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AT&T’s Big Week

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Greetings from our nation’s capital (now home to the World Series champion Washington Nationals) and Lake Norman, NC.  This was a very busy week for earnings with Apple, AT&T and T-Mobile all announcing earnings.  We are going to start with AT&T given their 3-year guidance but will also devote time to both Apple and T-Mobile earnings.

Given the level of earnings-related news, we will not have a TSB Follow-Ups section this week but will resume this section in an upcoming Brief.  First up – AT&T.

 

AT&T’s Multiple Headlines:  Legacy Bottom Within Sight, New Wireless Pricing Plans, Fiber Penetration Coming, and Renewed Reseller Focus

 

AT&T led this week’s earnings with a detailed assessment and lengthy earnings call hosted by CEO Randall Stephenson and CFO John Stevens.  At the end of the earnings presentation, they showed the following waterfall chart outlining how they would improve earnings per share:

at&t waterfall chart

There are many important things to note in this slide.  First, the 2.0% (200 basis point) improvement in overall margins.  AT&T’s reported 3Q EBITDA was ~ $15.4 billion when you exclude Puerto Rico operations (entire PR and US Virgin Islands P&L is held in Corporate & Other) on a base of $44.6 billion in 3Q operating revenues (34.5% EBITDA margin).

 

To improve 200 basis points, AT&T will need to remove ~$890 million in quarterly costs or about 5.5-6.0% of their total expense base across the corporation AND replace each lost dollar of EBITDA (e.g., from premium video or DSL or legacy business voice) with a dollar of EBITDA from new sources (higher value-added fiber subscribers, mobility ARPU increases from service upgrades, higher revenues from smartphone insurance).

 

On top of this, AT&T will need to cut an additional $350 million in quarterly costs ($1.4 billion annually) to cover the HBO Max investment (which will not significantly impact revenues and EBITDA until early 2Q 2020).  Roughly speaking, the operating expense net improvement will need to be ~$1.24 billion per quarter or about $5 billion per year (again, some of this improvement may come from the differential between higher new product and lower legacy product margin differentials, as we will explain below with fiber).

 

Highlighted throughout the earnings call was the need to penetrate more households with fiber.  On the residential side (small business and enterprise were not reported), AT&T ended 3Q with 3.7 million fiber customers on a total base of 20 million fiber homes and businesses passed.  This equates to a 19% penetration.  Assuming 10% of the 20 million represent business locations passed, the residential penetration rate comes out at 21%, within the 20-25% range mentioned by Randall Stephenson on the earnings call.

 

Assuming the fiber penetration in the chart above is achievable, AT&T is targeting growing the 3.7 million base to ~ 9 million (on an 18 million homes passed with fiber base) over the 2020-2022 period.  An incremental 5.3 million broadband customers (at a $55 ARPU – 10% higher than current) represents 440,000 net additions every quarter for the next 12 quarters and would generate $3.5 billion in incremental annual revenues and $1.8-2.0 billion in annual incremental EBITDA by the end of 2022.  Bottom line: Increased fiber penetration to homes is a big part of AT&T’s profitability improvement plan.

 

To put this in context, Comcast’s rolling four quarter High Speed Internet additions quarterly average is 304,000 and Charter’s metric is around 350,000.  Assuming that Comcast and Charter are ~100% share of decisions (including DSL migrations), the 440,000 net additions figure assumes that AT&T reverses that trend nearly overnight AND take some legacy share from cable (!).  All this in light of the DOCSIS 4.0 rollout of cable to multi-Gigabit speeds at very low incremental capex costs.

 

To reemphasize, AT&T’s average growth in the fiber base (much of it from fiber-fed DSL, also called IP broadband) over the last several quarters has been between 300,000-320,000.  Assuming growth comes from net new growth (not DSL conversions), the operation will need to grow 30-40% overnight.

 

More to come here, as we have assumed a 10% premium and cable is either matching or 10% lower than AT&T pricing, and we have not begun to talk about T-Mobile’s plan to acquire wireless high speed data customers using their combined spectrum holdings.  Bottom line:  There’s little reason to believe that AT&T will be able to materially move the share of decisions needle and grow 20-30% market share points in Los Angeles (Charter), Dallas (Charter), Chicago (Comcast), Atlanta (Comcast), or Miami (Comcast) at a market premium in light of T-Mobile’s (and others) market entry.  As a duopoly, it’s a stretch – with three or four players, it’s a pipe dream.

 

Another source of growth mentioned on the call was Reseller.  As we noted in other blog posts, Reseller losses were almost perfectly offset by Cricket (Prepaid) gains.  As AT&T explained on the call, this was largely by design due to spectrum capacity constraints.  Asked in the earnings call Q&A whether AT&T would consider an MVNO relationship with cable, Randall Stephenson replied:

Yes. We would actually be open to that. So you should assume that, that’s something we’d be open to. And not just cable guys, but there are a number of people in the reseller space that are reaching out. And it’s just as John said, we got a lot of capacity now in this network, and we’re at the point of evolution in this industry where we ask, how do you monetize most efficiently, capacity? And so we’re going to look at all those channels.

As we discussed in last week’s TSB, the cable operators want more call control.  Would AT&T really offer that?  At what cost?  At what margin?  Could Altice convert their new T-Mobile core + AT&T roaming relationship into a true wireless least cost route mechanism which would only use AT&T in areas where their own (CBRS, C-Band, other) network and new T-Mobile could not reach?

 

This was a surprising comment to say the least.  AT&T has not courted large wholesale customers since Tracfone in 2009.   A simple glance of the Wikipedia AT&T MVNO list includes a number of smaller players as well as AT&T-primary providers such as  Consumer Cellular, PureTalk USA, and h2o.  It’s very hard to imagine a major MVNO play that would not harm Cricket (which grew 700,000 net additions over the last four quarters) or the core business.

 

Lastly, the mobility business, even in the “golden era” of relative price stability, video compression, and low device upgrades, did not improve adjusted earnings much in Q3.  Here’s their income statement:

AT&T Mobility Results 3Q 2019

 

Unlike Verizon, who still has a large base of traditional subsidy-oriented plans (for every dollar of equipment revenue, Verizon has $1.06 in equipment costs) AT&T has minor if any equipment subsidies.  The implication is that for every dollar in reduced equipment revenues, operations and support costs should decrease a dollar.  This did not happen on a sequential basis (equipment costs +$303 million, operations costs +$426 million) and the 3Q to 3Q reduction is negligible (equipment revenues down $136 million, costs down $156 million).  If incremental scale is driving incremental profitability, it’s being offset by other spending.

 

Embedded in these numbers is FirstNet, now with close to 900,000 connections across 9,800 agencies per the most recent Investor Handbook.  In the second quarter, the same figures were “over 700,000” connections.  Given our understanding of the public space, let’s assume this translates into 175,000 net additions from FirstNet in 3Q with 125,000 (70%) of these coming from phones.  Bottom Line: AT&T reported 101,000 postpaid phone net adds in the quarter, and without FirstNet, it’s very likely they would have been negative.

 

Bottom line:  AT&T continues to integrate into an end-to-end premium content and network communications provider.  They made a big three-year earnings promise that depends on new and different execution (particularly broadband growth and reseller market penetration) that has not been seen from AT&T in decades.  We are confident that AT&T can cut costs but equally skeptical that they can grow share.

 

Apple Card Launches, and 0% a.p.r Financing is Announced.  The First Impact is Device Financing. 

 

On Wednesday, the Cupertino hardware (and now services) giant announced strong, Apple Card picbroad, and expectations-beating earnings.  iPhone sales, while down 9% from last year’s quarter, were still strong and Apple CEO Tim Cook gave very bullish guidance on this quarter’s device sales.  In this light, Apple announced that trade-in volumes were more than 5x greater than they were a year ago (recall that Apple highlighted lower monthly payments and device values with trade-in starting with last September’s announcement.  The 5x figure is therefore based on a few weeks – this figure could be much higher after a full quarter is measured).

 

The big announcement came through Tim Cook’s discussion of Apple Card performance:

… I am very pleased to announce today that later this year, we are adding another great feature to Apple Card. Customers will be able to purchase their new iPhone and pay for it over it over 24 months with zero interest. And they will continue to enjoy all the benefits of Apple Card, including 3% cash back on the total cost of their iPhone with absolutely no fees and the ability to simply manage their payments right in the Apple Wallet app on iPhone. We think these features appeal broadly to all iPhone customers, and we believe this has been the most successful launch of a credit card in United States ever.

A customer purchasing an iPhone 11 (64 GB) with their Apple Card would pay $21 less using this plan than purchasing through Verizon or AT&T (T-Mobile offers the 3% cash back Apple Card feature) or $28.25 per month prior to trade-in.  This represents a $71 reduction ($2.96/ month) from what a customer would have paid for the iPhone XR (64 GB) in 2018 and produces an optically significant sub-$30/ month price point.

 

On top of this, Apple is offering slightly better than average trade-ins per our comments with analysts who follow store activity (hence the 5x increase described earlier).  If customers believe that using Apple directly delivers a better financial outcome, they will go direct.

 

The 0% a.p.r, 24-month term mirrors the offer Best Buy currently gives to their My Best Buy Visa Credit Card customers (more on that offer here).  While unlocked Android devices are currently covered (including the Samsung Galaxy S10 and Note 10), it remains to be seen if/ how the interest-free offer might be extended to Best Buy.

 

As we have discussed in previous Sunday Briefs, Best Buy and Apple recently extended their service relationship (more on that here), and Apple announced that their Authorized Service Provider locations had grown to over 5,000 globally.  Extending this relationship into financing is not a slam dunk, especially given the current success Apple experienced last quarter without Best Buy, but the option exists to tie Apple Card promotions to Best Buy distribution.  If this were to happen, the wireless carriers would need to demonstrate more value (financial, bundling, services) than both Apple and Best Buy.

 

As Apple disclosed on the call, this was the best quarter for Apple Care revenues on record.  As was also disclosed on the AT&T and Verizon calls, device protection was a driver for their wireless service ARPUs in the quarter.  This business is profitable to the carriers ($5-7/ mo. in incremental EBITDA for every device protection plan is material to customer lifetime values), and the consequence of the loss of this profit stream should not be ignored.  There’s more to this than the loss of revenues – service margins will be impacted by any move to Apple Card.

 

In the August 25 Sunday Brief, we suggested an enhancement that would significantly accelerate Apple Card usage and iPhone upgrades:  Multiply the Daily Cash savings (we suggest 2x) when it’s applied to your iPhone 0% a.p.r plan.  This would shift marginal purchases (especially for multi-line accounts) to the Apple Card (driving up transaction fees and potentially interest charges) while providing the benefit of potentially paying off the device faster.  Fully paid devices could encourage additional upgrades and improve customer satisfaction.  This would also be more difficult for the wireless carriers (or Samsung) to duplicate.

 

Five-fold increases in trade-ins with only a partial quarter of measurement… best-ever Apple Care revenues… now Apple Card 0% a.p.r financing and 3% daily cash for 24-months.  That would be a lot to digest even if iPhone sales were missing expectations.  But, as we will show in a TSB online post in a few days, the iPhone 11/ Pro/ Pro Max inventory levels are still tight heading into the Holiday season.  This may not be the time to push the idea of Daily Cash sweeteners. The opportunity, however, is almost too good to pass up.

 

T-Mobile’s Stellar Quarter – Only Treats from BellevueJohn Legere Halloween pic from Earnings Call

Caught between AT&T’s earnings, the HBO Max announcement, and Apple’s surprise financing offer was the continued strong performance of T-Mobile.  They reported the following:

 

  • 754,000 branded postpaid phone net additions (versus 101,000 for AT&T – see above – and 239,000 for Verizon). Most importantly, T-Mobile’s net additions beat Comcast + Charter’s combined figure of 453,000.
  • Branded postpaid monthly phone churn of 0.89% (versus 0.95% at AT&T and 0.79% at Verizon)
  • Service revenue growth of 6% (versus 0.7% total mobility services growth at AT&T and 1.83% at Verizon)

 

We were very close to our early September estimates of 205 million POPs covered by 600 MHz (200 million actual) and 235 million POPs cleared (231 million actual).  T-Mobile also updated their estimate of POPs cleared by the end of 2019 to 275 million, slightly down from previous guidance of 280 million.

 

We think that the addition of 100-110 million new POPs in the second half of 2019 provides plenty of room to grow even without Sprint.  Also, T-Mobile’s total debt (including debt to Deutsche Telekom) is down to $25.5 billion from $27.5 billion at the end of 2019, and the resulting debt to EBITDA ratio stands at 2.0x, down from 2.3x in 3Q 2019.

 

We will have a full readout of T-Mobile’s earnings in next week’s TSB (which should be viewed against Sprint’s earnings due Monday and T-Mobile’s special Uncarrier announcement this Thursday).

 

Bottom line:  T-Mobile had a spectacular quarter, outpacing AT&T and Verizon in nearly all consumer metrics and is well prepared to thrive in a post-merger environment.  We still anticipate a settlement of the AG lawsuit in the next month or so, but believe that a trial outcome is likely to be found in T-Mobile’s favor for reasons stated in previous TSBs.

 

That’s it for this week.  As mentioned earlier, we will be posting the latest Apple inventory charts to www.sundaybrief.com in the next day or so.  Next week, we have Sprint and CenturyLink earnings as well as the T-Mobile Uncarrier announcement to cover.  Until then, if you have friends who would like to be on the email distribution, please have them send an email to sundaybrief@gmail.com and we will include them on the list.

 

Have a terrific week… and GO CHIEFS!

Three Headlines that will Impact First Quarter Earnings

lead pic (13)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:

YTD gains.emf

 

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)

 

  1. 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-mobie churn history

 

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.

 

  1. phone net additions losses chart“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.

 


  1. “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 cricket wireless characterssubscribed 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 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 Sporting KC!