carrier corporate and in-store personnel.
- 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.
- 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.
- Smartphone operating systems are shown in their respective colors.
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).
With 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:
- Verizon’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.
- 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.
- 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 email@example.com and we’ll subscribe them as soon as we can. Have a terrific week!
Greetings from rainy and cold Dallas (one of those rare no travel weeks). There’s a lot to cover this week as this is our last part of the earnings preview. Before we go there, let’s summarize the events of this week:
1. In case you missed it, the government partially shut down. Fierce Wireless describes the effect on the FCC here (98% of the FCC was deemed non-essential). While this will not impact today’s device launches, the fact that there is now a growing backlog of equipment authorizations cannot be good. There is speculation but no confirmation that it could produce a day-for-day slip in the H Block auctions scheduled for January. And who is monitoring broadcasts for the “seven second” rule? Not a single soul, according to the LA Times – cuss away, Jon Stewart.
2. Nothing appears to be able to stop the incredible pace of Samsung Electronics’ earnings, which the company estimated increased 25% to 10.1 trillion won ($9.4 billion) on sales of 59 trillion won ($55 billion). It’s important to note that this earnings growth does not include chipset revenue from Apple for the iPhone 5s. (Interestingly, the article also talked about Samsung’s growing cash hoard of about $50 billion. Definitely something to keep an eye on).
3. The New York Times also reported that Kevin Packingham recently left Samsung. Kudos to Kevin, who guided Samsung from carrier-specific device manufacturer to global brand.
4. Speaking of Apple, many of you probably missed the article that Best Buy is slashing prices on the iPhone 5c to $50 this weekend (using a $50 gift card as an incentive). Not to be outdone, Walmart cut the iPhone 5c price to $45. Based on the findings from last week’s Sprint chart, this news is not a surprise.
5. Speaking of departures, the Wall Street Journal reported the news of Paget Alves’ and Bill Malloy’s departures from Sprint (Alves is head of retail and business sales; Malloy is the chief marketing officer). This news has been out a month or so, and is the least disruptive change at the senior level. Paget is the longest-tenured operating executive to survive the transition from the Forsee to Hesse eras. Bill’s announcement comes after two years with Sprint. Matt Carter takes over Paget’s Sprint Business responsibilities (think M2M for businesses and wholesale), while Bob Johnson takes over retail responsibilities. These announcements are less likely to be an indicator of net add performance due to corporate liable disconnects (iDEN transition), and more likely to be attributable to normal changes that any large company experiences with new management.
3. Finally, there’s a showdown going on in Austin, and thankfully it has nothing to do with the 2014 governor’s race. Google Fiber is coming to Austin very soon, and incumbents AT&T and Time Warner Cable aren’t taking their entry sitting down. This week, AT&T announced U-Verse with GigaPower ™, a 1 Gbps fiber based network to be deployed throughout Austin. Austin homes recently received a 45Mbps upgrade through AT&T’s Project VIP initiative, but “Google New” is threatening to trump Ma Bell. Meanwhile, Time Warner Cable significantly expanded their Austin Wi-Fi network to 900 hot spots with plans to eventually grow this to 1350. The Cable Alliance announced on Monday that they had topped 200,000 nationwide hotspots in September.
There’s a lot more going on, and, with the readership of The Sunday Brief continuing to diversify, we get a lot of comments about including or not including the “Five You May Have Missed.” Some of you want deeper articles (like the Blackberry “tell all” article that recently appeared in the Globe and Mail or the 16,000 word iOS7 review that Ars Technica recently posted). We will begin posting FYMHM on the www.mysundaybrief.com website and likely not including it in every week’s Sunday Brief. However, we welcome your comments and additional article suggestions on the site.
We have covered the following trends thus far heading into third quarter earnings:
- The importance of customer (as opposed to account) penetration
- The criticality of Machine-2-Machine growth (tablets, tracking and monitoring devices, etc.)
- Capital spending readjustments (some higher, others lower)
- The relative unimportance of the Apple iPhone launches to third and fourth quarter profits (third quarter driven by timing; fourth quarter driven by iPhone 5c demand)
- The complexity of Sprint’s network transition
- The power of the MetroPCS brand and the newfound importance of prepaid retail wireless services to T-Mobile (and the threat that SIM card swaps present to AT&T)
These trends have a remarkably wireless focus. There is a very large trend brewing in the wireline world, however – the battle between a resurgent Project VIP-enabled AT&T and their cable competitors.
This competition had been going on for the past five years, and, without a doubt, cable has been winning. FiOS deployments have stopped (still no FiOS in Baltimore or parts of Boston). Even with FiOS and U-Verse deployed in much of Comcast’s territory, Comcast has grown 5.9 revenue-generating broadband connections over the past eight quarters for every one added by AT&T and Verizon – combined. Including Time Warner’s High Speed Internet growth, the figure is nearly 10 to 1 (9.4).
Let’s pause on the statistics described above. AT&T’s High Speed Internet (U-Verse + DSL) subscriber count has been flat for the past 8 quarters (16.476 million in 3Q 2011 and 16.453 in 2Q 2012). Verizon’s FiOS count has grown 1.1 million over the same period, but DSL subscribers declined 790,000. Meanwhile, Comcast grew 2.178 million net new customers (this figure excludes small business; AT&T and Verizon’s include this segment), and Time Warner Cable added 1.282 million. And we have not included the gains at Cox, Brighthouse, Charter, Suddenlink, Mediacom and others.
Enter AT&T’s $20 billion annual capital budget, which is split between wireline and wireless (AT&T spent $2.5 in capital for every $1 spent by Comcast and Time Warner combined over the past eight quarters). Fiber to the tower/ building, central office improvements, data caching and other content delivery network optimizations improve both wireless and wireline economics. The rollout of the 45Mbps tier across much of the AT&T footprint creates greater comparability. AT&T’s marketing machine is just starting to get fired up.
On top of this, you have the trend outlined in the chart below (note: this reflects Comcast subscribers only; the lines are actually converging faster for Time Warner Cable):
Comcast has done a terrific job of growing their High Speed Internet (and Digital Voice) base. However, they are running out of eligible customers. The gap between video and High Speed Internet subscribers was 7.14 million at the beginning of 2010. Using conservative growth estimates, the gap will be reduced to less than 1 million by the end of this year.
The converging of these two lines reflects the changing face of cable. To cable subscribers born after 1983 (sub-30 year old demographic), there is an expectation of faster speeds and open networks. WatchESPN means something to this demographic. Netflix and Hulu are channels just like ABC and CBS (and likely more important than either of these broadcast networks).
Comcast is where these customers get their Internet. Sure, they also get “cable” (video), but Internet is what matters (don’t ask this demographic about home phone services). Increased speeds drive retention, but in the end, little loyalty has been built around the network brand. If another provider emerged with faster speeds at a lower price, Comcast and Time Warner Cable would have to react with price. Video loyalty is diminished, and, with no network branding established, High Speed Internet has become a duopoly-driven competitive product.
Google Fiber could certainly change the equation. However, faster networks in Kansas City, Provo, and Austin do not make a case for faster networks in Los Angeles and Chicago (and the time to get municipal approvals would be horrendous).
Cable is at a crossroads. Do they use deeply deployed DOCSIS 3.0 plant and fast Internet speeds (with high margins) to drive increased customer penetration (resulting in the red line crossing the blue line in 2014 or 2015)? Do they deploy DOCSIS 3.1 plant to put the “fastest network” argument to rest for the foreseeable future? Or do they “optimize” residential subscriber revenues and milk the massive cash cow they have produced, leaving more investment opportunities for business customers (especially in-building fiber investments for wireless coverage)?
Right now, it’s great to be in cable. The decisions they make over the next years, however, determine whether they become utilities or technology megabrands. It’s time to choose wisely.
Next week, we’ll go back to wireless and focus on devices lineups headed into the Holiday selling season. Until then, if you have friends who would like to be added, please have them drop a quick note to firstname.lastname@example.org and we’ll subscribe them as soon as we can. Have a terrific week!