Reality Check: Earnings spotlight on consumer data and enterprise growth

Editor’s Note:Welcome to our weekly Reality Check column. We’ve gathered a group of visionaries and veterans in the mobile industry to give their insights into the marketplace.
We are quickly approaching the end of the second quarter, and the industry isn’t without some headlines (by the time you read this, I anticipate that Apple will have announced that it sold 1 million iPhones since Thursday). However, specific phone model sales (which impact subsidy and churn) rarely impact the current wireless carrier quarter, especially when they happen in late June. So what could impact the quarter, and what will the carriers avoid that could be a sign of operating income weakness? We’ll cover two this week and two over the holiday weekend. To start, let’s look at consumer wireline data growth and enterprise growth:
1. Consumer data growth will be seasonally slow, and likely weak for all parties. As we mentioned in the first quarter analysis, the fact that AT&T’s DSL net additions were positive in both the first quarter of 2009 and 2010 virtually assures us that the second quarter will be negative for DSL. Also, if the trend holds, we will likely see ~200,000 U-Verse additions (this would definitely be on the low side of expectations). Broadband data has been a rare bright spot for the telcos, especially AT&T. Using the past four quarters of net additions, the annualized revenue from high-speed Internet alone is $230-250 million. Against $60 billion in total wireline revenues, that’s a small (0.4%) growth against a tide of declines, but it’s a positive number nonetheless (refer to the “Tale of Two Waterfalls” Sunday Brief from last fall for more information). Interestingly, AT&T, using the last four quarters of net additions and a $30 average revenue per user, has outpaced Verizon’s high-speed Internet growth by over $100 million. Against a backdrop of large numbers, this is not material, but it demonstrates that AT&T has not thrown in the towel on the bundled, (mostly) wired home as a strategy.
Comcast, who, outside of Clearwire, has no wireless segment, clearly shows what a data focus can produce. Comcast’s 51 million homes passed outperformed Verizon and AT&T in the first quarter by about 10%. They also did it in Q3 and Q4 2009. Remember, Comcast does not have New York City, Los Angeles, San Diego, Dallas, San Antonio, St. Louis, Charlotte, and many other cities in their footprint. Verizon and AT&T do.
Why is understanding high-speed Internet growth important? Because with their penetrations and scale, the margins from high-speed Internet growth are significantly higher than any other product line (except for switched access revenues which are in steady decline). Of the $250 million that flows to the top line for AT&T, the incremental cash flow margin is above 80%. $50-100 million in increased cash flow represents a 2-3% increase in EBITDA.
Look for data to be a source of growth for cable and a talking point when they discuss growth. If the traditional telcos mention the word “data” without “wireless” in front of it, I’ll be very surprised.
2. Business and wholesale revenues, which comprise significant portions of the Telco wireline revenue and profit pictures, are going to decline even further. When was the last time you saw Randall Stevenson or Ivan Seidenberg talk about secure end-to-end enterprise Internet solutions? Or attempt to explain what IPv6 or MPLS represented to medium or large business customers? Or discuss the profit margins they were generating connecting their competitors’ wireless towers to their switches (called special access)? I cannot think of the last time a carrier CEO has been associated with large and medium business growth. And business is a significant portion (60%) of AT&T’s wireline revenues.
Here’s an insight: Outside of the largest customers, most telcos don’t know how effectively to serve the wired needs of business. Cable is just as bad. Yet when challenged with the prospect of wholesale and non-branded indirect channels, the sneers from cable and telco executives emerge. The largest telecommunications providers (Frontier and larger on the telco side, Mediacom and larger on the cable side) are too nationalized and too inexperienced to deal with anything but basic transport needs. That is, until you want to buy four wireless lines on a shared plan, and then they will usually roll out the red, yellow, and blue carpets to subsidize your handsets in exchange for a post-paid contract. It’s a messed up world for business.
As a result, business trends are dismal for both AT&T and Verizon. Of course this is due to the economy, but also to a systematic de-selection of all but the largest business and wholesale customers as a market segment.
While our economy grows, AT&T’s business shrinks (or, in the case of small business, stalls). Wholesale, using their sequential (Q4 to Q1) figure, is headed for a double digit annual revenue decline in 2010. Larger enterprises are using VoIP and wireless-only solutions more than ever, moving to Ethernet, employing home-based contractors, and, in the case of larger corporations, moving their servers from company-owned data centers to more efficient and newer ones. Sure, the economy still stinks, but there’s a lot more going on underneath suggesting the $2 billion or so in lost revenues is going to be harder to recover than most analysts and executives think.
Verizon, who will likely post an operating loss for their wireline unit in Q3 (to reflect the sale of the former GTE properties to Frontier), has a similar picture to AT&T.While year-over-year percentage declines are not as significant as AT&T’s, it’s clear that wholesale revenues for Verizon are trending toward a double-digit decline as well. Where are these revenues going? Isn’t this the category that we have highlighted as the most profitable for any telco, and one that is growing due to more backhaul needs from wireless carriers? My guess is that for the $2.6 billion in enterprise and wholesale losses at AT&T and Verizon, about $520 million or 20% have gone directly to Time Warner ($170M) and Comcast ($350M). About 30% or another $780 million is due to cyclical economic changes. And we can probably attribute 5-10% to other cable companies and other new competitors such as Zayo and KDL.
That leaves just over $1.1 billion in annual revenues that is not being driven by competitors or the economy. That’s the effect of VoIP, Ethernet, and wireless. And, most painfully, it’s 70%+ operating margin revenue that will not return. To put into context, it’s another 7,000 to 8,000 jobs that need to be cut by Verizon and AT&T just to stay earnings before interest, taxes and depreciation neutral. Or, to the first example, consumer Internet needs to grow by 2-3 fold more than current trends to stay even on revenues.
Bottom line: There’s more to AT&T than Apple (although this will be the headline). And Android will need to morph into something “Incredible” to replace business and wholesale losses at Verizon. ARPU will rise (we’ll talk about this next week), as will prepaid customers (Wal-Mart), and connected devices (M2M). Growth for the remaining business remains a significant challenge, however, and mounting EBITDA pressure is beginning to emerge.
Next week, we’ll dive into two more topics: capital and bandwidth.
Jim Patterson is CEO & co-founder of Mobile Symmetry, a start-up created for carriers to solve the problems of an increasingly mobile-only society. He was most recently President – Wholesale Services for Sprint and has a career that spans ove
r eighteen years in telecom
and technology. He welcomes your comments atjim@mobilesymmetry.com.