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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!

 

Bloomberg interview – In the Loop with Betty Liu (August 11)

patterson picture

 

This morning’s interview with Betty Liu on Bloomberg’s “In the Loop with Betty Liu” is here.  Many of the same points emphasized in the Sunday Brief are in the interview.  Marcelo, you have your work cut out for you.  Best of luck!

Also, don’t post here, but if you have tips on how I could have a better interview presence, I’m all ears.

 

 

Smartphones and Rate Plan Announcements – Do Any Make Sense?

phillyGreetings from Dallas, Denver, Philadelphia (pictured) and the overheated New York City.  This week was full of change, from Microsoft’s $900 million Surface RT tablet write-off (see the Tech Crunch article here) to the dismal Nokia earnings (BGR summary here), to Google’s mixed earnings release, to Charter’s seismic aspirations to acquire Time Warner Cable, to what could be the largest “going dark” event in the ongoing retransmission saga between cable and content, the week did not lack for big news.  On top of this, Verizon Wireless had their quarterly earnings call.

Before digging into the pricing and phone plan changes announced by each of the four largest carriers over the past month, let’s get a quick “health check” of the industry through the eyes of Verizon.  On Thursday, the telecommunications giant announced impressive earnings and cash flow growth, driven almost entirely by their wireless segment.

First, the bad news:  Verizon has a wireline unit that, despite continued investments in fiber, cannot manage to offset its losses from legacy technologies to earn a profit.  With the exception of FiOS Internet and Video, the rest of the business is largely a victim of increased wireless substitution, VoIP (as opposed to traditional TDM voice) penetration, cable competition, and the cloud.

Structural issues create competition within the company for enterprise wallet share.  New markets, such as cloud, have new competitors who are more expert in computing and data center management than Verizon.  If there is an economic recovery, it’s not showing up in the results.  If you are managing the wireline business, there’s plenty to be worried about at Verizon.

In fact, as we have said many times, if all they had were a wireline unit, they would not be a going concern.  Have a look at Verizon’s consolidated liabilities (note: Verizon reported $2.41 billion in cash & marketable securities):

Verizon balance sheet

On the conference call, Fran Shammo responded to a question about Verizon Wireless’ share of that.  He responded:

On the update of the net debt for Wireless, gross debt is at $10.1 billion and net debt is $9.7 billion. And as you know, we did a distribution at the end of June of a total of $7 billion out of the partnership to both of the owners.  Also just to keep in focus here, we have about $1.5 billion of Wireless debt coming due in the fourth quarter this year and another approximately $3.5 billion coming due in the first quarter of next year and we plan to pay that debt off at this point in time.

Verizon has $39.7 billion in gross debt without Verizon Wireless and about $2 billion in cash.  Their wireline segment generated $8.2 billion in annualized EBITDA but spent $6.2 billion in capital over the same period.   That leaves $2 billion annually to pay taxes, nearly $6 billion in dividends, interest and principal for $40 billion in debt, and fund $34 billion in pension benefit obligations (I am taking some liberty in assigning all of the pension benefit and dividend obligations to the Telecom unit but you get the point).  As a standalone business unit, Verizon Telecom would be nearly worthless.

But that is not the case.  As we have discussed many times, wireless is a growth and cash machine.  As Fran says above, they have $10.1 billion in debt and are generating $8.5 billion in EBITDA per quarter ($31.8 billion the past year).  When they finish paying off $5 billion in debt at the end of the year, they will have a cash flow to debt ratio of 0.16.  That’s a Google or Apple level, and, most importantly, it’s not a Sprint, T-Mobile, or AT&T level.

The Annoying Verizon Picture

What will Verizon do with the over $6 billion in quarterly post-capital expenditures free cash flow it generated in the second quarter?  They will not make a bid for Leap.  They will actively explore the Canada market (Fran’s quote: If you look at the population of Canada, about 70% of that population is between Toronto and Quebec. That’s adjacent to the Verizon Wireless properties. Again if you look at the spectrum auction, it mirrors up exactly what we launched here in the United States on the 700 megahertz contiguous footprint.”).  Looks like someone has been reading The Sunday Brief (the picture is the same one we used in the July 1 earnings preview issue of TSB).  How will Verizon invest its free cash flow?

The answer is simple:  If the investment supports a stronger network or Internet delivery platform, Verizon has the capability to do it.  Better LTE in-building coverage is on the list.  Spectrum auctions are on the list.  Pioneering the first LTE-only device by the end of 2014 is on the list.  Moving to LTE Advanced and VoLTE technologies ahead of Sprint/ Clearwire and AT&T is on the list.  Third-party paid (a.k.a, “Toll Free”) data platform development is on the list.  As discussed above, international expansion is on the list.  And, at the right price, buying out Vodaphone is on the list.

Verizon Wireless will also have to sing a few verses of “He’s Ain’t Heavy, He’s My Brother” (a classic video link worth watching) as they assist in lowering the liabilities of the Telecom unit.  But where would you rather be – with a pre-Clearwire (Q1 2013) Sprint of $4.4 billion of annual adjusted EBITDA and $16.7 billion in net debt (3.8x net debt to EBITDA ratio) with several quarters of LTE investment and Clearwire integration remaining, or at Verizon Wireless’ 0.16x end of 2013 ratio with $24 billion in post capital spend free cash flow over the next four quarters to invest?

verizon-edge

One thing is for certain, Verizon has chosen not to invest in acquiring postpaid customers through aggressive plan changes at this time.  Their Edge announcement is great if you have to have the latest technology.  For example, if you wanted the latest Nokia Lumia 928 (retail price = $450), you could pay $18.75 per month for 24 months for a) the right to upgrade after the first year, and b) no contract limitations.  Or, if you paid the same $100 as you would in a traditional post-paid agreement, you could get a new phone after 7 months (50% of the balance is paid off).   With a Samsung Galaxy S4 ($650 retail price), the new phone interval with $200 down is 17 months.

The issue with Verizon’s Edge and AT&T’s Next programs is that they fail to couple plan relief with the handset subsidy.  To the consumer, both represent short and long-term drains on disposable income (and we have discussed many times how many Americans live paycheck to paycheck).

sprint my way plan

Let’s consider a family of four that wants to move to Verizon from another carrier.  They have four smartphones and will consume 6GB of data per month.  With Verizon’s Share Everything, that would cost $240 per month plus $108 per month in Edge payments.  With Sprint’s new My Way Plan, that would cost at least $220 per month ($140 + $80) and yield 2GB less total data and no sharing capabilities.  However, with current promotions, the family could get four new Samsung Galaxy S4s for $400.  If the family could determine who would be using the most data (it’s probably inversely related to age), there’s a strong case that Sprint’s plan could be of equal cost but more valuable over the short and long-term than Verizon’s.

T-Mobile has a new, but not necessarily as compelling, offer.  For the same four Galaxy S4 phones, and on the JUMP (Just Upgrade My Phone) plan, the family of four would be paying $140 (2.5 GB per line) + $80 in phone installment payments + $40 in JUMP plan payments (which includes phone insurance and mobile security) + $600 in phone deposits.   That’s $260 per month + $600 in out of pocket costs.  If the family has good credit, Verizon’s Edge/Share Everything plan is competitive.  Sprint’s smartphone promotions (which will not end with the BOGO Galaxy S4 promotion) are compelling as well.

The problem is that consumers have to do a lot of math to figure this out.  Store reps do not like to do a lot of math and neither do consumers.  They have been trained to look for 2-yr promotional pricing, and, with T-Mobile’s recent success, perhaps consider this against a monthly payment plan alternative.

The bottom line for consumers is “WAIT and SAVE.”  After 120 days from initial launch, the Blackberry Z10 went from $200 to free for both Verizon Wireless and AT&T customers.  The heavily subsidized $100 Nokia Lumia 928 is now $30 on Amazon with contract.  A family of four can get free Samsung Galaxy S3 devices on Amazon if they are switching.  More phones, including a bunch of free LTE devices can be found on the attached table in a recent Sunday Brief post.

If consumers can wait six months to a year prior to buying their next device, they are probably better off pocketing the savings and using the balance to self-insure their device.  That will certainly not end up being the case for many Americans, but the surcharges required for “latest and greatest” phone status are generally not worth it.

Next week, we’ll put the microscope to AT&T’s earnings.  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!

Everyone Gets a Headline This Week

dallas weatherGreetings from Dallas, where the traditional summer heat is breaking for two days (Minneapolis is forecasted to be 10 degrees warmer today and 15 degrees warmer tomorrow than Dallas).  However, there is no break from the blistering pace of telecom news that occurred this week.

On Friday, AT&T announced that they were acquiring Leap Wireless for $15 per share in cash.  The transaction, including the acquisition of $2.8 billion in net debt as well as proceeds from the sale of the Chicago “A Block” 700MHz spectrum, is valued at just under $4.2 billion.  While this transaction represents an impressive premium to Leap’s closing share price on Friday, it’s one fifth of the amount MetroPCS was willing to pay for Leap’s assets just six years ago (see the Fierce Wireless article here.  It’s a “What were you thinking?” moment for the Leap Board).

Leap Wireless (a.k.a, Cricket) has a lot of spectrum, particularly in the AWS band, that AT&T can pair with its spectrum portfolio to produce a large LTE coverage area.  Here’s the AWS coverage areas for Leap (the hashed area is the result of Denali Holdings’ win of the Great Lakes spectrum band) as well as for Cingular:

leap wireless aws licenses including denali

cingular wireless aws licenses

While is important to note that the large swaths of blue above are not in the same AWS block, they are in the same band.  This improves AT&T’s coverage in the Great Lakes area, and complements AT&T’s 700MHz LTE coverage in the Eastern US.  For a good spectrum band chart, click here for Phone Scoop’s tutorial.

That announcement dropped late Friday, and it’s nearly certain that there will be another bidder for the Leap Wireless asset.  Regardless, this transaction will drive up spectrum values for remaining holders of 700MHz, 1900MHz, and AWS spectrum bands.  C-Spire, US Cellular, Ntelos and other smaller (private) companies will be receiving phone calls.  It’s a good day to be an asset owner.

It’s not a good day, however, to be a smartphone provider.  This week, we learned just how bad sales of the Blackberry Z10 were in the second quarter as AT&T commenced a fire sale on the newly released Blackberry.  Here’s the listing on Amazon – $49.99 (down from $199.99).  Best Buy has the Blackberry Z10 listed at FREE.

blackberry z10This does not appear to be because the phone itself is defective.  Over 225 people have reviewed the device on www.verizonwireless.com and it is clear that those who own the phone adore it (4.4 stars out of 5.0; 85% or reviewers recommend the phone).  However, it lacks enthusiasm from shartphone switchers, at least compared to the other new phone entrant, the Nokia Lumia 928.  It’s one of the highest rated devices on Verizon Wireless with 4.8 stars and a 95% recommendation level.

Blackberry’s CEO, Thorsten Heins, referred to “lessons learned” at Blackberry’s annual shareholder meeting this week.  One of those lessons learned is that the bar for switching phone manufacturers and operating systems is very high.  Blackberry has a real price point problem on its hands as they ready the US rollout of the Q5 in a few months.  Not much room for a “scaled down” version of the Z10 or the Q10 with pricing for the Z10 at or nearly free.  There are many chapters left to unfold with Blackberry, but the Z10 launch will be remembered as one of the most taxing times in the Canadian company’s history.

On the opposite end of the spectrum comes the super-premium Nokia 1020.  As one reviewer put it, “You can sum up Nokia’s just-unveiled Lumia 1020 in three words:  41, mexapixel, camera.”  Nokia held a pretty well attended launch in New York City this week, where reactions to the camera were generally positive.  C|Net proclaimed, “The Lumia 1020 puts the mega back in megapixels.”  However, there are concerns that there is too much camera focus in this model, and more than one analyst worried that it could relegate Nokia to the “niche” market.

nokia lumia 1020

I think there is a much larger market for image capture than many expect, especially with the social media-focused crowd.  This is a phone that consumes LOTS of data (even with a 5 MP “shrunk for social” version of the picture, there’s the potential for many more uploads), and with the blogosphere continuing to demand higher resolution photography, there are many who will want this device.  The accessories are fantastic.

Admittedly, this is not a device for everyone, and Nokia will need to balance this with a lineup that satisfies a palate of diverse smartphone budgets and interests.  Without a doubt, Blackberry owns the keyboard phone.  And now, without a doubt, Nokia owns the picture phone.  They are both feet in the very large and unforgiving doors of smartphone incumbency.  If Nokia can turn the corner on (business) applications, and then offer free Gigabytes of wireless data usage over AT&T for new 1020 buyers, we could have a challenger to the Galaxy S4 in the making.

In case you missed the significance of the last statement, let me reiterate:  Smartphone differentiation, particularly for challengers, can be achieved with a) more storage (Microsoft Drive) and also b) application-driven subsidy (e.g., first 500MB of data charges to and from Microsoft Drive are free for the first year).  AT&T can accommodate these changes today, and I would not be surprised if a “limited time offer” is extended to new Lumia 1020 users to allay fears about the increased data usage a 41MP/ 5 MP phone can drive.

As Nokia moves to change its position in the US phone market, their chief partner, Microsoft, announced a substantial restructuring on Thursday.  The chief outcome of the reorganization was a functional structure, led by four engineering-focused groups:  OS, Apps, Cloud, and Devices.  This change should help Nokia as they integrate the Lumia product line into the Xbox2 and other products Microsoft will introduce.

There have been many debates about Separate Business Units (SBU) versus functional organizational models.  Clearly, Microsoft sees a more integrated software/ hardware future (which seems to be the trend), and the change from traditional PC to Mobile/ Tablet computing is occurring at a very rapid rate.  However, the SBU function allowed Microsoft to be competitively focused in the Enterprise space against business-oriented companies like Oracle and Cisco.  This is not impossible in a functionally-aligned organization, but it’s certainly a lot harder to hear the voice of the customer when there is no division “lead” with P&L authority and responsibility.

microsoft org leads

The New Functional Leads at Microsoft

Also, Windows 8 has not been wildly embraced, which goes to show that too much change can backfire.  At the end of June, Microsoft announced Windows 8.1, which contains a host of features specifically designed to ease the transition from Windows 7 to Windows 8.  A full recap of the Windows 8.1 features is here.  Any reorganization should be able to definitely answer the question “How will Microsoft’s customers benefit?”  I’m not sure that the Windows user community benefits from this reorganization.  If anything, it’ll result in more changes with less regard to the velocity of the user impact which could backfire on Microsoft’s PC-based business.

Microsoft’s reorganization helps apps.  It definitely helps their consumer business, especially Microsoft Drive integration.  But will it improve customer interest in Windows, and will it create a more competitive Enterprise presence?  That appears to be seen.

If spectrum-driven acquisitions, super-premium smartphone announcements, and the reorganization of one of the most important forces in technology aren’t enough, we had individual and family pricing plan changes announced from two of the four largest US wireless carriers this week.  Given the length of this week’s article, we’ll devote the entirety of next week’s Sunday Brief to an economic analysis of T-Mobile’s JUMP (Just Upgrade My Phone) and Sprint’s Unlimited, My Way plans.

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!

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

Earnings Drivers for the Second Quarter (Part 2)

softbank sprint

Greetings from Dallas.  This is the first time in 17 weeks I have not included a list of cities before or after Dallas.  A week without travel – very sweet indeed!  However, this was no time for a vacation, as news was busting out all over.  With the vast majority of shareholders approving Softbank’s revised offer for Sprint, and with Dish deciding not to counter Sprint’s latest $5/ share offer for Clearwire, the path has been cleared for Sprint’s resurgence.  More control does not equate to a higher probability of success, however.  I’ll be speaking more on this and other telecom topics on Bloomberg Business News Monday morning at ~ 8:30 or so CT.  (Here’s the link to the last interview.  I was a little rusty).   UPDATE:  The new interview has been posted.  Thanks, Bloomberg News, for having me on!

But Sprint was not the only telecom company making news this week.  On Tuesday, Mary Dillon abruptly left her role as CEO of US Cellular and went to Ulta, a Chicago-based cosmetics producer.  Here’s the chart comparing the two-year performance of USM and ULTA:

us cellular vs ulta

Clearly, there was some friction that led to the departure.  After Mary’s excellent panel facilitation at CTIA, as well as her brilliant sale of non-performing properties to Sprint (which raised $480 million), it was hard to see anything but long-term tenure for the former McDonald’s executive.  Best wishes to incoming CEO Kenneth Meyers.

US Cellular made news on Friday as well, selling AWS spectrum to T-Mobile for $308 million.  The price of 95 cents per MHz pop is 37% more than Verizon Wireless paid for the Spectrum Co (cable company consortium) spectrum last year.  The $788 million in cash from this and the Sprint transaction will help US Cellular accelerate its LTE deployments and make the carrier more attractive in the future to Sprint and others.

Blackberry reported earnings that even disappointed and surprised skeptics of the stock.  As a result of a 16% decline in service revenues, and the failure to report any separate sales statistics on the Z10, shareholders went running for the exits on Friday.  As a result, the stock gave back all of its 2013 gains plus $1.25 in one day.  As we have noted in several previous columns, Blackberry has no foothold in the US – they are an afterthought in 2014 strategic planning, even in their enterprise and government sweet spot.  More details below.  Tough times for the smartphone pioneer.

With this week’s focus on the handset makers and Verizon, it’s completely appropriate to end the weekly news with a discussion of Verizon’s rumored bid for Canadian operator Wind Mobile.  This article from Canada’s Globe and Mail outlines a three pronged strategy:  a) buy and consolidate Wind and Mobilicity; b) leverage handset and network scale; and c) participate in Canada’s upcoming 700MHz auctions.  Here’s Verizon’s coverage from Buffalo to Detroit – it’s not hard to see from this map Verizon extending its reach into southern Ontario:

What this does indicate is that despite all Vodaphone buyout hype, Verizon Wireless has other options, including an aggressive Canada deployment strategy.

verizon LTE coverage canada

What should we expect from Verizon when they report earnings on July 18?  Here are a few things we know are on their list from recent investor presentations:

  1. Average Revenue per Account.  This figure is rising (from $146.80 to $150.26), even as overall postpaid accounts fell in Q1 by a nominal 114K or 0.3%.  This means that the customers who are most connected are growing their business with Verizon Wireless (from 2.64 to 3.67 connections per account).
  2. Customers who subscribe to an LTE device (and the traffic they drive).  As of the end of Q1, nearly seven out of ten Verizon postpaid smartphone and Internet connection (Mifi, other postpaid device) subscribers were confined to 3G speeds.  Driving this figure to 33/35/37% and the corresponding tonnage to 60% or more is going to be critical to increased profitability.
  3. 3G network utilization/ Wholesale strategy.  Verizon has a reputation of being an inconsistent wholesale provider, but they are coming off the back of an incredible first quarter as a result of supplying data to TracFone for the WalMart Straight Talk iPhone.   If the 3G network is being drained of retail megabytes, it’s going to be important to keep it full through the TracFone relationship.
  4. Cost reductions.  This is not confined to improved gross margins (which greater 4G usage will naturally drive), but covers sales/ marketing and customer service improvements as well.  With Share Everything plans including unlimited voice and data, the ability to grow the customer base and close additional call centers is inevitable.
  5. Cash flow/ overall capital expenditures.   AWS deployment costs money to deploy.  But it does not have the same backhaul and backbone effort that was required with the initial LTE rollout.  Verizon Wireless has capital opportunities through the second half of 2013.

As we discussed in last week’s Sunday Brief, it’s likely that Verizon adds a few hundred thousand post-paid retail subscribers this quarter due to Sprint’s iDEN transition, and that they add an additional several hundred thousand data-focused connections to existing accounts.  Given no significant handset dilution from a blockbuster smartphone launch (although the Samsung Galaxy S4 has been at Verizon since late May), it should be an extremely profitable quarter, well above Q1’s 50.4% EBITDA margin.

Many analysts will try to plot linear growth trends for Verizon from second quarter results, particularly for data growth.  However, it’s important to understand that there is an upper bound for the Share Everything model.  We were reminded of this with the release of the latest Bankrate.com survey, which showed that only 50% of Americans have saved enough to cover three months of savings, and that 27% of Americans have no savings at all.   There is a spending ceiling, even for LTE.

Also, it’s not hard to see Sprint or T-Mobile really taking aim at the unlimited voice and text part of Share Everything prior to the completion of their LTE networks.  With average minutes used decreasing for most smartphones, Verizon’s $40 charge for unlimited voice and data is $10 higher than many MVNOs (network resellers) are charging for the same coverage.  When there’s $25 or more (depending on usage) of operating profit per account each month generated through breakage, it’s likely that competitors will devise plans to curtail that profit stream.

BlackBerry-Q10 imageMany of you sent me thoughts on Blackberry’s earnings.  It’s easy to pile on Blackberry, and, as an applications software developer, I have no sympathy as the pain Blackberry put applications developers through during 2009-2011 was immense.  They are in the first innings of a double-header transition period with no stable base or geographic stronghold from which to position a comeback.  Here’s their US results to date (using a blend of online “most popular” results from several sites as well as discussions with Dallas store reps):

  • Verizon:  Blackberry does not register as a retail option. The store rep I talked to put it perfectly:  “If I am asked about Blackberry, I will show them the Z10 or Q10.  If I am asked about a smartphone, I show them Samsung and Apple.”   On Amazon Wireless, Blackberry Z10 and Q10 models rank 7th and 8th (Amazon figures exclude Apple products).  Most importantly, Blackberry trails HTC and Nokia at Verizon.
  • AT&T:  Blackberry scores better, but still lags behind HTC and ties with the Nokia Lumia brand.  Resuming a leadership role at AT&T is going to be very difficult given the stronghold Apple has in the consumer/ prosumer (professional consumer) segment.  “It’s easy to upsell an iPhone5, especially when the customers see the speeds.  The trade-in bonus is accelerating the change.”  This leaves the enterprise segment at AT&T, which is going to sell a lot of Blackberry Q10 devices, but also a lot of Galaxy S4 with SAFE/ KNOX capabilities.
  • Sprint:  Sprint does not offer the Q10 or the Z10 at this time.  It required real sleuthing to even find the Blackberry Bold in the store.  The store rep put it in succinct terms when he said “I have yet to sell a Blackberry to an individual user that is under 40, and I’ve been at this store for over a year.”  Rumor has it that launch date will be either the weekend of July 27th or August 3rd.

With service revenues languishing (even with adjustments, a 10% quarterly decline is alarming), Blackberry has a limited window to reinvigorate its US presence, particularly with LTE subscribers.  For HTC, Apple, Nokia and Samsung, this means more opportunities to pick away at their lucrative base.  It’s possible yet hard to see a scenario where Blackberry succeeds globally without first being successful in the US.  And it’s even harder to see Apple iPhone users returning to Blackberry under any circumstances, especially with Blackberry’s PlayBook aspirations on hold.

Next week, we’ll look at the quarter from the perspective of wireline and enterprise sectors.  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!