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Monthly Archives: February 2015

T-Mobile’s Math

Topening pic (7)exas rugby greetings from Austin and Dallas.  After a bruising match, the Jesuit Rangers came up short yesterday against perennial state champion contender Westlake High School.  It’s a rough sport and fortunately injuries were minimal.  Kudos to the Jesuit Rugby coaching staff on a terrific 5-1 start to the season.

 

We set a record for new Sunday Brief sign-ups this month, with over 60 new emails added.  I appreciate the continued “word of mouth” support and comments on each column (I read and try to respond to most of them).

 

For your calendar: Roger Entner of Recon Analytics is going to be hosting a panel on Auction 97 and Title II reforms on Monday, March 9.  I’ll be participating on the panel along with some well-known names in the telecom industry.  Rather than steal Roger’s thunder, I’ll provide more details next week and on the www.mysundaybrief.com website. Consider having a conference call “lunch” with me and a few other telecom thinkers two weeks from Monday.

 

Verizon’s Spectrum Auction Results Conference Call:  Densify, Baby – Densify…

Verizon’s Tony Melone (EVP Network) and Fran Shammo (CFO) held a short but extremely informative call helping the analyst and investor community think about the results of Auction 97 (full information and details here).

 

One of the first charts Verizon shows is the price per MHz POP for this auction versus other auctions:

Verizon spectrum lead chart

While the “headline” number of $44.9 billion of total bids is certainly an attention grabber, the relative cost of this spectrum compared to previous auctions is astounding (and, depending on the auction involved, the number and financial capabilities of the bidders were not dramatically different from Auction 97).

 

Spectrum obtained in this auction cost Verizon nearly 4x more than private spectrum purchases (SpectrumCo is the purchase from several cable companies in 2011) and over 5x more than the first AWS auction in 2006.  As a reminder, Verizon had $75.3 billion in license assets on the books as of 12/31/2014 which is likely more than the total net Property, Plant and Equipment deployed to make the spectrum commercially available (Verizon’s total wireline + wireless net PP&E is just shy of $90 billion).  Things were already getting expensive before Auction 97 – now what?

 

The answer to that came from Tony Malone on the conference call:

 

… certainly at a time where spectrum was at a certain price per megahertz POP, that was a very effective solution. As those prices increase, small cell technology, with the improvements there, just the balance of the comparison between the two changed dramatically

 

This is the raw truth – if you have contiguous spectrum (a hallmark of Verizon’s purchases to date), the ability to add additional capacity through small cells becomes a financially better solution for the shareholder at some point.  Said another way, small cell architectures become a more viable alternative if they can be introduced nationally.

 

Verizon has the capability to do this, and, as discussed on the conference call, already has some metro deployments underway (including a 400-node deployment in Boston).  This is good news for small cell and fiber providers who have been working with Verizon for several years.

 

Verizon also showed their new map of spectrum holdings before and after the auction:

VZ spectrum depth pre and post auction

It’s very clear that Verizon’s strategy was to nationalize their total holdings.   Generally, they achieved it (46 of the top 50 markets with more than 40 MHz of AWS spectrum), but there are going to be areas where mid-band (1900 MHz) is going to need to be repurposed quickly (or densification needs to happen quickly):  Chicago, South Florida, Oklahoma, Kentucky, West Virginia and South Texas did not improve holdings significantly.  Fortunately, there are good fiber partners in most of these locations.

 

In more rural markets, there are US Cellular (Kansas, Iowa, Oklahoma, Nebraska, West Virginia, Maine), C Spire (Mississippi, South and Western Tennessee) and other alternatives.  With a friendlier FCC, they could even be more than friends.

 

Bottom line:  Verizon will be accelerating their small cell deployment efforts with more than $500 million in incremental spending each year for the next three years.  This is good news for the industry, and potentially worrisome news for those expecting another record-breaking FCC auction in 2016.

 

T-Mobile’s Math

On February 19, T-Mobile released earnings and hosted an informative and entertaining 90 minute quarterly earnings call.  While we have covered a lot of T-Mobile’s accomplishments in recent Sunday Briefs (see more here), it’s worth noting just how far T-Mobile has come in the past year.  For 2014, they achieved the following:

 

  • 4.0 million phone net additions
  • 4.9 million total postpaid net additions
  • 8.3 million total net additions
  • 9.0% service revenue growth
  • 13.1% total revenue growth
  • 6.0% adjusted EBITDA growth
  • 56 million more POPs covered with LTE (209M to 265M)

 

After such stellar results, their meager estimates of 2.2-3.2 million postpaid net customer additions has a lot of people scratching their heads (including yours truly).  True, this lower postpaid net customer addition estimate is paired with an $800 million -$1.2 billion increase in adjusted EBITDA and only a slight increase in capital spending, but 2.2 million?  Really?

 

Let’s start with some basic math.  T-Mobile ended 2014 with 27.185 million branded prepaid customers.  For the sake of round numbers, let’s assume 450 thousand customers churn each month (1.66% monthly churn), leaving T-Mobile with 5.4 million churned customers and a requirement of 7.6 million gross additions required to hit the low end of guidance (27.185 million – 5.4 million churning + 7.6 million gross additions = 29.385 million projected year ending 2015 customers).

 

T-Mobile LTE coverage chartWhile 7.6 million customers may seem like a steep number, let’s consider the tailwinds T-Mobile has at their disposal.  First, as the chart from their earnings presentation shows, they enter 2015 with a larger LTE footprint that’s going to continue to get larger throughout 2015.

 

At the end of 2013, T-Mobile covered 209 million POPs with LTE.  This grew to 233 million by 2Q 2014, 250 million in 3Q and 265 million in 4Q.  Prior to this point, if customers had any coverage, it was at a 2G (Kbps as opposed to Mbps) speed.  Any LTE expansion should therefore be viewed in the same light as a market re-launch.  Because these are not new market launches, adoption rates for the new network occur at a slower (not faster) rate – the brand (and the investigative tendencies of a skeptical population) needs time to catch up with network speeds.  T-Mobile’s current LTE and 2G network coverage is shown in the map below:

t-mobile network map feb 22 2015

T-Mobile currently has ~ 12% of the “Big 4” branded postpaid market (Sprint at 29-30 million; T-Mobile at 27 million, AT&T at 76 million, and Verizon at 102 million).  Let’s assume that their market share in the 2G only markets is 3-4% and that once the market re-launches, share grows by 2% in the first month and 1% per month thereafter until the 12% threshold is reached (again, these are placeholders only).  If these estimates are close to reality, then T-Mobile should grow 1% each month for at least 3 months for the 32 million POPs that it grew from 2Q 2014 to 4Q 2014 (233 million to 265 million).  That is their first 1 million gross additions (and close to that for net additions).

 

Add on to that the projected growth of 35 million LTE POPs in 2015.  Assuming that they grow these markets by 6% throughout 2015, that’s another 2.1 million gross additions (and close to that for net additions).  Bottom line:  LTE expansion in 2G markets alone gets T-Mobile at least 3 million of their 7-9 million gross additions required to hit their 2015 guidance (note: LTE expansion also helps T-Mobile’s retail prepaid expansion as well).

 

That leaves about 4-6 million additional postpaid gross adds.  One of the Uncarrier moves has been to extend EIP credit status to T-Mobile prepaid customers who have paid 12 consecutive bills (as John Legere and Mike Sievert indicated on the call, this is likely a much better indicator than anything coming from a credit agency – see more here).  T-Mobile currently has 16.3 million branded prepaid customers.  Let’s assume 36% of them meet the criteria outlined above and that 1/3rd of these opt into EIP status.  That represents an additional 2 million retail postpaid “gross adds” (and also increased prepaid churn).  More details on why 36% and the 1/3rd rate make sense are available upon request.

 

That brings us to 5 million gross adds (3 million from LTE expansion + 2 million from the Smartphone Equality initiative).  We have yet to look at external customers coming in from Verizon, AT&T, and Sprint for the remaining base.  If we assume that the rest of the base does not gain any market share whatsoever, T-Mobile will add 5.4 million gross additions to cover their churned base.

 

Bottom line: With moderate to conservative assumptions, it’s likely that T-Mobile will generate 10-11 million gross additions in 2015, not the 8-9 million implied in their guidance.  They will get this from the following:

 

  • “New market lift” for 2H 2014 LTE markets launched of 1 million gross additions
  • “New market lift” for full year 2015 LTE markets launched of 2 million gross additions
  • Smartphone Equality postpaid gross additions of 2 million (with a similar amount of branded prepaid churn)
  • Existing (end of 2014) market gross additions from Sprint, AT&T, and Verizon of 5-6 million (which allows the existing markets to stay even on a market share basis with 2014 levels).

 

We have not even touched on increased gain from family plan initiatives hinted to on the earnings call (which would boost the 5-6 million figure above), and any increase in tablet gross additions from a new iPad launch.  Either T-Mobile’s math is light, the Smartphone Equality initiative is a PR play and will not be seriously marketed to the base, or there is an unmanageable churn surprise just around the corner.  I’m going with the math sandbag, and hope that Verizon and AT&T are paying close attention to their market shares in the Midwest and South.

 

Next week wil be very busy with the Title II details released as well as Comcast earnings and Mobile World Congress news.   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 (and they can go to www.mysundaybrief.com for the full archive).

 

Thanks again for your readership, and have a terrific week!

Four Questions for the FCC Chairman

Rushmore panoramicValentine’s and Presidents Day greetings from Charlotte and Dallas.  This week, we’ll review the FCC Chairman’s recent comments on proposed regulation, look at CenturyLink’s earnings, and provide some overall comments on the state of the industry as we await T-Mobile (19 Feb) and Comcast (24 Feb) earnings.

 

Four Questions for the FCC Chairman

Many of you have called/ written me about the general chatter about regulatory changes proposed by FCC Chairman Tom Wheeler.  The telecom industry needs to take Tom Brady’s advice and “R-E-L-A-X.”  While it is strangely undemocratic that the Chairman would be very collaborative in the process to date yet embargo the release of the proposed Report & Order from the public, the report will be released in a matter of days and, as AT&T CEO Randall Stephenson said in his CNBC interview on Friday, the industry will ask for a stay of the order pending the completion of court action.

 

nabu network imageChairman Wheeler made some statements last Monday at the Flatirons event which can be seen here.  They describe the three elements of a regulatory framework:  a) Establish a higher “bar” for Internet speed to reflect the changing consumption patterns of Americans; b) Provide the regulatory cover to enable public sector (in this case, municipal taxpayer) monies to be used to compete against incumbent networks, and c) Establish rules that prevent incumbents from using their monopolistic or duopolistic structures to further thwart the advancement of a faster and fairer Internet.

 

Rather than pick apart the Chairman’s speech (see article here providing a lot more detail on why NABU failed – it had less to do with the cable industry in the 1980s and more to do with a business model that predated email, the browser, and Wi-Fi enabled devices), let’s focus on four questions that this Report & Order should address:

 

  1. Does the strategy encourage Google to quickly deploy a third (fiber or otherwise) broadband alternative? Google is the only one of the larger Internet players who have taken steps to do so.  We know that when they announce that they are entering a market, the incumbents immediately take steps to make their networks more competitive (and they provide better service alternatives like StepOne, a start-up client, which is being trialed in Round Rock and Austin, a Google Fiber city).  If the strategy does not encourage Google (and others) to do this quickly, then restart the process.

 

  1. Does the strategy lead to two-sided business models that increase the affordability of broadband services? Interestingly, when Chairman Wheeler outlines his objectives in the Flatiron speech, he cites “fast, fair, and open” but does not tackle the issue of affordability.  To get a perspective on this, have a look at the recent findings of the Corporation for Economic Development:  44% of Americans are living with savings of less than $5,887 for a family of four.   These families care don’t run Ookla speed tests, cannot afford the latest iPhone 6, but some/ most of them use a five inch screen (mobile) from an iPhone 4s or a Samsung Galaxy III to get their daily information.  Raising the bar on home broadband speed means nothing to them if they cannot afford the computing devices that connect to the modem.  Steve Case won because he understood the value of a two-sided business model (advertising on the AOL home page).  Paid prioritization and sponsored data are a couple of examples of two-sided business models that might work.  If alternative models can increase affordability, why eliminate the option?

 

  1. Does the strategy leverage existing government investments? This column has been critical of the NTIA’s Broadband Technology  Opportunity Program (BTOP) which sought to deploy additional resources into underserved (rural and urban) markets with limited success (see this excellent New York Times article outlining the failures of the program through February 2013 – there have been several additional failures since this article).  BTOP allocated just over $4 billion in funds – the Chairman is proposing more than $12 billion in the next round?  What have we learned, and how will this time be different?  How do we leverage the existing fledgling/ failing investments?

 

  1. Does the strategy drive more fiber investment? This is the most critical question.  Market forces have driven the deployment of fiber to tens of thousands of cell sites and tens of millions of homes.  Existing DSL technologies will drive 75Mbps speeds, and new technologies leveraging the G.fast standard will drive more than 1 Gbps to homes starting this year (see Ars Technica article here).  Both of these require deeper fiber deployments, if not to the home, to the nearest aggregation point (e.g., the node).  While the Chairman declares the goal of “economic return as an incentive for an investment in broadband infrastructure” to be legitimate, no details have been provided to show how government policy will accelerate fiber deployments.  If the policy does not accelerate fiber deployments, then restart the process.  (Note: relatively speaking, the applications using the broadband infrastructure have created hundreds of billions more shareholder wealth than the wireless and wireline networks they transit.  See more here).

 

There’s a lot the government can do to improve broadband availability and affordability.  Competition is the catalyst for success.  If the FCC cannot promote capitalistic solutions to solve these problems, the issue will be left up to either a) judges, or b) the Congress and the President.  More to come after the details are released.

 

CenturyLink’s Earnings:  Caught in the Middle 

CenturyLink provided a quarterly and full year earnings report last Wednesday.  As we have stated in several previous Sunday Briefs, they provide a fairly good proxy for the state of the incumbent local exchange provider section of the telecom ecosystem.  Like their peers, CenturyLink is in the midst of a transition, although it appears that the worst declines are behind them.

 

CTL waterfall chart q4 2014Their fourth quarter waterfall chart provides a good visual of the transitions affecting the company.   Legacy revenue, consisting mainly of voice and low speed access services continue to be under pressure, although it appears that the largest declines are behind the company.  Data Integration revenues (Customer Equipment and special construction revenues) were also down from the fourth quarter of 2013.  In total, these revenues represent just over 3% of the beginning revenue balance (revenue losses from local lines net of strategic revenues have been as high as 6% in recent years).

 

Of greater concern is the inability to grow new revenues.  CenturyLink spent $160 million on AppFog and Tier 3 in the last half of 2013 (net of cash on hand), and these acquisitions should have started to show meaningful revenue gains.  Fifty million of revenue growth (with no material sequential revenue growth due to collocation revenue pressures) is very slow, especially on a quarterly revenue base of over $2.3 billion (note: even a “normalized” figure shows a strategic services growth rate of 3.5%).

 

To increase the sales opportunity base (and to get the right salespeople in place to sell cloud and security services), CenturyLink reorganized.  While the full extent of this reorganization is not yet known, management tempered H1 2015 expectations to reflect the transition time needed to sell and provision cloud services.  Two CenturyLink veterans (Karen Puckett and Maxine Moreau) now run the company – this number had been as high as five in recent years.  Provided that the bureaucracy of a large corporation can be minimized (meaning decisions can be made more quickly and that market performance can be localized), this is a recipe for success.  There are many who doubt that this can translate into the growth expectations established by the company – any growth above 3% will be viewed as a positive sign.

 

Bottom line:  CenturyLink needs a win before the Comcast/ Time Warner Cable merger is completed.  The Data Gardens and Cognilytics acquisitions are good starts, but there must be a sales force to create a compelling value proposition to customers.  This starts with end-to-end service performance and pricing that reflects marketplace realities.   More earnings detail is available here and here.

 

Six Undeniable Trends Shaping 2015

While there are a lot of events swirling throughout the telecom ecosystem, here’s some undeniable trends based on recent news:

  1. The US economy is going to grow faster in 2015 than 2014. This growth will be disproportionately in the South and West, with Texas leading the way.   No other region of the world (except China) matches the 2015 growth prospects in the United States.
  2. Price competition is going to be more prevalent in the wireless consumer marketplace. This will help T-Mobile and Sprint, and hurt Verizon and AT&T.  The extent of the impact will be driven by the success of Verizon’s churn reduction efforts.
  3. Legacy (T1, DS3, OC3, OC12) circuits are going to be quickly replaced by fiber-based (Ethernet) initiatives. This change is not confined to carriers alone – there are many small businesses eagerly awaiting the availability of fiber-based providers (see point 5 below).
  4. Absent the resumption of radical regulatory policy, fiber deployments for core network needs (small cells, fiber to the tower, in-building fiber) will continue to grow.
  5. Cable commercial services will be the fastest growing sector in telecom ($1.1 billion or 20-22% growth on a combined basis for the combined Comcast/ Time Warner Cable in 2015).
  6. Apple + Google + Facebook + Microsoft + Amazon (network users) will generate $2-3 in equity market value for every $1 created by the entire telecommunications industry (network providers).

 

Next week, we will wrap up the Big 4 with T-Mobile’s earnings.   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 (and they can go to www.mysundaybrief.com for the full archive).

 

Thanks again for your readership, and have a terrific week!

 

Sprint’s New Vision

 

opening photoFebruary greetings from Paris (Notre Dame Cathedral pictured), Austin, and Dallas.  True to 2015 form, this has been a very full news week with Chairman Wheeler taking to Wired’s blog site to outline his recommendation to implement Title II regulations (more on this as more details are disclosed; for a very interesting article on how we got here, see Friday’s  New York Times OpEd), to Verizon’s $15 billion sale of wireline and tower assets to Frontier and American Tower, to RadioShack’s historic bankruptcy (which strangely involves Sprint as a savior/ partner for 1,750 stores), to Verizon’s data rate card reductions.

 

Despite these meaningful news stories, we’ll spend our time this week focused on Level3 and Sprint earnings.  Before diving in to the numbers, however, two quick shout outs.  First, the Verizon tower sale represents a clean sweep of sorts for TAP Advisors, which was founded by former UBS executives Davis Terry and Karim Tabet.  They either advised the seller (Verizon, AT&T, T-Mobile) or buyer (Sprint) of each of the US carrier tower portfolios.  Kudos to Karim, Davis and the entire TAP team on this remarkable achievement.

 

Secondly, former Cablevision/ Frontier/ Broadview/ Telx/ NTT exec Chris Eldredge was announced as CEO of DuPont Fabros Technology this week (announcement here).  Chris and I set up one of the first wireless tandem bypass solutions in the industry in 2002 (in Cablevision territory), and we’ve been colleagues ever since.  Making the step to public company CEO is a big one for Chris, and I hope you will join me in congratulating him on his accomplishment.

 

Sprint’s New Vision

Sprint announced earnings on Thursday, and in doing so proved that the promise of lower prices will result in higher gross adds (and break-even profitability).  There is no doubt that Sprint is proving that it’s attractive to value-focused families and data-hungry individual users.  But what turns today’s popularity into sustainability?

 

The simple answer is a lot of capital – not the few million dollars per city variety, but billions of dollars per year in data-focused deployments.  Sprint already realizes this, and in their most recent earnings, accrued capital expenses took a dramatic turn:

sprint cash and accrued capex trend

 

When Sprint originally announced their Network Vision program (first in December 2010 but with greater details in October 2011 – see announcement here), the program was going to be completed by the end of 2013, cost $4-5 billion in incremental capital, but result in $10-12 billion in economic benefits over the 2011 to 2017 period.  From this announcement, and from expectations established with the completion of the Vision project in the second half of 2014, there’s a reasonable expectation that capital expenditures would fall to $1.2-$1.3 billion per quarter.

 

network vision original pictureWhen Sprint originally presented Network Vision, the profitability impacts were amazing (the slide shown is from Sprint’s 3Q 2011 quarterly earnings conference call).  With $5 billion of incremental spending, Sprint would get back on track and happy days would return.  That assumed, of course, that T- Mobile would remain a subscriber target for Sprint’s recovery, and that there would be upfront lease payments coming in from LightSquared (1.6 GHz band) to fund part of the project costs (these assets are still in bankruptcy court – see latest details here).

 

On top of this, it’s likely that data volumes grew faster than engineers estimated in 2011, and that pooled/ metered billing would replace unlimited as the choice for family plans.  All of this goes to show the danger of making long-term assumptions in the wireless industry.

 

With the entry of Marcelo Claure as CEO (and the subsequent scuttling of merger talks with T-Mobile), Sprint will need a new vision.  This sequel will need to continue to focus both on voice (800 MHz) and data (1900 and 2500 MHz spectrum bands).  It will also need to redefine the term “densification” given the nature of their spectrum holdings.  And it will cost money – lots of money.

 

While 4Q 2014’s accrued capital expenditures probably represent a catch-up to the capital delays seen in the first half of the year (which were probably a function of the presumption that the T-Mobile merger would be approved), there’s a very good chance that Sprint could reach $2.0 billion in accrued quarterly expenditures in 2015 (cf: Sprint originally forecasted spending $7 billion in 2014 but this was cut to $6 billion in the first half of the year).  This spending would be focused on increased metro deployments (see the preliminary results of this focused building in the RootMetrics Chicago results here) as well as Sprint’s carrier aggregation efforts (more here).

 

It’s likely that Sprint will be more forthcoming in their next earnings release (which corresponds to the end of their fiscal year), but a $7 billion (or higher) shot in fiscal year 2015 would not be surprising even in the light of decreasing service revenues.

 

With the “cut your bill in half” promotion fully underway and highly likely to continue throughout 2015, Sprint clearly has Verizon and AT&T in their sights.  These customers are less forgiving than T-Mobile converts, and Sprint will need to be very attentive to their needs (and learn from last August’s exclusion of the Sprint base from the 20GB/ $100 promotion, a move which likely drove up 4Q churn).  Mix changes should drive a new customer experience vision.

 

Lastly, new focus is needed for business customers.  The previous strategy which ran after a difficult and complex part of the market (very small business) and away from Sprint’s traditional corporate base was flawed (see original Dear Marcelo Sunday Brief here).  Sprint had a reputation for understanding wireline and wireless data needs.  While Claure paid lip service to this in the conference call transcript (“going forward we expect to place a greater focus and emphasis on our MPLS and IP solutions”), he needs to back this up with clear examples where customers are buying and renewing Sprint for quality and innovation (versus price).

 

Bottom line:  Sprint has a clear understanding of its short-term value proposition and network improvement needs.  Articulating the capital implications of deploying a 2.5 GHz focused strategy must be clearer, along with the corresponding value proposition.  Lower prices without a corresponding low-cost network and operating structure is not a value generating strategy.

 

Level 3 – Consistent and Increasing Free Cash Flow in Sight

Level 3 Communications also reported earnings this week and provided a peek into cash flow and earnings with their latest acquisition, tw telecom.  The full earnings release can be seen here.  Even with their latest acquisition, Level 3 remains a global story – about 22% of the pro forma 2014 Core Network Service (CNS) revenue comes from EMEA or Latin America.  On the conference call, CEO Jeff Storey described one of their initial synergy initiatives is to sell Level 3’s global capabilities into the tw telecom base.   A small take rate across the tw telecom base would have a meaningful impact to non-US revenues and margins.

 

For those of you who are not familiar with the revenue composition of the combined company, this slide provides an explanation:

level3 pro forma fourth quarter cns composition

The bottom line from this chart is that 76% of Level 3’s revenues (IP & Data, Transport & Fiber) are growing at 7%, and that the remaining 24% of CNS revenues are shrinking at 2%.  About 25% of the revenues shown here are outside of the US.  To execute a cash flow growth strategy, the winning formula is pretty straightforward:  drive increased on-net penetration (across any currently deployed capital) and improve each domestic investment to yield incrementally more value to the base (increase the “network effect” of the 40,000 on-net building footprint).

 

Level 3 issued very strong EBITDA ($2.6 – $2.7 billion) and Free Cash Flow ($550-600 million) guidance for 2015 while keeping capital guidance at just over $1.2 billion (which represents just over a 30% increased from pro forma 2014 levels).  Level 3 will likely end 2015 with combined margins in the low to mid thirty percent range.  To compare, Century link has achieved YTD 2014 (9 month) margins in the upper-30s (including the former Savvis assets), Sprint’s wireline business unit has low single-digit adjusted EBITDA margins, and Verizon’s full year wireline segment EBITDA was in the mid-20s (and will likely head lower with the divestiture of FL, CA, and TX assets).  Given the currency risk inherent with Level 3’s asset mix, they compare favorably to their peers.

 

Bottom Line:  Provided that they synchronize operations to minimize customer disruption (something firmly in the minds of their long-time customers), the tw telecom purchase will likely go down as the best in Level 3’s history.  If Level 3 can achieve 4% revenue and 12%-15% margin growth in 2015, more opportunities will emerge to repeat their M&A success.

 

Next week, we will take a deeper look at cable earnings and examine other events of the year to date.   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 (and they can go to www.mysundaybrief.com for the full archive).

 

Thanks again for your readership, and have a terrific week!

 

AT&T’s “Future Forward” Message

2015-01-28 07.06.59Grande game day greetings from Tampa, Miami (sunrise pictured), New York City, and Dallas.  Lots of plane time this week, which means lots of time to think about earnings announcements and trends.  On top of this, the week was heavy on non-earnings news, with T-Mobile’s innovative smartphone approach to credit challenged customers (see more here), to Google Fiber’s southern fiber expansion announcement (see blog post here), to Dish Network’s surprising second place finish in the AWS auction bidding (see analysis of the results here).

 

These three news items would be enough to fill three Sunday Briefs.  Believe it or not, we’ll only tangentially touch on them in this week’s Sunday Brief, and focus instead on AT&T and Time Warner Cable earnings.

 

top 20 growth marketsAs a backdrop for the earnings discussion, a recent article from Forbes magazine listed the 20 fastest growing US cities (full article here).  If you are not familiar with the term DASH (which stands for Dallas-Austin-San Antonio-Houston), you should add it to your telecom lexicon.  Including Ft. Worth (sometimes included in the Dallas market), these markets account for half of the fastest growing cities in the United States.

 

Several interesting insights emerge about the results:

  1. Not surprisingly, AT&T is the primary local incumbent telco provider in 13 of the 20 markets. While they did not state this on their earnings call, it’s likely that the wireline part of the Velocity IP (Project VIP) has been focused in these areas.  This means more fiber, faster speeds, and better in-building coverage to smaller footprint buildings (e.g., 100,000 to 400,000 square feet).  The answer to the question “Why is AT&T more focused on wireline than Verizon?” can be answered with this chart.  No one is Fewer people are moving into Verizon territory than into either AT&T or CenturyLink markets.  Simply put, the quantity of decisions (and the cost to add) are less when there is more moving.  This is what makes the Verizon (FiOS) vs. Cablevision (Optimum Online) market share/ switching battle in the Northeast such an interesting one to watch.
  2. Six of the top 10 fastest growing markets are in Time Warner Cable (TWC) footprint. Four of these are in Texas, and the other two are in the Carolinas (with some growth as well in San Diego as noted).  Time Warner Cable should be booming, but, as we will see from their results, they are not.  AT&T is grabbing their highest U-Verse market share in Texas.  TWC has nowhere to go for growth after the Top 10 with Cox and Bright House Networks splitting the 11-20 spots with Comcast.
  3. Finally, there is CenturyLink (CTL) with six of the top 20 markets as the incumbent. Compared to their fellow high-yielding peers (Windstream, Frontier), their growth horizon is much greater.  Is CTL missing out on opportunities to create increased shareholder value with only $3 billion in spending (last four quarters; full year 2014 to be seen when they report earnings in February)?  What are the effects of decelerated capital spending on Comcast’s (and Bright House Networks’) market shares in these markets?

 

This table (and other items within the Forbes article) help to frame the addressable growth markets for broadband and wireless.  Texas is the place to be, North Carolina is a close second, with California third.

 

AT&T’s “Future Forward” Message

at&T wireless growth chartAT&T reported earnings on Tuesday and the results were mixed.  While total retail postpaid subscribers rose, the phone portion of those net additions shrunk by 115,000.  Prepaid and reseller subscribers also fell in the quarter (although Cricket gained a small number of customers); these two segments combined have lost more than 1.1 million subscribers over the past four quarters, with most of them coming from the (AT&T branded) Go Phone losses.  Were it not for AT&T’s continued brilliance and strength in the connected device segment (driven by 800,000 automobile connections with free trial periods which begin to expire in Q1 2015), the wireless picture would have been solely focused on low-ARPU tablets. Even when accounting for Next (phone installment) payments, total phone-only ARPU customers fell by 2.3%.

 

Fortunately, the U-Verse picture was much brighter.  Revenues grew 21.9% after accounting for the sale of AT&T Connecticut, driven by Internet net additions of 405,000 and video net additions of 73,000.   AT&T reported 22% penetration of homes passed for video and 21% for broadband.  While low, this is a clear indication that there’s still a lot of room to grow (Verizon FiOS comparable metrics are at 36% for video and 41% for broadband).   Overall, broadband growth (U-Verse growth less DSL declines) was positive for AT&T and U-Verse is now a $15 billion dollar annual revenue stream.

 

Voice declines are halting EBITDA improvements, both in business and consumer markets.  The jury is still out on AT&T’s progress in their traditional DSL markets (75 Mbps is now available in more parts of California, Ohio, and Texas according to their earnings bulletin; 456,000 DSL losses this quarter).  The transition from legacy SONET-based services to lower-priced Ethernet services is impacting business and wholesale margins.  Few things at AT&T are in a steady state.

 

What to do when the core business is in decline but the balance sheet allows for additional leverage?  Buy spectrum ($18.2 billion to enable a nearly nationwide swath of AWS-3 spectrum) and expand competitive advantage through acquisition (DirecTV, Iusacell, Nextel Mexico).   AT&T established 2015 guidance of low to mid-single digit revenue and low single digit EPS growth including acquisitions.

 

As we have discussed in several previous Sunday Briefs, new revenue sources directly attributable to Project VIP need to account for approximately $50 billion in revenue for the next five to seven years.  Here’s the math:

 

  • $60 billion invested over the 2013-2015 interval
  • 8% post-tax cost of capital = $4.8 billion after-tax Net Operating Profit ($60 billion * 8%)
  • 35% tax rate = $7.4 billion pre-tax Operating Profit ($4.8 billion/ (1-35% tax rate))
  • 15% operating margin = $49.3 billion revenue generation required ($7.4 billion/ 15% margin)

 

That’s assuming a very conservative debt/ equity mix (60/40), a 5% cost of debt, and a 12.5% equity holder expectation (roughly split between a 5.7% dividend and a 6.8% equity return).

 

Given these lofty (and potentially unachievable) expectations, AT&T has to expand.  They need a            greater share of broadband decisions (helped by people moving into Texas, California and North Carolina).  They need businesses to expand their wireless and broadband data and security needs (again helped by their geographic locations).  They need a rejuvenated AT&T Mexico to result in market share gains in California, Arizona, New Mexico, Colorado, and Texas.  Most of all, they need content differentiation and cost reductions from DirecTV.

 

The list is long, and, while the Cricket integration is ahead of schedule, merging satellite and Mexican operations is a lot different than local wireline and wireless integrations.  AT&T will lose market and investor confidence if they materially fail in any aspect of this multi-part program.  One misstep, and their cable and wireless competitors will be waiting to harvest additional gains.

 

Time Warner Cable Earnings – Triple Play Comes Alive

Time Warner Cable also reported earnings this week (full details here), with triple play (voice+video+phone) and business growth driving total revenues and EBITDA up 3.8% and 5.6% in the fourth quarter.  The triple play story has two parts: a) upsell the single and double-play base (namely to digital phone), and b) acquire a disproportionate share of decisions of movers (see earlier in this Sunday Brief on population growth).

 

Clearly, they did a very good job on both fronts.  While single and double play customers fell in the fourth quarter (39,000 and 168,000 respectively), triple play shot up 274,000 customers.  Overall, voice revenue per unit continued its steady decline to $30.58 (from $34.30 in 4Q 2013 and $35.11 in 4Q 2012).

 

Voice is a high margin product when sold as a part of the triple play, however.  Think of voice as a narrowband application revenue stream riding over an existing voice or data stream.  While the incremental gross margins are not as high as High Speed Internet, they are still meaningful.

TWC 4Q subscriber resultsNowhere are these trends more apparent than in the nearby chart (note: this chart does not compare sequential growth, but rather changes versus previous 4Q figures).  High speed data growth – best for a fourth quarter in seven years.  Same story for residential video losses.  Voice gains were the best on record.

 

This is exactly what Time Warner Cable should be doing ahead of their merger with Comcast – driving subscriber growth and customer relationships with a focus on high speed data and voice acquisition (leave further video penetration for the eventual introduction of Comcast’s Xfinity platform).

 

While this column has been critical of Time Warner’s failure to capitalize on opportunities in the past, it’s very clear from fourth quarter earnings that the company is placing its priorities on plant overhaul, connection quality, and speed differentiation.  Adding additional revenue generating units to the mix is a heck of a lot easier with healthier New York and Los Angeles properties.

 

More on cable’s overall situation after Comcast’s earnings (February 24).  Most companies in Time Warner’s case would have milked the last couple of quarters of earnings.  In this case, their “full steam ahead” activities in 2014 provides TWC momentum throughout 2015.

 

Next week, we will look at Sprint’s earnings and touch base on Microsoft/ Google/ Apple / Amazon earnings which all happened last week.   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 (and they can go to www.mysundaybrief.com for the full archive).

 

Thanks again for your readership, and have a terrific week!