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Monthly Archives: July 2015

2015 Halftime Report: Verizon on Edge and AT&T through the Knothole

dallas cranesGreetings from New York City, Charlotte, and Dallas (pictured – cranes have become a part of the urban landscape).  It was good to see many of you at the Wells Fargo Conference on Thursday where I was honored to be the morning keynote speaker.  Davis Hebert and Jennifer Fritzsche were terrific interviewers, and I hope to have a link to the audio feed soon.

 

This week’s Sunday Brief will focus on AT&T and Verizon earnings.  While there were many other significant events that warrant additional review, their implications will have to wait for another week.  In the meantime, here’s a link to five of those events:

  • The FCC is withholding $3.3 billion in credits from two Dish-affiliated designated entities from the AWS auction. More here from Fierce Wireless.
  • wired jeep hack Fiat Chrysler is recalling 1.4 million vehicles with a hacking vulnerability. See WIRED report here and CNBC report here (and nearby picture).  Harman is the provider of the system and Sprint is the underlying network provider for Fiat Chrysler.
  • In-building DAS provider ExteNet was recapitalized by Digital Bridge and Stonepeak Infrastructure Partners for slightly more than $1 billion. More details about the transaction can be found from RCR Wireless here and from ExteNet PR Newswire here.  Kudos to fellow Davidson College alum Ross Manire for creating this successful liquidity event for his investors.
  • Honda has taken the bi-partisan perspective and will introduce both Apple’s CarPlay and Android Auto into the 2016 Accord. This follows similar moves from GM and Hyundai.  More from CNET here.
  • Nokia and Alcatel Lucent received merger approval from the European Commission. Their approval is here.

 

Verizon:  On Edge

Verizon led off the earnings parade this week on Tuesday, and the headline was their anticipated growth rate (3%) compared to their previously stated growth rate (4%).  The primary reason cited by Fran Shammo, Verizon’s CFO, was the Edge take rate:

 

…Some of the other changes in the assumption fact is the take rate of Edge. I would tell you we never anticipated that Edge would accelerate as much as it has, and looking forward into 3Q being at 60%, that’s much higher than we had anticipated. But the market has moved us there…  Coming into this year we knew that service revenue would dilute. We are seeing more dilution than we anticipated because more customers are selecting that Edge plan.

 

Moving customers from subsidized to Equipment Installment Plans (EIP) isn’t easy, and a higher percentage of customers moved to EIP-based plans than anticipated (49% in 2Q, up from 38% in 1Q and over twice the 2Q 2014 of 18%).  With each EIP line conversion, $15-25 moves from service to equipmet revenue.  Worst of all, this transition is just beginning for Verizon, with 16% of the retail postpaid base converting.

 

Verizon’s 10-quarter ARPA/ ARPC trends are as follows:

verizon arpa sumary

  • Total number of accounts grew slightly (0.1%). In the second quarter of 2014, total accounts grew by 0.4%.  Had Verizon grown at 2Q 2014’s sequential growth rate, accounts would have risen by an additional 82.6K (or about 241K connections using 2.92 connections per account).
  • Average revenue per account (ARPA) fell $2.41 in Q2, slightly better than the $2.68 decline in Q1. Without the sequential growth in connections per account (from 2.88 to 2.92), the quarterly decline would have been close to $4.00.  Verizon peaked on ARPA in third quarter 2014 and will likely experience a $10 annual drop (or more) in 2015.
  • Verizon did not talk about customers “pricing up” into higher buckets in the second quarter. This could be because many are just getting used to their current plans, and that customers can adjust their usage habits fairly quickly (e.g., watch more video over Wi-Fi).

 

Even with all of these changes, Verizon still managed to grow its segment, service, and overall operating margins.  Those trends are likely to benefit from increased EIP conversions in the short term (less subsidy costs taken into the “Cost of equipment” line item).

 

Edge/ EIP is a transitional event.  It is not a statement of Verizon’s cost competitiveness.  In fact, with more dark fiber leases going into the ground and 700 MHz purchased at what looks like a fairly attractive price, one could argue that for the next several years, Verizon could grow their margins considerably.  What will trigger this growth?  Video, whether it comes from their summer launch or from continued “price ups” in the traditional buckets.

 

What should put the telecom community on edge (pun intended) is Verizon’s deteriorating wireline performance.  Yes, they are selling three island properties which may have taken some wind out of the marketing sales for Tampa, Irving, and California, and yes, Time Warner Cable came back roaring with aggressive New York City/ New Jersey promotions after their Comcast merger was scuttled, but the wireline business is sick, and price/ promotion in the Northeast seems to be Verizon’s only way out.  Technology/ speed is not resonating with potential cable (or DSL) converters, and this should be very troubling.  More on this when TWC announces what should be strong subscriber numbers on Thursday.

 

Bottom line:  Verizon will grow their way out of the EIP transition.  How soon depends on data growth.  The real worries should be the ability to execute a new line of business launch (not done since FiOS and that was a new network and not a content broadcast business) and the ability to manage the DSL and TDM (circuit-switched voice to packet voice) transitions in their wireline business.

 

 

 

 

AT&T:  Through the Knothole?

knotholeAT&T announced earnings on Thursday after the markets closed (but before the FCC officially approved their merger with DirecTV).  There were many things to be encouraged about with AT&T’s current state, but the most important development was that they appeared to have hit the important subsidy-based to equipment installment plan conversion milestone.  This drove phone-only ARPUs sequentially higher (see below) and phone-only + Next billings to historical highs:

att selected statictics

Driving the phone-only ARPU is the fact that AT&T is beginning to see upgrades from the $100 for 10 GB data plans to the $130 for 15 GB and $150 for 20 GB levels.  Even with the addition of a one month rollover buffer (a smaller knothole added in response to T-Mobile’s Data Stash plans), ARPUs grew.

 

at&T smartphone statsWhat allowed AT&T to pull through this plan change knothole so quickly?  As the chart above shows, the massive ARPU decline resulted from their decision to allow existing customers (smartphone customers prior to Feb 2, 2014) to switch to the Mobile Share Value plans (including the $15/ month unlimited talk and text plan) with no termination penalties. With 77% of smartphones already on MVP, and 37% of the base already on Next (see nearby picture), AT&T now has to manage the impact of additional Next conversions (especially during the next iPhone cycle).

 

AT&T is through the worst of it.  Even with rollover, vacation schedules will drive phone-only ARPU higher (see 2013 and 2014 2Q to 3Q changes), and the fourth quarter iPhone cycle will continue the trend.   While postpaid phones continue their slow decline as customers leave for other carriers (likely Verizon and T-Mobile), the value from the existing base continues to grow.

 

Also worth noting in comparison to Verizon is AT&T’s improvement in prepaid metrics (Verizon’s prepaid and wholesale businesses get minimal focus compared to postpaid retail).  Rather than decommission Cricket, AT&T revived the brand and the prepaid subscriber base is now larger (both growing faster and churning less) then when AT&T combined AIO and Cricket a little over a year ago.  AT&T’s CFO John Stephens seeemed very comfortable with the tradeoff between Cricket and AT&T brands:

 

… on the prepaid side with both our Cricket and GoPhone brands, we added some premium customers. I think I mentioned that two-thirds of our Cricket customers are buying out of the higher plans. Those are $50, $60 month plans… And those ARPUs are higher than the feature phone ARPUs we are losing and quite frankly, higher than a lot of – some people in the markets postpaid ARPU. So we are getting great tradeoff…there is very low acquisition subsidy costs with regard to those customers. We did sell over 7 million smartphones through the – in the quarter. A lot of those were in our prepaid space…Beauty of it is that the customers are satisfying the financial requirements of those phones such that it’s allowing us to keep our margins up.

 

From these and other recent comments, AT&T does not appear to be punting on Cricket any time soon.

 

While AT&T seems to have pulled through one knothole, the transformation of AT&T as a result of the DirecTV merger represents a “make or break” event.  As the metrics above show, AT&T’s wireline broadband metrics were weak, and transitioning video customers from U-Verse to satellite is not as easy as it appears (versus Sling and other emerging over the top alternatives).  And, while AT&T was quick to take credit for reaching 900,000 small and medium business locations with fiber, it’s not clear from the second quarter broadband figures that it actually helped stem the exodus to commercial cable offerings (Comcast had over 20% or $200 million annual growth in 2Q, yet only has 25% penetration in small and less than 10% in medium/ regional businesses).

 

Bottom line:  While one knothole has been cleared in postpaid wireless, and AT&T has successfully integrated Cricket into the larger wireless portfolio, broadband continues to be weak.  AT&T faces a substantial challenge with new in-region satellite products, continued bandwidth disadvantages compared to cable in residential broadband (cable will likely account for more than 100% share of decisions relative to their telco breathern), and small business will become a highly competitive battlefield for the next several years.

 

Next week, we’ll fold in T-Mobile, Comcast, and Time Warner Cable earnings (Spolier alert:  they will all be strong).  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 enjoy the remaining weeks of summer!

Whither Unlimited Data?

new york skylineGreetings from many locations around this great country of ours:  Rochester, Buffalo, Atlanta, Charlotte, Kansas City, Austin, Dallas and, as pictured, the city that never sleeps.  While travel can wear one out, I have been extremely encouraged by the continued entrepreneurial optimism that continues to premeate our industry.  It’s refreshing and energizing.  Check out Vinli (in car diagnostics), Clutch (car leasing with 10 monthly flips – in Atlanta today, and ______ in September), and Robin (Uber for lawn care) for just a taste of where the digital economy is heading.

 

This week, we are going to take some time away from the day-to-day to examine the death of unlimited, not only for wireless, but also for wireline broadband.  Driven both by market growth and by regulations, the telecom industry is going the way of other utilities.  Unlimited will fade away a lot faster than most expect, not just because of economic unsustainability, but because the target market for unlimited plans has changed dramatically over the past six quarters.

 

Wireless Unlimited:  Can it Survive?  How? 

One of the great debates over the past several months has been the sustainability of unlimited data.  While both Sprint and T-Mobile offer unlimited plans (although Sprint just eliminated their $50 iPhone offer in favor of “All-In”, described later in this Brief), each is emphasizing plans that carry fixed allocations (20 GB for up to five lines in the case of Sprint, and 10 GB per person for a family of four in the case of T-Mobile).  The economic model has changed from usage to breakage.

 

Can carriers make money with unlimited data?  Let’s look at Sprint’s iPhone Unlimited, All-In and 20 GB family plans.  The iPhone plan was offered for $50/ mo., and replaced by the All-In plans introduced in June at $80/ mo., including phone lease.  The 20 GB family plan is currently promotionally priced for $100/mo., increasing to $160/mo. after September 30, 2016.

 

It’s important to caveat all of this with the fact that these are our best estimates for the purposes of determining the sustainability of unlimited plans only (read more into it at your own risk).  All costs described in this analysis should be viewed as directionally accurate (+/- 20%). 

sprint chart

 

Obviously, individual usage is much more difficult to model (and therefore manage) than family plans.  The usage patterns of each individual are different from families, and, as many in the industry have discovered, many/ most individual users are smartphone dependent.  Individuals tend to buy more add-ons like insurance, roadside assistance and international calling, as well as spend on applications like MLB At-Bat, Caller ID applications like Privacy Star (still Android only thanks to Apple’s neanderthal approach to calling number interrogation), and Spotify.  They are a unique blend of high volume voice, SMS, and data usage.  And, in increasing numbers, they are cutting all cords and streaming content through Wi-Fi or HDMI directly to their HDTVs.  These trends would furrow the brow of any CEO who had a concentration of truly unlmiited subscribers.

 

The resulting economics indicate that while the average customer is still generating a positive gross margin (our estimate is about 20%), an increasing percentage of Apple Unlimited plan subscribers are marginally or perhaps actually unprofitable.  Assuming phone dependent characteristics (which will drive 1500 to 3000 voice minutes per month), any individual customer using more than 6 or 7 GB of data each month (500 MB/ day) likely has Sprint concerned.  Given their recent retraction of the modified All-In queuing policy (see here as well as the June 21 Sunday Brief for more details), it’s not clear how they will turn this segment of their base around.

 

Sprint’s latest plan (All-In: $80/ month for leased smartphone + unlimited voice/SMS/data) buys them $7-8 dollars of additional allocated ARPU – a short-term profitability extension, but not a long-term cure for unlimited usage.  To maintain the same (low) gross margins as the $50 Apple Unlimited plan produced, All-In, with an implied $57 ARPU, can only accommodate 700 MB of additional LTE usage (just over 100 MB per day; model available upon request).  Bottom line:  Sprint’s All-in plan buys time, but will not result in sustainable profitability for truly unlmiited plans.

 

Individual unlimited voice/SMS/LTE plans (without throttling after 7-8 GB) will soon be as rare as a Blackberry Torch or Morotola KRZR.  We’ll remember them fondly.

 

Are Current Wireless Family Plans More Sustainable?

The second half of the above chart shows Sprint’s revenues from both the promotion and the post-promotion levels of their successful 20GB for $100 family plan (which goes up automatically to $160 in September 2016).  Note that we have attached four lines to the Sprint plan for comparison purposes, although Sprint allows up to five.

 

Many of you asked me “What was Marcelo thinking?” when Sprint first launched the 20 GB plans a year ago.  As the analysis shows, he was thinking quite rationally.  20 GB for $100 was a very effective way of increasing postpaid credit-worthy gross additions.  It’s important to remember that, unlike the Framily plan of 2014, this plan was marketed directly to existing AT&T and Verizon families.  They bring a habit that focused on limiting data usage (including connecting to home and business Wi-Fi) – these conservation practices would not have been broken in the first month or quarter (note: the conservation mindset applied to data only – unlimited voice and text plan components were unchanged).   Unlike the individual usage profile described above, families are less likely to cut all cords, more likely to have High Speed Internet, and plan on keeping some level of cable or satellite TV services.

 

over limit messageWhen family members (or likely the owner of the account) stopped receiving AT&T and Verizon “nearing data limit” messages, household data enforcement slackened.  Samsung began to offer free subscriptions to Netflix with each Galaxy S6 sold, which likely caused a few heart palpitations in Overland Park.  Google continued its improvement of YouTube content delivery, and new applications began to consume more bandwidth (see full list here).  The recipe of faster smartphone processing and additional 2.5 GHz spectrum deployments drove up Sprint’s data usage (we have modeled ~50% increase, and have heard from wireless carriers that data growth is likely to be 40-60% for 2016).

 

When the promotion rolls off, ARPU jumps to $160 (using four lines).  Even with a healthy growth in data (and a slight decrease in SMS volumes due to increased use of data-focused messaging services like WhatsApp and iMessage), overall gross margin rebounds to 53%.  To achieve a similar gross margin percantage as Sprint had with the $100 promotion, family data usage would need to increase to 10 GB (think about this when Verizon announces earnings results next on Tuesday).  Even with the assumptions outlined above, full utilization (all 20 GB) would still be marginally profitable (single-digit percentage gross margins).

 

Bottom line:  Family plans are more sustainable than unlimited individual plans because they depend on generationally-driven usage patterns and in-home/ in-building Wi-Fi established connectivity habits.  The shift from usage to breakage (even with Rollover/ Stash plans) paves the way to family/shared plan sustainability.

 

What About Wireline?

Much of today’s discussion about the future of unlimited is focused on wireless.  There are several cable companies (e.g., Mediacom and Suddenlink) who have high data caps today to rein in a very small percentage of users.  Those who exceed caps pay additional fees for blocks of additional data.

 

AT&T, however, is finishing up Project VIP and should obtain approval to purchase DirecTV shortly.  This will allow their DSL infrastructure improvements to be focused on faster data for more people.  What if AT&T pulled a T-Mobile on the cable industry and offered a Simple Choice High Speed Internet equivalent Max Plus 45 Mbps  plan with no contract for a $99 one time fee and $29.99/ mo. [as a way to entice new AT&T wireless customers], with the only catch being a 40 GB cap ($15 for next 40 GB)?  Could the traditional DSL providers (especially those with wireless offload needs) be a thorn in cable’s side as they use a low cap to grab market share?

 

The simple answer is yes.  Speed sells, and AT&T could pair in-home Wi-Fi just as easily with a Mobile Share Value plan as they could with voice or TV.  It is very possible that an activation fee + low monthly charge with a cap could become the pricing norm for wireline just as it has for wireless.  Given the financial return requirements AT&T faces for Project VIP, they will need to price/ postion the product to make themselves one customers would try before making the change from cable.

 

As we have written about on several occasions (one recent article here), eventually High Speed Internet caps will be as common for wirleine as they are for wireless.  And with robust in-home and in-office Wi-Fi growth, it only takes a few years for a household using 25 GB/ month to be at 50 or 75.  It’s still a few years out, but High Speed Internet value options will emerge as twisted pairs lie fallow, and cable will be forced to respond to telco’s new pricing structure.

 

Bottom line:  Metered usage is the hallmark of any utility, and High Speed Interet is quickly moving to utility status.  Whether wireless or wireline, truly unlimited plans will soon be museum artifacts.

 

Next week, we will examine Verizon’s and AT&T’s earnings.  It will be a study in incrementalism.  After their reports, we should have good idea of who stole market share from whom (Spoiler alert: T-Mobile won).  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 enjoy the remaining weeks of summer!