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The Sunday Brief: Earnings Drivers for the Second Quarter (Part 3)

 

san diego fourth of julyGreetings from San Diego and Dallas.  Hopefully most of you are reading this after your Fourth of July weekend has ended.  This has been a busy week in telecom.  Late Friday, as we predicted, the FCC unanimously approved the Sprint/ Softbank and Sprint/ Clearwire mergers.  This paves the way for the Clearwire shareholder vote on Monday (July 8) and then the synergy expectations game begins.  Exciting changes are afoot, and, as I indicated in my Bloomberg interview last Monday, they must execute with an unprecedented degree of precision.

Many of you commented on the interview through LinkedIn or through direct emails/ texts.  A couple of you asked me for my sources on the EBITDA and debt levels that I mention in the interview:  Sprint is here, Clearwire is here, and Verizon Wireless is here (click on the transcript for the net debt comment and the financial and operating information for the trailing 12-month EBITDA).  The exact numbers (and I have excluded the EBITDA for Sprint and Verizon’s wireline operations in this metric) are Sprint wireless + Clearwire adjusted trailing 12-month EBITDA = $4.3 billion; Sprint + Clearwire adjusted net debt as of 3/31/2013 = $20.2 billion; Verizon Wireless net debt = $6.2 billion, and Verizon Wireless trailing 12-month EBITDA = $31.0 billion.

This equates to a debt-to-EBITDA ratio of ~ 4.7x for the combined Sprint/Clearwire and 0.2x for Verizon Wireless.  Clearly two different ends of the spectrum (pun intended) when we are looking at financial “wiggle room” should synergy expectations be delayed.   The 4.7x is better than it would have been under Dish, and there are few doubts about Sprint’s ability to pay their debts for the next few years, but Verizon’s options are far greater.  It’s why Verizon has returned more equity value to their shareholders in the past six months than the entire market capitalization of Sprint (see chart below).

We’ll talk about Sprint more after their earnings announcement on July 30, but, as I said in the interview, a new captain (Softbank) with discarded (iDEN) ballast and cash availability filling their sails makes the Sprint ship more formidable.  But the straits they must navigate are narrow, and the room for error is slim to none.

In the “missing expectations is everything” column, Samsung Electronics reset second quarter expectations this week – consolidatedApple vs. Samsung 5-yr chart revenues would only be 20% higher, and operating profits only 47% higher (to $8.3 billion).  The stock was not bludgeoned as Blackberry was, but it did add to the chorus of ecclesiastical analysts who are convinced that smartphone growth will never return to the good old days of 2011/2012.  Here’s one analysis by The New York Times who almost feels obliged to quote Mark Newman from Sanford C. Bernstein at the end.

The reporting misses two key factors that affected smartphone sales – 1) the Galaxy S4 really did experience supply chain/ inventory shortages with Sprint and T-Mobile at the end of April (and expectations did not adjust); and 2) Verizon and AT&T adjusted their handset upgrade programs from 20 to 24 months, creating potential confusion among the current subscriber base (these changes do not take effect until January and March, 2014, respectively).  As others begin to aggressively adopt T-Mobile’s “Pay for your device each month” model, the power of high-end devices like the Galaxy S4 become affordable to tens of millions of additional users.  This is also will be very good news for Apple.

In the “It’s good to be king” column, Amazon is facing a fresh set of charges alleging that it is taking price increases on books where there is less demand (and as a result less competition) for the title.  The first report of this came from The New York Times on Friday.  This is an excellent article, but leaves me at a loss – don’t most publishers have their e-book formats distributed across multiple operating systems (Amazon, Google, Apple, Nook)?  Did Amazon simply raise the price to the Google Books level (I spot checked several popular books and they all happen to be nearly or exactly the same price)?  Regardless, this article could not come as a less opportune time for Amazon as the Apple price fixing trial awaits a decision.

Basic RGBIn the “Every dog has his day” column, Xobni (Inbox spelled backwards), an innovative yet aging contact management application was purchased by Yahoo! for a rumored $30-40 million (although there appear to be another $30 million or so in earnouts according to TechCrunch).  I was a Xobni user during the Mobile Symmetry (MS) days.  The software in 2009 was better than anything else in the market – it tried.  But, as my former MS colleague, Neil Tenbrook, said, “This contact management stuff is hard!”  Xobni raised $42 million (not even a 1x return before earnouts), had 100 million+ Microsoft Outlook downloads, and some success in the iOS, Blackberry and Android formats.  But it missed the restructuring of information, the demise of email as a communications medium, and the rise of contact management through social/ business networks.  Good luck to the team as they integrate into Yahoo – if done right, I might even rethink using a Yahoo email account.

Finally, in the “Just Weird” column, we have Prince.  In a wide-ranging interview with V magazine, he is asked whether he owns an 1372803915_prince-v-magazine-cover-467iPhone.  Prince’s response:

“Are you serious?” he says. “Hell, no.” He mimics a high-voices woman.  “Where is my phone?  Can you call my phone?  Oh, I can’t find it.”    

 

I think there is a bit of Prince in all of us.  Even if it’s a very tiny amount.

This week, we continue our evaluation of second quarter earnings.  Here are our findings to date:

  1. The beginnings of a meaningful metrics (but not EBITDA) change will appear at T-Mobile.
  2. Verizon’s lead in profitability will widen because of their high mix of LTE-based traffic.
  3. Sprint’s 2Q will be driven by networks in transition (iDEN to CDMA; 3G to 4G; contract to no contract; government-subsidized to consumer-driven).
  4. No one will see an EBITDA dip due to new phone brand launches (Samsung, HTC, and Blackberry numbers all back this up).
  5. AT&T will (slightly) surprise on LTE footprint and postpaid additions (thanks to Sprint’s iDEN turndown), but disappoint on many other metrics.

That leaves us with cable and LEC/ CLEC wireline earnings.  As you can see from the table at the end of this column, publicly traded cable stocks have been driven up in the past month by M&A speculation.  Through mid-April, only Comcast and Charter had posted gains for the sector.

Outside of synergy speculation, there are two reasons to be excited about cable and, to a lesser extent, LEC/ CLEC broadband.  First, the housing sector is beginning to recover.  As the chart from the St. Louis Federal Reserve shows, new housing starts are beginning to come back from historical lows.

new housing starts graph

Because we suffered a 75% decline in new housing starts over three years, it’s hard to see the bottom.  Clearly, however, we hit it in 2009 and a have recovered about half of the expected gains.  (Note:  that leaves at least 500,000 new units to get back to a median historical level for the industry, or about $600 million in new telecommunications services opportunity).

Turning housing starts into profits depends on strong and steady plant investment, especially in high growth areas such as Texas, Florida, Georgia, North Carolina, Arizona and California (see here and here for ADP job figures).  This favors cable companies such as Brighthouse Networks (Tampa/ Orlando), Comcast (Houston, Atlanta, South Florida), Time Warner (North Carolina, LA, Dallas, Austin, San Antonio), Cox (Orange County, Phoenix, San Diego), and Suddenlink (West Texas, who is having an economic boom like no other).

However, with the exception of Arizona, the states mentioned are in the heart of AT&T territory (although parts of FL and NC are managed by CenturyLink).  This is where they have concentrated much of their fiber investments for the past decade.  When the South and West recover, AT&T’s opportunity grows.  This is one of the reasons why we started to see consumer revenues grow in Q1 (+2% annually) and why 2013 will be the fastest growing year for U-Verse since their early launch days (2008).  With “mover” activity on the rise into and within these markets, it’s a promising time for AT&T.

On the enterprise front, fiber and Ethernet connectivity from office buildings to geographically redundant and secure servers is growing.  The transition from client-based servers to private and “hybrid” clouds began in 2005 (if not earlier).  Much (although not all) of the server growth for the mid-market and non-essential enterprise information is occurring offsite.  This is driving up the need for bandwidth and accompanying managed services.

Since this issue is running a bit long, I’ll reference the latest earnings and investor conference presentations from tw telecom (TWTC) as reference for fiber/ Ethernet trends.  They are investing $350-370 million in 2013 to densify their networks in 75 markets and satisfy the “fiber to the building” need.  While they will face formidable competition from Verizon, AT&T, CenturyLink/ Savvis, Zayo, Level3, and Comcast (and Time Warner) Business, the dynamics of the recovery are covered in their earnings and investor conference discussions.  Companies that are successful in this space are unwavering, consistent, and patient.  There are no “quick bucks” with metro fiber.

Next week, we’ll take a closer look at Dish’s options after Sprint/ Clearwire (opinions welcome).  Until then, if you have friends who would like to be added to this email blog, please have them drop a quick note to sundaybrief@gmail.com and we’ll add them to the following week’s issue.  Have a terrific week!

ytd stock returns

The Sunday Brief: Who’s Hiding The (Negative) Postpaid Subscriber Surprise?

b_strong_whiteGreetings from Dallas and Atlanta.  Tragedy and horror exploded on both sides this week in Boston and West, Texas. Our prayers are for the many suffering, rescuing and recovering. These events remind us how much we appreciate those who run to trouble, protecting those they may not even know.

Outside of the tragic news coming out of Boston, it was a fairly eventful week in telecom.  Verizon and America Movil (parent of TracFone) both announced earnings, which we will discuss below.  Google decided to buy the municipal fiber network in Provo, Utah (as opposed to building one from scratch).  (Note: a report out on Friday seems to indicate that they received a bargain basement price for the asset.)  Time Warner Cable announced that they will be adding live, out-of-home streaming of live TV on Apple devices (others already offer some streamed content, but TWC’s deployment looks to be the broadest lineup yet).  And then there is the much anticipated Samsung Galaxy S4 release, with phones starting to ship next week.  In a sign that demand for the new Galaxy will be brisk, Sprint is now sold out of pre-ordered S4s.

Speaking of Sprint, they received an unsolicited bid from DISH this week which generated a few dozen emails, texts, and phone calls asking for my take on the transaction.  At the end of the day, Sprint’s Board (see link to see their current members) has the following to consider:

Softbank:            $4.03/ share in cash and 30% ownership in the recapitalized Sprint

DISH:                     $4.76/ share in cash and 32% ownership in the new DISH/Sprint

$0.73/ share results in a ~$2.2 billion cash difference between the two offers (using 3.01 billion outstanding shares).  What is harder to determine is the value of the remaining equity interests – Does the recapitalized Sprint have the opportunity to create more value than DISH shares?

This leads to the following question (and, before you answer this question, please refer to the attachment):  “How broad and deep does Sprint’s data (LTE) network need to be to compete effectively against AT&T and Verizon Wireless?”  We have raised this question in several Sunday Briefs, citing the fact that Sprint is heavily dependent on third party networks (namely Alltel, which is now owned by Verizon Wireless) for voice and 3G data coverage.  Until their announcement this week with C-Spire, a regional provider focused on Mississippi, Memphis, Mobile and the Florida panhandle, Sprint had not reached an LTE roaming agreement with any other provider.

Sprint’s data coverage vs. VZ and AT&T

The attachment shows the current data coverage state of three networks (as of April 20).  At the top is Verizon’s LTE and 3G network for the Southeastern US.  They have committed to take lighter shades of red to dark red in the next 90 days.  Even if they miss that by a quarter, they remain the clear leader (Verizon’s LTE network covers 287 million pops in the US today, and they have ~15 million remaining to fully cover their 3G CDMA footprint).

As we have discussed previously, an LTE-focused network means more efficiency:  Lower costs per GB, the opportunity broadly to implement Voice over LTE (VoLTE) without a lot of handoffs, and lower handset subsidies resulting from single-mode chipsets are three of the myriad of benefits a new and faster network brings.

The second network (lower right) is AT&T’s, with the current (HSPA) data network covering just over 290 million pops (LTE to be deployed by the end of 2014).  Project VIP, as we have discussed several times, is the most ambitious network enhancement that suburban/ ex-urban/ rural America has seen in the past 50 years.  Particularly in the Southeast (BellSouth territory), AT&T will focus on deep coverage from fixed wireless data and DSL improvements.

In the lower right is Sprint’s current 3G network, excluding roaming (source: Virgin Mobile’s website.  See Straight Talk’s map on right Sprint map WalMart Straight Talkfor a nationwide view).  There is a lot of white (and not a lot of orange) in Sprint’s map, highlighting the continued dependence by Sprint on ALLTEL/ Verizon for roaming throughout the Southeast (the situation is more bleak in the Western US as the Straight Talk chart shows).

Without self-sourced LTE coverage, Sprint will need to deploy and extensively use other carriers’ networks (namely Verizon and AT&T).  Even if LTE capacity is available, those GB of data will not be cheap.

A recapitalized Sprint (courtesy of Softbank), however, will have a balance sheet that can combat this issue (an extra $10-15 billion in network build will help both in-building and regional coverage).  It is hard to determine how DISH will a) cross market to customers in the white area (where DISH has a distribution advantage over cable for video) and b) raise money as a highly levered company to expand the orange service area in the attached charts.  It is not clear from their conference call that DISH’s management has performed a granular assessment.

If Sprint’s network looked like VZ or AT&T, DISH’s offer would be extremely compelling, but can DISH pull off a network expansion to achieve the cross-marketing synergies it promises in their proposal?  It’s unlikely given the $11 billion of expense and $2 billion of capital synergies they have included in their estimates.  (The full DISH presentation on the Sprint acquisition is here.  Synergy slide is page 4).

There will be plenty more to discuss on the Sprint/ DISH offer in coming weeks. While Sprint’s Board has a lot to consider, it’s fairly apparent that DISH is not going away.  Engagement will be critical – there’s a sequence here that can create competitive differentiation for Softbank, Sprint, and DISH (and perhaps T-Mobile).

After analyzing this week’s earnings announcements from Verizon and America Movil, plus the positive surprise from T-Mobile, I noticed a gap that does not seem to have been picked up by the telecom community.  The news from this week signals a 300-600K postpaid subscriber surprise by either AT&T or Sprint.

Here are the facts as we know them today:

  1. T-Mobile stemmed their Q1 contract losses by 300,000 (losing 199,000 as opposed to 510,000 in Q1 2012).  Branded prepaid customers also increased for T-Mobile.
  2. The T-Mobile improvement did not affect Verizon Wireless’ numbers.  VZW actually accelerated their postpaid subscriber gains (from 501K to 677K).
  3. In turn, Verizon also announced on their earnings call that through TracFone, they had added over one million customers in the quarter over WalMart’s MVNO called StraightTalk (to those of you who politely corrected my network choice in the column on WalMart, look again.  You were duped into believing the color and not the coverage of the network in the StraightTalk collateral).

At a minimum, #1 and #2 above mean at least 478K subscriber losses need to be absorbed by AT&T and Sprint (or the postpaid market miraculously grew in what is historically the weakest quarter of the year).  However, given the size of iPhone’s addition through StraightTalk, one has to believe that the net effect is actually higher.  As the chart below shows, there are only two places this postpaid growth can come from – AT&T and Sprint.

Postpaid net subscribers by quarter 1Q 2013

Let’s assume that AT&T has 200K postpaid additions for 1Q.  That would imply a 400K loss by Sprint just to keep the total postpaid net additions growth on par with 2011’s Q1 level (again, none of this includes the portion of StraightTalk/ TracFone growth that came from postpaid customers).  Sprint’s loss would be closer to 700K to match 1Q 2012’s level.

While many analysts are expecting an increase in net losses for Sprint due to lower iDEN recapture rates, the news thus far this month (T-Mobile stems sub losses, VZW increases postpaid gains, and TracFone launches their iPhone offering and adds over 1 million net new subscribers through VZW) cannot be good.  Either Sprint had modest losses (and AT&T breaks even on postpaid subscribers) or Sprint’s losses were steep.

Clearly, there will be no positive surprises next week.  After AT&T announces earnings Tuesday afternoon, we’ll have a pretty good idea what Sprint’s number will be.  We’ll also know the extent of subscriber movement across the industry.  Stay tuned for a full roundup next Sunday and throughout the week at www.mysundaybrief.com.

Thanks again for the many Sunday Brief referrals.  If you have friends who would like to be added to this email blog, please have them drop a quick note to sundaybrief@gmail.com and we’ll add them to the following week’s issue.  Have a terrific week!

Samsung’s Phone Evolution (as told by Ars Technica)

Samsung’s Phone Evolution (as told by Ars Technica)

A great article (click on link above) highlighting the evolution of mobile devices.  As you wax nostalgic (“I had one of those..”) think about two things – 1) How the supply chain to mass produce devices changed during this period (just ask HTC about supply chain issues), and 2) The sudden bloom of mobile applications that fueled the acceleration of the chipset-OS-handset-spectrum band-backhaul-CDN ecosystem.