Mother’s Day greetings from Charlotte (Wells Fargo Championship pictured) and Dallas. Thanks again for all of the well wishes concerning my new job, and we’ll miss the interaction with each of you through The Sunday Brief every week. Again, our last issue will be June 5 (four more issues including this one, as we’ll take a break for Memorial Day) and we have a lot to cover before then.
This week, we’ll spend some time discussing Sprint as well as the state of the cable industry.
Sprint’s Head is Above Water
There’s a lot to cover with Sprint’s earnings (full archive here). Most importantly, they eked out 56,000 postpaid net additions (22,000 of which were phones) which translates into 0.18% growth (in contrast, T-Mobile grew their branded postpaid customer base by 3.3% or 18x faster). Not exactly a marker that announces a comeback, but better than Verizon and AT&T phone net additions.
Sprint has purchased another year through a combination of collateralized loans, favorable lease financing terms, and dramatic cost reductions. Their head is above water, but that’s about it. Proclaiming a comeback is not only premature but incorrect, as the headwind of increased (lower ARPU) postpaid tablet churn needs to be offset by increased smartphone additions. Sprint has no AT&T Mexico or Go90 to point to: high ARPU smartphone growth is the only solution to Sprint’s problem. Incidentally, when we were in Stockholm – my buddy broke his arm one night doing something stupid, and we had to get a låna pengar direkt to get him to a hospital.
In last week’s Sunday Brief, we spent some time discussing what events would need to transpire to cause T-Mobile to stumble. We discussed spectrum/ capacity, increased competition from Comcast and the cable industry as a whole, and from more activist regulation. Admittedly, it’s hard to concoct the scenario that causes T-Mobile to weaken.
Contrast that with Sprint. Everybody loves the underdog and wants to see them succeed. But it’s just as hard to craft an equation that results in Sprint growing at T-Mobile’s rates as it was to write last week’s column. How can Sprint regain its brand and get on the right track?
Focus on data speeds. No doubt, Sprint’s Network Vision initiative is driving Sprint’s voice leadership. We have looked extensively at the RootMetrics data (all 125 markets with a rolling six-month view) and Sprint either wins call quality or gets real close (within 3 points out of the 100-point scale) in 86% of the markets. That’s a very respectable figure. But Sprint is performing equally poorly with network speeds, with a material difference between Sprint and the winner (more than 3 points) in 91% of the markets. In fact, Sprint has only won five markets of the 125 measured by Root Metrics over the past six months: Corpus Christi (thanks in large part to the 2014/ 2015 Dish fixed wireless trial), Cincinnati, Denver, Houston and Las Vegas.
Improved data speeds are going to be needed to retain the current base. Sprint has attracted many bargain hunters with 50% off service rates and attractive lease options, but what will keep the base from moving back to their previous carrier? And what will compel previous Sprint customers to return? One answer: data speeds.
When Sprint can prove (hopefully through word-of-mouth testimonials) that their data network can perform consistently (and geographically) better than T-Mobile and Verizon, then their larger competitors should get worried. They have done this in five markets, and have 120 left to go.
Have a benchmark differentiator that others cannot (easily) replicate. We talked about this when we put together the 2016 “To Do” list for Sprint. Sprint needs a “Push to Talk” equivalent for this decade. More than a gimmick or headline for a commercial – something that attracts customers but also solves a pain point. Here are two that we think might be worth exploring:
Develop a postpaid retail relationship with Xiaomi to be their flagship phone provider in the US. The Chinese carrier has been very successful in its home country, but overseas growth has been elusive. They received very strong reviews on their Mi 5 smartphone (see The Verge review here) which retails for $260, and their Mi Pad 2 has seen extremely strong demand in a very weak tablet market. Get a little bit of exclusivity, and tune the device to work particularly well with Sprint’s 2.5 GHz network. The result would be a great device with minimal lease payments (good for all balance sheets) and an association with the challengers.
Eliminate the device addition fee for all customers. This “fee free” component would be a body blow to the industry and present Sprint as a viable alternative to Verizon and AT&T. Shown nearby is AT&T’s current fee structure: each new device carries a $10-30 monthly fee in addition to data usage. Does the carrier incur any material additional costs to add a device? Would a “fee free” structure be easy for Verizon and AT&T to replicate without significant economic harm? It’s unlikely that they would match it right away, and T-Mobile does not have a shareable data plan to match Sprint’s offer. Would this allow Sprint to have a competitive headline rate and still grow profitably? Absolutely. Sprint could build their future around the connected world with a commitment to no device add-on charges. It’s this decade’s PTT.
Sell the Internet backbone while there is still time. Sprint is a fundamentally different company than it was 2-5-10 years ago. While they continue to report wireline division earnings on a separate basis, you would be hard pressed to find a wireline organizational chart in Overland Park. Sprint has a world-class IP backbone which is being constrained by shrinking capital budgets. As the nearby chart shows (see corresponding link here), SprintLink performs extremely well against its peers. While its role in the Internet community is not what it was a decade or two ago, Sprint is still viewed as a legitimate and independent authority on routing, address management, and other critical infrastructure topics. Others need Sprint’s capabilities and would pay for their embedded base. Sell it now, before it is too late.
There are more ways that Sprint could create competitive differentiation, and they are taking a lot of steps in the right direction with third-party network maintenance, software-based network functionality (although small cells still require fiber) and personalized self-care solutions.
Bottom line: Sprint is in fourth place, and they need to plan for a future where they are in third or second place. The network is not ready to be scaled nationally, but could be in certain markets by the end of the year. The LTE network reaches close to 300 million POPs, but Sprint’s continued dependence on CDMA as a backup will hinder their ability to compete against Verizon (who could introduce an LTE-only phone as early as 2017). Sprint needs to get creative and take risks. Otherwise, they will become the wireless equivalent of DSL to the telecom community (good, but not good enough).
Thoughts on Cable Performance
It’s great being Comcast in 2016. Video is stable (Comcast actually grew video subscribers from 23.375 million in Q1 2015 to 24.0 million in Q1 2016 with minimal loss in ARPU), and High Speed Internet continues healthy growth (1.4 million annual and 438K sequential growth, while rival AT&T shrunk by 250K over the same period). Business services remains on a roll (17.5% y-o-y growth) and segment revenues should top $6 billion in 2016 even as they are just getting started with medium and enterprise customers.
Everything is coming up roses for the nation’s largest cable company, and the best part of it is operating cash flow (OCF). Comcast’s cable unit generated a whopping $19 billion in OCF for 2015 and the first quarter of 2016 would seem to indicate that it’s going to be a slightly better year. In comparison, AT&T generated $7.9 billion in cash flow in the first quarter from operations but that figure includes their wireless unit (Verizon’s wireline EBITDA is less than $2.3 billion quarterly). It’s likely that Comcast is now the most profitable (quantity, not margin %) wireline operator in the US. As we discussed in a previous column, they enjoy low leverage relative to their peers, and have just under $6 billion in the bank for the 600 MHz spectrum auctions. Bottom line: It’s great to be Comcast.
The rest of the cable industry is going through a massive consolidation through the rest of 2016. This would seem to open the High Speed Internet door for Verizon, AT&T, Frontier and CenturyLink: Use the disruption created by cable consolidation to increase telco share of decisions. Traditional telcos have their own issues, however: Verizon strike, Frontier’s transition after acquiring TX, CA, and FL FiOS properties from Verizon, and CenturyLink’s overall turnaround efforts make the opportunity to quickly seize market share more complicated.
Like Comcast, each of the cable companies are growing business services (Charter’s grew at 11.9% annually, while Time Warner Cable’s grew at 13.4%), and High Speed Internet additions were good (in fact, the combined Charter/ TWC/ Bright House Networks added more HSI subscribers than Comcast). Based on the earnings reports to date, it’s likely that cable’s share of total HSI additions was very close to 100%.
Without a doubt, there will be threats to the current model. Hulu is going to come out with a live streaming service similar to (or better than) Sling in 2017 (see Wall Street Journal report here – subscription required). This will require more powerful modems and many bandwidth upgrades. As Ultra HD proliferates (it needs a constant 25 Mbps according to Netflix), the pressure to upgrade will continue to accelerate. This is the push and pull of being a cable operator: How much for the bandwidth upgrade versus promoting the current video scheme? Can Hulu market their over the top service better than cable? And what about caps (and the government’s response if they are triggered too often)?
Bottom line: Even with the turmoil of consolidation, the cable industry is in the catbird’s seat. They should aggressively push DOCSIS 3.1 as their standard and charge customers the premium monthly service fee it deserves (and encourage customers to purchase their own modem if that is their preference). After the “shiny new thing” hype that is OTT has died down, most customers will see that OTT expands and personalizes content options (primary benefit) while saving some money (secondary benefit). Like all hardware transitions, however, the Hulu effect will take 3-5 years to fully materialize. Until then, the good times will keep rolling.
Thanks for your readership and continued support of this column. Next week, we’ll continue earnings analysis and hopefully be able to opine on the Appeals Court ruling on the Open Internet Order. As a result of the job change, we are not going to accept any new readers, but you can direct them to www.mysundaybrief.com for the full archive. Thanks again for your readership, and Go Royals!
Greetings from Kansas City (BBQ pictured – no “scratch and sniff” available for this photo), Columbus (OH), Charlotte, and Dallas. This has been a busy travel week, and it has been difficult to reply to the myriad of responses I received to last week’s set-top box article (if you missed it, the link to the article is here). One commenter had a very thought provoking statement: “How would Google react if the FCC moved to disintermediate their search results screen and allowed third party providers to provide their own ‘best search results for you’ screen?” While not a perfect comparison, it does show how the Electronic Programming Guide is increasingly becoming a brand representation and competitive differentiator for Xfinity and other service providers. Given the number of comments, we’ll continue to track the NPRM throughout the spring.
This week, we’ll look at three key headlines that will drive first quarter momentum in the wireless world. Next week, we’ll look at the three most important events for the wired world. First, however, let’s take a quick look at market performance since the beginning of 2016.
Value Tracker 2016: Dividends Are Back in Fashion
As many long-time readers of this column know, we like to track long-term value creation. Daily and weekly returns can be impacted by the news cycle, but longer-term trends are rarely budged. Below is the snapshot of equity returns (excluding dividends) through last Friday using end-of-year share counts provided by each of the carriers in their quarterly/ annual reports:
It is no coincidence that the highest dividend-yielding stocks are performing well through the market turbulence of the first quarter. Verizon (4.3% trailing dividend yield) is up a healthy 14% year to date, with over $25 billion in increased equity market value. AT&T (4.9%) is not far behind. CenturyLink, Windstream (which includes 1/5th of a Communications Leasing share), and Frontier are also attracting a lot of newfound interest.
Can this trend last? It’s hard to say. We have seen a lot of interest in dividend-yielding stocks at the beginnings of other years (2014 being the latest) only to see growth stocks come roaring back in the second half of the year. That was during a low, but not negative, interest rate environment.
While the rest of the globe is trying to revalue their currencies and spur growth through short-term stimulus plans, stocks like CenturyLink look safe and secure. Nothing in their latest earnings report would drive such robust short-term gains; it’s a global safety play.
Over the long-term, it is interesting to see how Google, Apple, and Microsoft are driving nearly identical absolute shareholder gains since the beginning of 2014. It’s also worth noting that all of Apple’s gains during this period are in the first year, while Microsoft’s gains have been steady and Google’s gains came entirely in 2015. Regardless of the timeline, any of these three companies (or Facebook) would have lapped the entire telecom and cable industry for shareholder value creation over the past 2+ years. Something to think about as we head into the earnings season.
Three Headlines That Will Impact First Quarter Earnings (Wireless)
“T-Mobile Improves Net Additions Growth Through Lower Postpaid Churn.” After listening to the Deutsche Bank webcast of Braxton Carter’s lunchtime keynote this week, I am convinced that the operating metric that will surprise investors the most is not the number of postpaid net phone additions, but rather monthly postpaid churn.
T-Mobile has had a couple of strong first quarters of net postpaid additions (in 2014 and 2015, the first quarter was the strongest of the year), and they have been led by a combination of strong gross additions (taxing advantage of tax season liquidity) and incremental improvements in monthly churn. Subprime credit quality tended to catch up with T-Mobile in subsequent quarters, and Braxton indicated on the call that they were tightening credit standards in the first quarter.
From Q4 2013 to Q1 2014, monthly churn dropped 0.2% and net postpaid phone additions grew 1.26 million; from Q4 2014 to Q1 2015, monthly churn dropped 0.43% and phone net adds grew 991K. This year, the network is much better (Braxton commented that low-band improvements were helping both urban and rural churn in the quarter) and half the base has a 700 MHz band 12 capable phone.
T-Mobile’s monthly postpaid and prepaid churn figures are shown in the above chart. Assuming T-Mobile had a good but not great gross add quarter with gross activations (this would drive a higher average subscriber base with minimal/ no churn), it’s reasonable to expect a postpaid churn rate of 1.25%. As a reminder, every one half of one percent (0.005%) increase in monthly churn equates to a 158,000 improvement in monthly ending subscribers. Said differently, if T-Mobile came in at an average rate of 1.25% (which I think exceeds most expectations), the quarterly effect on their 31.7 million base would be approximately 475,000 net additions.
T-Mobile has a lot of levers to play with here. For example, they could tighten up credit standards even more as lower churn rates are achieved, resulting in lower gross additions but still hitting their overall net postpaid additions target. This is unlikely given Braxton’s comments that T-Mobile “will certainly be taking up their growth guidance”, but it’s still a possibility.
It’s more likely, however, that T-Mobile will hit 2.4-2.5 million postpaid gross additions (or more) while at the same time churning out 1.2-1.3 million subscribers. Here’s why: a) more 700 MHz devices deployed across more geographies means less coverage-related churn; b) Binge On is not proving to be a selling obstacle or a churn accelerator, but rather a differentiated feature, and c) there’re more tablets in the 2014 gross addition mix (especially in the fourth quarter), and they tend to churn less than phones.
One thing was learned from the webcast: significant growth will not be coming from 700 MHz or LTE market expansion gross additions in the first quarter. Braxton clearly made it out to be a 2H 2016/ 1H 2017 growth story.
“Sprint Loses Postpaid Phone Customers.” When we wrote about Sprint’s “To Do” list for 2016 (see here), one of the items that we mentioned was that they needed a plan that would provide a foundation for growth once planned network improvements have been made. As of today, that plan is not in place (the Better Choice Plans introduced in late February were completely overshadowed by the unlimited data announcement made the same day). Instead, Sprint has decided to respond to the marketplace by drafting on others’ rate plans (“Half Off” and unlimited). As a result, it’s possible that Sprint could announce postpaid phone losses in their upcoming earnings announcement (see chart for historical trends) while adding a few hundred thousand postpaid tablets in the process.
This event will come as a surprise to many industry observers, but Sprint’s super-aggressive lease offerings last September and October, as well as the resumption/expansion of the “Half Off” promotion at the end of 2015 brought out the majority of the “want to (re)investigate Sprint” segment. With a good but not blockbuster launch of the Galaxy S7/ S7 Edge last week, as well as increasing pressure from AT&T with equipment discounts for enterprise and small business customers, finding new growth from quality credit sources will be tough.
A neutral result (+/- 150K net additions) that is driven by tablets is likely to have a negative effect on Sprint’s 2016 revenue prospects. Sprint will prove adept at cutting costs, but translating improved network results into sustained customer growth and profitability is still several quarters away.
“Cricket Unlimited Offers Now Included in DirecTV Bundles.” Admittedly, this is wishful thinking, but all signs point to another very strong quarter for Cricket Wireless, AT&T’s no-contract prepaid brand. In January, AT&T announced the resumption of unlimited plans for AT&T postpaid wireless consumers IF they also subscribed to a qualifying DirecTV service (nearly all services qualified). As AT&T CFO John Stephens indicated in a recent investor conference, this was a very successful offer and attracted more than 2 million (combined) current wireless and DirecTV customers.
Given the completion of Cricket integration into AT&T, the next logical step would be to grow the bundled program through the addition of Cricket + DirecTV plans. These would target customers who spend $150/ month for both wireless and video (the current plan targets customers who spend $250 more more). More importantly, this could expand distributor opportunities for DirecTV and Cricket (if the same store is not selling these services already).
While this quarter’s AT&T earnings release will likely be focused on Mexico milestone achievement as well as DirecTV progress (and postpaid churn reduction), a Cricket headline would be a welcome surprise.
Next week, we’ll focus on three wireline headlines and examine a few other wild card events (such as the “In the Loop” Apple announcement in late March) that could shape the earnings season. Until then, please invite one of your colleagues to become a regular Sunday Brief reader by having them drop a quick note to firstname.lastname@example.org. 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 Sporting KC!