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Monthly Archives: November 2015

Third Quarter Wrap-Up and Sprint’s New Leasing Structure Explained

lead pic (9)Pre-Thanksgiving greetings from Chicago, Charlotte, and Dallas.  Unfortunately, the Jesuit College Prep football playoff run came to a halt on Friday evening with a 38-27 loss to Rockwall.  What a memorable season.  On to the December exams, finishing college applications and spring rugby.

 

This week, we will wrap up third quarter earnings with four earnings items you may have missed.  We will also analyze Sprint’s leasing announcement that came out on Friday.

 

Please note that we will be taking a break next week for Thanksgiving.  We are thankful for the several dozen referred email subscribers in the past month.  The website traffic has also been nothing short of incredible with over 600 unique visitors from 28 countries so far in November.

 

Four you may have missed

 

  1. iPad Pro Repositioning – It’s Not a Laptop Substitute. There’s a lot of things going on with the iPad Pro launch and none of them are good.  First, this article from CNET covering the supply chain constraints for the iPad Pro launch (a lot to read and absorb here).  Second, while the tablet is generally available (32 GB Wi-Fi version with only a few days of backlog), the accompanying Apple Pencil and Apple Keyboard are delayed 4-5 weeks (!).  Finally, reviews are mixed (see this one from Wired and this one from Engadget which declares the latest device “not a laptop substitute”).  It’s unclear what effect this will have on other iPad sales (likely little) but the iPad Pro is not off to a good start.

 

  1. Binge On news continues. Computerworld ran a great article on how T-Mobile’s adaptive bitrate technology works.  We also recommend this Bloomberg article where FCC Chairman praises Binge On as “highly innovative and highly competitive.”

 

  1. Great article on the formation of Verizon’s Go90 from Fierce Wireless. Caution: it’s lengthy, but terrific insights into the formation of their video service.

 

  1. Our interview with Dan Meyer at RCR Wireless. Part if our continuing effort to assist those suffering from insomnia, it’s a video version of The Sunday Brief.  Full interview here – full dosage kicks in at 13:30.

 

Is Sprint’s Leasing Arrangement a Competitive Advantage?

On Friday, Sprint announced a new leasing structure which could provide the company with a global competitive advantage.  Here’re the highlights of the structure:

 

  1. sprint cash flow exampleCustomers lease the latest and greatest phones from Sprint. Depending on the device and term, the lease could run $12/ month cheaper than a conventional Equipment Installment Plan (EIP).
  2. Sprint enters into a sale/ leaseback agreement with to new company called Mobile Leasing Solutions, LLC (MLS). Part of the proceeds are held in reserve to cover nonpayment and other items (in the case of this transaction, it’s approximately 7.7% of the entire facility).  This company is partially owned by Softbank, who also owns Sprint.  Brightstar, also owned by Softbank, assisted in staffing and providing systems to Mobile Leasing Solutions.
  3. Brightstar has the contract to distribute and remarket devices as they come off lease. Brightstar will keep the first $XX of profits (an unknown but important number) per device remarketed.  All profits above this number will go back to Sprint.
  4. Foxconn (not owned by Softbank) has entered into an agreement with Brightstar to purchase the leased devices (note: Foxconn’s purchase price, as we will discuss below, is not necessarily the difference between the device’s original MSRP and the cumulative payments. It is likely a fraction of this figure).
  5. Using a third party in the lease transaction prevents Sprint from using a lease structure to improve their EBITDA.
  6. Most importantly, Sprint can use this financing structure to improve their short-term cash flow. Phone purchases represent the largest single cash expenditure for Sprint.

 

The question posed by many after the announcement was “How will this structure impact overall profitability (in this case, operating margin)?” Here’s an example to help you think through the transaction:

 

Example:  Customer leases an Apple iPhone 6S for $15/ month for 22 months (regular lease price is $22/ month; total cost of phone is $650).  The residual value of the device is $166 ($650 less 22 payments of $22).  A traditional Equipment Installment Plan option is also available at $27.09/ month for 24 months.

 

  • If the contract were sold on the day the customer signed up and assuming the current terms of the contract were used ($1.3 billion in phone value, $1.1 billion immediate cash proceeds, $1.2 billion including holdbacks and other considerations), Sprint would have sold the device to Mobile Leasing Solutions for roughly $600 (92.2% of $650). Another $50 or so would be held by Mobile Leasing Solutions in abeyance until (some portion of) the lease payments have been made by the customer.  Mobile Leasing Solutions now owns the device.

 

  • Brightstar purchases the phone trade-in from Sprint for a pre-determined amount (this would be consistent with the commercial rates between the two companies). For purposes of this example, let’s assume that the purchase price is $154.  Sprint receives cash, and Brightstar receives all of the risk (and reward) of repurposing the trade-in.  Sprint should have a deferred asset (prepaid expense) account for the difference between the lease and the sale price just as they do for their Equipment Installment Plans (see next bullet point).

 

  • Sprint passes on a $22 lease payment to MLS each month. Sprint records this as an equipment revenue with an offsetting lease expense.  Sprint should have already recorded the discount between the $22 lease payment and the $15 sale price as a deferred asset when the trade-in was sold to Brightstar.

 

  • Up to this point and throughout the lease payment process, there’s a $5.09/ month ($27.09 EIP price less $22 lease rate) advantage to the customer (and competitively for Sprint) from this financing vehicle versus a traditional Equipment Installment Plan. The only time Sprint would enjoy an additional competitive advantage is when Verizon or AT&T’s receivables rate is lower than 7.7% (and the 7.7% assumes everything is paid on time).

 

  • After the 22 months have passed, the customer could do several things. The most likely situation is that they exit the lease and enter a new lease on another device.  At this point, MLS redistributes the device globally to the highest bigger through Brightstar (backed up by Foxconn if there are no buyers).  Once this has happened, the lease facility can be replaced by another lease.  Again, Sprint has no recourse at this point – the residual value risk is solely borne by MLS and Brightstar.  Sprint does, however, have upside if the device value exceeds a certain rate.

 

  • If the customer decides to buy the phone after the lease period has ended, MLS would take payment, and neither Brightstar nor Foxconn would have any additional activities.

 

  • If the customer continues to pay lease payments (presumably at $22/ mo.), the residual value would reflect the new total.

 

This financing structure works for devices where the projected residual value of the device is high.  There are only a few devices that Sprint will offer for lease at any given time.  For example, the iPhone 6, 6 Plus, and 5s are not available for lease today– only EIP.  Same for the HTC M9 and Samsung Galaxy S5.

 

Bottom line:  Sprint’s new leasing vehicle is interesting and definitely takes advantage of Softbank’s value chain ownership.  It also provides Sprint some short-term incremental cash, both from the sale of the new phone contract and the value of the trade-in.  It becomes a competitive advantage if 1) Sprint can extend this construct to the broader line-up of devices (which seems highly risky); 2) Sprint can use the lease payment as a promotional tool (e.g., lower or no lease payments for the first three months) or 3) if Sprint can improve the rate it receives for the lease contracts from 7.7%.

 

Of greater interest (pun intended) than the lease payment was the disclosure of the transformation costs and their effect on 2015 EBITDA and Operating Income.  The charts below show the impact to earnings guidance:

sprint guidance ebitda op income

Based on these charts, it appears that transformation and program costs will be in the $400-450 million range.  Not all of this is headcount, but if 60% of this figure is related to severance payments (of ~ $80,000 per separated employee), this appears to be a 3,000-3,400 person reduction in force.  As we have stated in previous Sunday Briefs, the surgical removal of this amount of employees on the back of nearly eight years of cost containment under Dan Hesse and Bob Brust/ Joe Euteneuer is going to be very difficult (5-star Sudoku level).  Inevitably, Sprint’s dealer relationships, front line retail relationships, and customer service are going to be impacted.  It’s also possible that there are some workforce responsibility changes/ alignments as Sprint moves on to its next task: structuring its network leases.

 

Meanwhile, T-Mobile continues to Binge On, Verizon continues its aggressive winback/ switching campaigns, and AT&T bundles everything it can with DirecTV.  The incentive auctions are just around the corner, and 2016 is a Presidential election year.  Sprint is involved in a dynamic industry in its quest to create a competitive advantage, and time is running out.

 

Next week, we’ll take a break for the Thanksgiving Holiday and be back with three final 2015 Briefs focused on creating competitive advantage.  Until then, please invite one of your colleagues to become a regular Sunday Brief reader by having them drop a quick note to sundaybrief@gmail.com. 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 Go Davidson Basketball!

The Sunday Brief: The State of Wireline through the CenturyLink Lens

BataclanSomber November greetings from Austin and Dallas.  Our hearts go out to all Parisians affected by Friday’s attacks.  Regular readers of this column know that I am a frequent traveler to the “City of Lights” and as a result the images have been personally shocking.  We hope and pray that the city will recover and that the terrorist perpetrators will quickly be apprehended and brought to justice.

On a brighter note, several of you sent me messages on Saturday asking about the outcome of Friday’s Jesuit College Prep high school football playoff game.  The Rangers defeated Mesquite Horn 42-21 in an exciting match that featured a goal line stance (by Horn) and a 96-yard interception for a touchdown (by Jesuit) in the first half.  The high school playoff scene in Texas is unique and accelerates with each advancement.  On to Rockwall next Friday!

This week, we are focusing on the state of wireline connectivity through the lens of one of the largest US providers, CenturyLink.  We’ll also provide some initial thoughts on T-Mobile’s inclusion of video streaming services in the majority of their plans.

 

Verizon’s Response to Strategic Asset Sale:  “Factless…Conjecture… Speculative… No Foundation”

 

Fran Shammo was interviewed this week by Jennifer Fritzsche from Wells Fargo Securities as a part of Wells Fargo’s annual Technology, Media & Telecom Conference (transcript here).  Fran spoke on a wide range of topics and reiterated many of the same points covered on Verizon’s third quarter earnings call.

When discussion came to the possible sale of data center assets, Fran was extremely succinct in his response:

I think these are the same reporters and bankers who keep telling me I’m going to buy Dish. They are factless, they are conjecture, they are speculative, and there’s no foundation behind these comments. So the question I kind of wonder about is are our competitors trying to get the enterprise customer a little antsy about Verizon and their continued support? I think we’ve shown it. This is part of our portfolio and we will continue to support our enterprise customers. These rumors and speculative information is just ridiculous, so there’s really no comment to make beyond that.

 

Fran also went on to talk about capital spending, stating that there would be a higher allocation of wireless spending in next year’s $17.5-$18.0 billion range (which he reiterated would be closer to $17.5 billion due to the divestiture of FiOS assets to Frontier in California, Florida, and Texas).  He also indicated that enterprise wireline (data center) growth would be organic in nature and customer driven (Verizon is already spending several hundred millions of dollars per year).

Having tracked Fran’s comments for six years, there are several things to read into both his comments above and throughout the transcript as it relates to wirleine.  First, Verizon clearly sees growth in areas of wireline, and they are attempting (through a tough stand in union negotiations) to make the case for a  concentrated and scalable cost structure.  This is the only way they believe that they can right the share-of-decisions ship against cable.

Second, Verizon is walking a pricing tightrope – they need to find the optimal price point to maximize profitability.  As many economics majors know, being a 42% (Verizon FiOS Internet share; video is lower at 36%) participant in a duopolistic structure might be the best mix that they can achieve in their FiOS regions.  That is, until Comcast, Time Warner, and Cablevision begin to challenge their postpaid wireless business.  Then all bets are off.  More on this topic in December, but it appears that Verizon has some capital/cash flow opportunities in wireline which they could use to improve the deteriorating enterprise situation that we documented last week.

 

CenturyLink:  More Speed = More Capital Need

CenturyLink (CTL) announced earnings on November 4.  For those of you who are not familiar with thecenturylink map company and its transformation, CTL started their most recent phase of inorganic growth in 2008 with the acquisition of Embarq Communications (EQ was a spinoff of Sprint’s local telephone operations).  In 2010, CenturyLink acquired Qwest Communications, yielding today’s national foorprint (see nearby network map), and followed that up with the acquisition of cloud and data center provider Savvis Communications in 2011.

From these mergers came a lot of integration activity.  Savvis became CenturyLink Technology Solutions in 2014, and was later folded under the CenturyLink Business organization in 2015 (note: unlike Verizon, the topic of last week’s Sunday Brief, CenturyLink appears to be holding their own on the Gartner ratings – for more information see here).  Qwest, Embarq, and legacy CenturyTel continued to streamline and centralize operations, and in 2014 CTL began a more aggressive expansion of its Gigabit-capable Passive Optical Network to better compete with cable High Speed Internet solutions.

CenturyLink’s earnings were driven by several dynamics which are not unique to many of the US wirleine providers:

  1. Legacy voice and special access (T1, DS3) revenues are quicky being replaced by wireless or cable alternatives.
  2. New revenues are not growing (in absolute terms) as fast as legacy revenues.
  3. Cost structures are not dropping as fast as legacy revenues. In particular, programming cost structures for Prism TV, CenturyLink’s IPTV product, are challenging overall consumer margins (meaning more growth may not lead to scale-like margin growth).

All of these things came to fruition in the latest earnings report.  On the CenturyLink Business front, strategic revenues have actually fallen by 0.7% over the last eight quarters (overall revenues have fallen 5.9%), while costs of service have risen 1.8% (more here – see pages 9 and 11).

The Consumer business is a lot better thanks to GPON and Prism (driving strategic revenues up 11.7% over last eight quarters).  Overall Consumer revenues are essentially flat, however (0.9% growth over the past eight quarters), and costs are rising thanks to programming and labor increases (up 2.0%).  A better story than the Business segment, but lots of room for improvement.

To resume mid-single digit growth, more capital is needed for GPON and Prism deployments.  While the company has deployed Fiber to the Premise solutions to 490,000 businesses, there are needs for at least another 200,000 builds.  The same capital need exists as CenturyLink expands from their 780,000 residential footprint.

This capital fight is going on across the traditional wireline provider community as cable continues their march to Gigabit speeds with the introduction of DOCSIS 3.1 (see Cox’s September announcement here).

uses of cash flow ctl

Look at the nearby chart which outlines CenturyLink’s actual uses of operating cash flow in 2014.  Capital expenditures of $3 billion equated to 16.7% of total operating revenues, a figure that would be fine for most cable companies (Comcast’s 2014 cable segment capital spending was in the 16-17% range), but for cable and collocation (especially in the growth stage that CenturyLink is currently in), the figure should be higher (~$3.6 billion if CyrusOne’s cap ex to revenues ratio is used).

 

This is why CenturyLink’s strategic assessment of their 58 collocation centers makes a lot of sense.  The capital intensity per dollar of revenue compared to traditional (or even new) network spending is close to 3x.  The dividend from competitors is lower than CenturyLink’s current yield (CyrusOne = 3.39%; Equinix = 2.51%; DuPont Fabros = 6.29%; Rackspace does not pay a dividend).  And network spending needs to increase to ensure the value of the local exchange franchises remains intact.  Provided that they can work a deal that allows more capital and time to be spent on value-adding data analytics service companies that they have bought, a partial monetization of this asset makes a lot of sense for shareholders and customers.

 

Binge On!

T-Mobile announced across the board changes in their pricing structure (including a $15/ month spike TableSimpleChoiceAmped_lowhere).  Binge compresses the video feed to 480p speeds which is probably good enough for all but the highest-end smartphones (with 5.5” or larger screens).

Both Sprint and AT&T were quick to question T-Mobile’s network capabilities and overall business model at the Wells Fargo industry conference (more from this FierceWirless article).  Sprint CFO Robbiati’s prediction that “the hangover will come” was the headline – if it doesn’t, Sprint’s subscriber growth will most certainly dip back into negative territory.

Network armageddon is unlikely unless large amounts of customers are simultaneously accessing Netflix or Hulu from the same cellsite.  Even then, it would need to be a disproportional increase (which would correspond to supernormal subscriber growth) to materially impact overall service quality.  The likelihood that issues will emerge in a particular market (e.g., New Orleans where T-Mobile has a low RootMetrics raing) are higher, but the chances of this happening systemwide are remote.  We’ll include more on Binge On after trying it out firsthand, but it’s very unlikely that the service quality is going to inhibit service adoption.  Explaining to customers that T-Mobile will not be able to control service quality in a Wi-Fi environment, and removing the “10 GB for all” and “Two for $100 unlimited” offers are likely to be more concerning to customers.

Net-net, T-Mobile stole the show for the fourth quarter with Binge On.  They will likely affect cord-cutting with their Sling $14/ month promotion, and every other carrier (but particularly Sprint) has to respond to their video-centric pricing structure.  This is not a promotion, but a strategic necessity for the #3 provider.  It just happens to also be one that will super-size their postpaid customer base and raise ARPU.

Next week, we’ll comb through the remaining third quarter reports for additional insights.  Until then, please invite one of your colleagues to become a regular Sunday Brief reader by having them drop a quick note to sundaybrief@gmail.com. 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 Go Jesuit Rangers!

 

 

Sprint’s Comeback (?)

kc victory parade 2November greetings from Atlanta, Charlotte, Long Island, and Dallas.  The lead picture is unaltered and reflects an enormous outpouring of fan support (800,000 estimated attendance) for the World Champion Kansas City Royals after their Game 5 victory at Citi Field last Sunday.  It’s been a thirty year wait for the return of the Crown to the City of Fountains, and the celebration was truly grand.  Kudos to the team, fans, police (only three arrests – another testimony to the fans), and owners for creating a lifetime memory.

 

This week, we’ll explore Verizon’s announcement that they might shed $10 billion worth of assets to further focus on wireless and media, and take a look at Sprint’s mixed earnings release.

 

Verizon:  No Backbone?

On Friday afternoon, Reuters reported that Verizon was considering the sale of up to $10 billion in wireline assets that include their MCI enterprise division (domestic and global) as well as their Terremark data centers (including the flagship NAP of the Americas).  This comes on the heels of CenturyLink’s disclosure earlier in the week that they will likely sell off most of the Savvis data center assets, and Windstream’s sale of their data center assets to St. Louis-based TierPoint.

 

How could something that was so valuable and strategic in 2011 turn into an albatross four years later?  Was the “everything-as-a-service” strategy that promised secure yet speedy connections a failure?  What are the implications of this to FiOS (residential and business fiber services in the Northeast) and to their main wireless competitor, AT&T?

 

The answers to these questions are found with a basic examination of the enterprise market:

  1. Voice, the primary source of enterprise revenues a decade ago, has moved from being circuit to packet-based. New architecture costs are fundamentally cheaper, and business opportunities have changed from being end-to-end service providers (retail) to being experts in circuit-to-packet translations (wholesale).  This is the primary component of the “secular changes” frequently cited by Verizon management in quarterly earnings calls and presentations.
  2. Cable is providing increasing competition to AT&T and Verizon’s DSL connection alternatives. In the very small business (less than 50 employees) and small business segments (50-500 employees), DSL and SONET-based connectivity was the standard.  Now it’s split between DOCSIS (capable of delivering at least 50 Mbps circuits to most locations for $70-90/ month) and DSL (service availability varies; costs vary; highly priced voice circuits might be required).  Verizon made several comments over the past decade that they struggled with figuring out the small business segment.  Comcast, Cablevision, Cox, Bright House and Time Warner Cable solved that equation.
  3. gartner magic quadrantMost of the major cloud competitiors (IBM/Softlayer, Amazon, Microsoft Azure, Google) do not sell or market end-to-end backbone connectivity to enterprise customers. Their focus is on delivering highly reliable, scalable and affordable computing services.  Nearby is shown Gartner’s Magic Quadrant for Cloud Infrastructure as a Service.  Verizon slipped in May to the “Niche Player” category (they had previously been consistently viewed as one of the Visionaries), joining the ranks of NTT, CSC, Virtustream, Rackspace, and others.  Interestingly, Verizon has been consistently slipping over the years in their “Ability to Execute” rating.  This perception does not bode well for the potential buyer unless they are a current visionary or leader.
  4. Lastly, the number of Corporate Liable (CL) wireless devices is shrinking as a percentage of total enterprise connections. Given this “Bring Your Own Device” or BYOD trend, the age old argument that wireless services are “pulled through” because of a robust wireline product portfolio is becoming less meaningful.   Also, Verizon and AT&T continue to dominate what remaining corporate wireless spending remains due to Sprint’s increased focus on retail (consumer) footprint expansion, and T-Mobile’s limited success above the 500 employee level.

 

With these and other factors as a backdrop, the question now becomes “Who buys what assets?”  Is it a foreign carrier who wishes to establish an enterprise foothold (and it would be a significant one) in the United States?   Or is it someone like Level3 Communications, who would be able to use these assets as a competitive differentiator against Zayo and AT&T, particularly in the Federal space?  Or could it be an entirely different entity such as a systems integrator who orchestrates a rollup of data center and backbone assets to compete against Amazon and Microsoft?

 

The simple answer is that it depends on how these assets are being packaged.  At the end of the process, Verizon will be more domestically focused on expanding their leadership in wireless services.  More capital for Verizon means more spectrum and faster speeds.  Their ability to build a bigger “moat” around their 111 million retail connections just got a lot better.

 

Sprint’s Comeback (?)

From a casual view of Sprint’s third quarter earnings report, another Kansas City comeback is in full swing (puns intended).  They were able to hit very strong retail postpaid subscriber additions of 553K, with tablets being 228K (41%), hotspots and other connected devices being another 88K (16%), and converted retail prepaid subscribers totaling 199K (36%).  This leaves a small but positive 38K gain which can be largely attributed to Sprint’s aggressive iPhone 6S lease promotions (although many of The Sunday Brief readers think there could have been additional positive movement from WiMax to LTE transitions for data-centric devices and perhaps a few phone stragglers).

 

In addition to the positive postpaid phone additions, Sprint pitched very low monthly postpaid churn of 1.54% (likely due to their large base of 3.1 million tablets which tend to have lower ARPUs and churn, but also a testimony to the dust clearing on the Network Vision project).  Without a doubt, churn is headed in the right direction.  In addition, CEO Marcelo Claure stated that the prime mix was the highest September quarter in seven years.

 

Sprint went on to tout several recent reports which show them to have improving network quality and  data latency.  The company now has 12 devices (11 smartphones) that are capable of carrying Sprint’s 20×20 MHz super fast network (iPhone 6S and 6S Plus are two, and the HTC M9, HTC One A9, LG G4, LG G Flex II, and Samsung Galaxy S6/ S6 Edge/ S6 Edge +/ Note Edge/ Note 5 round out the smartphone list).  Sprint is introducing this faster network configuration to 80 markets by the end of the year, and the results of initial testing have been very positive (if customers have a compatible device).

 

Positive phone net additions + lower churn + network progress.  Is this enough “small ball” to tie the game in the ninth and send it into extra innings?  Two schedules tell the tale.  First, because of the myriad of accounting treatments due to changes in device financing, it’s necessary to look at the statement of cash flows (Sprint includes this in their detailed financial schedules).  Here’s the roster of progress over the past 6 months compared to the same period in 2014 (when they were finishing up their Network Vision upgrade):

sprint cash flowThe storyline is mixed at best from the statement of cash flows analysis shown nearby.  Cash provided by operating activities barely grew even with $1.5 billion in operating expense reductions that started last fall.  The effect of the leasing program is clearly seen in the $1.1 billion leased devices investment (re: this is a six-month figure – the twelve month figure is $1.7 billion).  And net debt rose a few hundred million dollars as a result.

 

The net result of several years of 2014/2015 activity  would be a juggling act comprised of expense reduction, metro-focused network expansion, and net additions if Sprint did not carry $34+ billion in total debt and $542 million in quarterly interest payments.   It’s a hard slog, but a winnable equation if it weren’t for those bondholders.

 

Sprint is not a debt free company, however, as the purchase of the Sprint and Nextel affiliates along with the costs of the Vision upgrade added over $18 billion of debt over the past decade (more here – see selected financial data on page 33).  Sprint disclosed their near-term debt obligations in their earnings discussion.  Over the next six months, $700 million of debt will either be repaid or refinanced.  That figure jumps to $3.7 billion in fiscal year 2016:

sprint cap ex liquidity slide

As he was presenting this slide, CFO Tarek Robbiati indicated that the December quarter would likely involve a similar use of cash as the June quarter, when the company consumed $2.0 billion to further their growth plans.  If the expected leasing facility is delayed by more than a few weeks, Sprint’s near-term liquidity issues will reach an acute level just as customers enter Sprint’s new stores for Black Friday specials.

 

There is no doubt that Sprint has made a lot of progress over the past year.  Several questions remain, however, that challenge whether Sprint has any intrinsic equity value:

 

  1. Can Sprint repay or refinance $4.4 billion worth of debt, pay $1.2 billion in restructuring costs and continue to grow the business? If they refinance, how will total cash interest be affected and what additional covenants will be placed on the company?  (How) Will these covenants affect the forthcoming lease facility?
  2. Will the (~$12) monthly payment difference between phone leasing and Equipment Installment Plan (EIP) purchasing attract customers away from Verizon and AT&T (see the differences in last month’s Android World write-up)?
  3. How will Sprint market their carrier aggregated network (except through Reddit posts like the one found here)? WWJLD (JL are the initials for T-Mobile’s CEO)?
  4. Can a “match T-Mobile” strategy reduce Sprint’s total marketing spending? In the third quarter, Sprint introduced elimination of overages on family plans (throttling back to 2G speeds), incorporation of unlimited streaming music into select Virgin Mobile plans, Mexico/ Canada callling plans, and the establishment and aggressive marketing of a 1GB high speed level with extra data purchase options or throttling after that.  Whether Sprint can ride T-Mobile’s Uncarrier X wake is yet to be seen.
  5. Can Sprint eliminate in-city or area roaming and retain high call quality? See here for Sprint’s Scranton (PA), Harrisburg (PA), Ann Arbor (MI), and Madison (WI) 2H 2015 Root Metrics reports.  Without voice roaming (on Verizon), can Sprint hold their call quality ratings?  If not, does Sprint face greater concentration risk in larger metropolitan areas and in essence reduce themselves to become a regional/ metro-only carrier?

 

Theoretically, the value of any company equals the present value of total projected after-tax discounted cash flows (on a long-term basis) plus a terminal value (based on competitive differentiation and overall industry growth) minus the value of debt.  Given Sprint’s current market value of $18 billion (and debt of $34 billion), the market (and the analysts who support institutional buyers) is currently assuming $52 billion of after-tax cash flows from Sprint.  Even with rosy estimates, I cannot get close to this figure, and will gladly open up this column to someone who can rationally explain a $52 billion case.

 

Sprint has new owners, a new GM, and an entirely new lineup, but they have fallen in the standings and are behind.  Given four quarters of positive trajectory, can they turn base runners into runs?  It will require a miracle not seen since the Royals Game 4 division win against the Astros or 2014’s miracle hit in the Wild Card game against the Oakland Athletics.  And, even if they win more games (and I expect Sprint will post strong fourth quarter results), can they win the Series?  If they can, it will overshadow the Royals comebacks of the past two seasons and draw a fan base of customers far larger than that in the lead photo.

 

Next week, we’ll dive in to the world of the Local Exchange providers (CenturyLink, Windstream, and their AT&T/ Verizon counterparts) and provide some thoughts on how they can win the broadband war.  Until then, please invite one of your colleagues to become a regular Sunday Brief reader by having them drop a quick note to sundaybrief@gmail.com. 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 Let’s Go Jesuit Rangers!

 

Here Comes Cable!

sal perez 8th inning game 4Royal November greetings (a jubilant Salvador Perez pictured after his hit in the 8th inning of World Series Game 4; Photo courtesy of The Kansas City Star) from Kansas City, Charlotte, and Dallas.  One more win…  This week we’ll look at earnings from T-Mobile and several cable companies.  We’ll also talk about the Google’s potential combination of Chrome and Android operating systems.

 

Google Merges Chrome into Android

The Wall Street Journal reported this week that Google will combine their Chrome and Android development teams with the goal of releasing a single system in 2017.  This change is not trivial, and indicates that development teams have bridged many of the gaps that have traditionally kept laptop/ desktop and tablet/ smartphone operating systems separate.

 

Many questions arise from this news.  First, it’s no secret that the adoption rate of Android releases has been much slower than their Apple counterparts (see nearby chart – note that KitKat, which was released in September 2013, continues to be the most frequently installed version).  Can Google use the consolidation with Chrome to tighten up concentration?  This, of course, assumes that Google will be able to continue their annual pace of major Android releases.

 

android version chartQuestions also arise about the future of Chrome from this announcement.  Google was quick to state their support for Chrome on Friday after the WSJ report came out, and many tech publications actually stated that the end state might be the continuation of Chrome and Android plus the formation of the hybrid operating system (the “something for everybody” scenario that Google loves to deploy).

 

There is no doubt that the characteristics of operating systems (touch vs. type, screen rotation, zoom through pinching, etc.) are trending mobile.  But there are a lot of reasons why iOS and Mac OS will likely remain separate for the foreseeable future on Apple devices.  A good indicator of adoption will be when Apple launches their 12.9 inch iPad Pro in mid-November.  If developers begin to balk at the requirements of the extra large screen, look for Apple to make changes that begin their own merging process.

 

T-Mobile’s Enlarged Territory

T-Mobile announced earnings on Tuesday morning (full details here), and held a lengthy earnings call that covered all aspects of their operation.  The bottom line is that T-Mobile added 895,000 net new postpaid retail phone customers (185,000 of these came from T-Mobile’s prepaid base) on top of 595,000 net new additions of retail prepaid subscribers (also inclusive of migrations to postpaid).  Postpaid churn came in at 1.46% which was up sequentially but down from 1.64% in 3Q 2014.

 

Most importantly, T-Mobile grew service revenues sequentially at 2.6% and annually at 10.9%, a reflection of the state of their transition from subsidy-based to EIP/ lease plans.   They also did this while decreasing Cost of Service sequentially (down $19 million) and annually (down $110 million).

 

While these results were strong, they missed many analyst expectations that were likely elevated by the preliminary net add figures shared by CEO John Legere at a mid-September investor conference as well as perceived momentum heading into the launch of the Apple iPhone 6S.  T-Mobile COO Mike Sievert stated on the earnings call that this was the “best quarter ever” for iPhone sales (measured as a percentage of total sales), so it’s likely that the issue was not selling, but rather fulfilling backlogged orders (see our post-iPhone launch coverage for the trends; provided that customers did not cancel their orders, T-Mobile has a robust launch backlog that it will continue to fulfill into November).

 

T-Mobile showed excellent discipline and focus throughout the summer, building their LTE network to 301 million POPs, and adding New York City, Portland, and Seattle to the 700 MHz coverage footprint.  The company also announced that they came to an agreement for 700 MHz deployment in several new markets covering an additional 20 million POPs, including Phoenix, Tucson, San Diego, Las Vegas, Norfolk, Baton Rouge, New Orleans, Fayetteville, Macon, and others.  They had a strong month in tablets (242K net additions), but did not try to juice the number with end of quarter promotions.  Spending scarce marketing dollars on acquiring the most profitable [phone] customers is a good thing to do, and building a farm team of potential postpaid retail subscribers through the prepaid channel is good business.

 

Even bigger than the addition of 20 million 700 MHz POPs, however, is the sheer growth in the footprint.  T-Mobile’s marketing messages reflect this:  Over 1 million square miles of LTE coverage have been (or will be) added in 2015.  John Legere recently commented that 260,000 new homes will receive T-Mobile network coverage each week in the fourth quarter.  As we have commented on previously, this creates a large “new store” (as opposed to “same store”) sales opportunity for T-Mobile at the end of 2015 and throughout 2016.

t-mobile coverage change

 

walmart family mobileWe’ll take more time with this in a future Sunday Brief, but it is clear from comments made on the call by T-Mobile CFO Braxton Carter as well as a disclosure about sequential sales and marketing expense increases that T-Mobile is investing heavily in these new territories.  As we have discussed previously, not only will they have to convince previous T-Mobile customers that they can deliver a parity (or superior) network experience, but that they can sustain that experience as they continue their rapid growth.  To a lesser extent, T-Mobile will have to convince Wal-Mart as a channel of the same items above as they revamp their Family Mobile plans (see nearby screen capture of their current compelling rates).

 

Bottom line:  Another strong quarter from T-Mobile.  With Metro PCS integration nearly complete (the last of the transition expenses should be reported in the fourth quarter), and 93% of subscribers already on Simple Choice plans, the new focus for T-Mobile is on territory expansion.  There’s no one better for secondary and tertiary market retailing than Wal-Mart, particularly during the Holiday season.  It’s a double tailwind that none of their competitors have as we exit 2015.

 

Here Comes Cable! 

A trio of the nation’s largest cable companies reported earnings this week (Comcast here, Time Warner Cable here, and Charter here).  Just a few quarters ago, the professional hand-wringers were lamenting the rise of the “Cord Never” segment and projecting their immediate impact on the long-term profitability and value creation capabilities of the industry (even as late as October, Forrester was out with a survey suggesting that in 10 years, half of the under 32 demographic will never have subscribed to a cable video service.  It reminds me of a recent State Farm Insurance commercial).

 

The cable industry faced the dual forces of higher satisfaction from satellite (see JD Power study results here), as well as the long-term secular trend away from residential phone service.  This left one option in the opinion of many analysts:  raise broadband prices while trying to get consolidation approval (and after that, to wring out any cost reduction possible).

 

It seems like someone forgot to tell the cable industry that broadband “Price ups” (a Verizon term) was the only lever left.  Here’s what the net subscriber additions look like for the companies that have reported through October 30:

 

subscriber summary through november 1Charter and Time Warner Cable, on a pro forma basis, are actually growing video subscribers.  With respect to High Speed Internet, the Charter+TWC entity has grown more residential HSI subscribers (363K) than Verizon has over the past three years (and adding in Bright House Networks only makes the total better).

 

This trend cannot continue forever.  After all, DirecTV and AT&T were in the process of merging and they are coming out with fervor in the fourth quarter.  Verizon is in the process of divesting some of their more profitable FiOS properties to Frontier (California, Texas, and Florida).  And voice – everyone knows that the cable companies are just throwing in voice for free to increase their conversion rate – no one is really using the voice product.  These gains are merely temporary and are driven by merger-related activities.  So goes the conventional wisdom.

 

What’s interesting about conventional wisdom is that few in the cable industry listen to it.  Those price hikes – Charter’s data ARPU was up 0.50% quarter-over-quarter (7.3% y-o-y), and Time Warner Cable was up 0.66% (3.7% y-o-y) – hardly the activities of revenue desperate entities but instead the product of increased triple play penetration and customer-requested speed upgrades.  Video is in a secular decline, but it’s being managed through different (skinny) bundles as well as OTT (see this article on Charter’s OTT efforts).

 

Comcast is taking a more expansive task with the X1 platform (which will get its own Sunday Brief this December) rather than withdrawing from the market.  Depending on the outcome of the Cox Communications trials, it might become the de facto standard for cable video transmission.  Purchasing volumes would help the X1 platform enormously.  Satellite providers are taking notice.

 

Then there is wireless, an opportunity no one wants to talk about publicly but there’s lots of private chatter.  Could a cable consortium emerge as a “dark horse bidder” (John Legere’s term)?  Could they actually implement a data-first network that would extend Sprint and T-Mobile signals farther into buildings/ neighborhoods (assuming they were cable broadband customers) while opening up the door to significant Wi-Fi or 600 MHz local coverage?  It would require Radio Access engineering and network operations competence that cable does not have today.

 

Is there a cooperative model that could work between Sprint, T-Mobile, and local cable providers?  Where there’s a will, there’s a way, and it’s been a decade or more since the last major product platform (VoIP) was launched.  Don’t count cable out of wireless – there are too many reasons for the industry to enter – now.

 

Next week, we’ll continue to sort through earnings news as CenturyLink (Nov. 4) and Sprint (Nov. 3) report earnings.  Until then, please invite one of your colleagues to become a regular Sunday Brief reader by having them drop a quick note to sundaybrief@gmail.com. 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 Let’s Go Royals!