From Wall Street to Main Street, the outlook for the cellular industry remains positive, especially for major players abroad and minor players at home that exploit markets with lower competition and penetration levels.
The new Telecommunications Act has unleashed forces that could transform the entire communications industry, including the cellular sector, into something completely different than it has been, in the view of Dan Pakenham, senior telecommunications analyst for Moody’s Investors Service Inc., New York.
“If you’re big and you think you’re a god in your industry, you’re setting yourself up for a fall. Never underestimate your opponents, no matter how small they are,” Pakenham said. “Smaller players could find additional revenues by riding on the coattails of the big guys, or they could get squashed like bugs.”
If they don’t rest on their laurels and let personal communications services providers move in and steal their turf, cellular operators possess a number of key competitive advantages, according to David A. Freedman, managing director of Bear, Stearns & Co. Inc., New York. Those advantages include wide area coverage; talented and experienced engineering personnel; broad distribution channels; a large existing customer base; strong balance sheets; inexpensive handsets; and the means to reduce fraud dramatically in analog systems.
However, according to Freedman, the 25 percent annual average customer churn rates for cellular carriers render them vulnerable to PCS providers, that could exploit churn to gain market share at the expense of cellular incumbents. Cellular providers also are handicapped by antiquated billing and customer service systems unable to provide “the advanced intelligent networking features their PCS cousins intend to offer,” said Freedman in his recent report, “Telecommunications Untethered, Volume II: Battle on Two Fronts.”
Furthermore, while analog networks and handsets have a cost advantage, the quick transition to digital service is essential in order for cellular to compete against PCS, in Freedman’s view. “We believe that the successful migration of the majority of their customers to digital service is critical for the cellular providers. This migration is essential for cellular to match PCS’s claims of privacy and longer battery life, not to mention the ability to lower effective service prices. The transition is made more difficult by the need to maintain the quality of the analog network and the lack of clear spectrum in many densely populated urban areas.
“If the major cellular providers have not successfully deployed digital air interface technology before PCS hits the market in 1997, the stocks of the cellular providers are likely to fair poorly,” he said.
Companies like 360 Communications Co., which “have a clear path to digital” and are involved in rural wireless opportunities, are attractive investment options, according to Prudential Securities Inc., New York.
“If you believe, as we do, that it will be quite a while before PCS comes to rural areas, if ever, then companies like Western Wireless Corp., a PCS-cellular hybrid, and CommNet Cellular (Inc.) are very valuable as roaming partners to the larger guys that want to expand their footprint,” said Barry Kaplan, senior telecommunications analyst for Goldman, Sachs & Co. “Goldman is focused on the rural operators, like [United States Cellular Corp.] because they are less subject to competitio …*and also on companies like Millicom (International Cellular S.A.), Vodafone (Group L.P.) and AirTouch (Communications Inc.) that are operating internationally where there is less competition and especially rapid growth, but low valuation.”
Pakenham of Moody’s begs to differ with this rosy outlook. “The rural players are all highly leveraged because they are up to their eyeballs in debt,” said Pakenham, who specializes in credit quality review of high-yield, high-risk corporate debt securities. Debt is senior to equity in the repayment pecking order.
“Not all the companies are like this, but the very small ones all have a boat load of debt,” Pakenham said, naming PriCellular Corp., Vanguard Cellular Inc., InterCel Inc., Centennial Cellular Corp. and CommNet.
Despite good roaming revenues and markets that are stable or growing slightly, high debt levels impute higher repayment risk to these companies, he said. Consequently, average default rates are significantly higher than for investment-grade debt securities.
However, officials of several independent cellular carriers said the landscape is looking good to them. “Our feeling is that our penetration rates are 11 percent to 12 percent of the state, and the growth continues on,” said Kevin Wiley, vice president of diversified operations for Lincoln Telecommunications Inc., Lincoln, Neb. A year ago, Lincoln merged with Nebraska Cellular, and the combined company will become Alliance Cellular in late August.
“PCS operators will probably affect us in Omaha and Lincoln, but it will be awhile till they make it out to the rural areas. Their niche market is limited to people who stay in Omaha and Lincoln, or travel only between those cities, but the majority of our business customers in the cities also use cellular in rural areas,” Wiley said. “And our pricing is comparable to rates Sprint Spectrum charges in Washington.”
To Richard Ekstrand, president of Rural Cellular Corp., Alexandria, Minn., the outlook in 1997 and 1998 is one of “a very vibrant cellular industry.” Rural Cellular, which went public earlier this year, has spent $40 million upgrading its network infrastructure to enhance coverage in its territory, where long-distance car travel is the norm for both business and pleasure.
Improved coverage also is a necessary precursor to the company’s digital deployment strategy since capacity-enhancing digital technology “is much less forgiving than analog,” Ekstrand said.
Unlike some urban cellular companies, Rural Cellular is not bumping up against its network’s carrying capacity, a situation that is likely to abet the early inroads of PCS in the role of operations overflow provider in major cities. Consequently, Ekstrand said, “we have the luxury of migrating to a digital platform on a much more orderly basis and in concert with our neighboring carriers.”
Rather than viewing PCS providers as interlopers, Ekstrand sees them as business opportunities. “As several new licensees unfold their strategies to build out their networks, we see new opportunities to market our roaming services to these carriers coming into our area,” Ekstrand said. “We’re very cognizant that we’re in the airtime business, and we’re very entrepreneurial. Over the next months, we will be having discussions with the PCS licensees.”
Similarly, John Lankes, vice president of wireless products for SNET Mobility Inc., New Haven, Conn., sees PCS providers both as potential competitors and as potential revenue sources. “We’re in a strategic position relative to roaming between New York and Boston, and that lends a lot of value,” he said. “PCS can’t build a network to cover the whole territory.”
Independent cellular carriers also are likely to remain autonomous, at least for the time being, in the view of Goldman’s Kaplan. The PCS auctions have been the main focus of attention for the major acquiring firms, notably AT&T Corp. and the regional Bell operating companies and their affiliates, for the past 12-18 months. Going forward, these companies may again look to acquisitions of PCS and/or cellular carriers in order to “complete their national or super-regional footprint,” Kaplan said.
Additionally, he noted, existing cellular companies may bid in the upcoming D-, E- and F-block 10 megahertz auctions.
“I don’t see a lot of acquisitions, given that more spectrum is available,” said Steven Watkins, a principal of management consulting services for Kraskin & Lesse, a Wa
shington D.C., law firm. “It could be that it is cheaper to buy spectrum than to buy another company.”
It also might be cheaper for large cellular companies seeking a diverse product mix to outsource provision of some functions to smaller players, said Pakenham of Moody’s. Long-distance carriers like MCI Communications Corp. and Sprint Corp. already have contracted out their cellular service to other providers.
“Smaller players must adopt guerrilla tactics, knowing when to team up, when to fight, when to move in and hit hard, when to pull back,” Pakenham said. “This is not a static niche strategy but more of a moving target (strategy), requiring continuing product and service mix development. Speed is of the essence because the big guys can’t move as fast.”
