Reality Check: Where have all the pre-paid subscribers gone? (and other earnings insights)

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.
Greetings from Kansas City, where the weather and political climate are both scorching hot. We had an earnings deluge this week, with most remaining companies reporting. As we mentioned in last week’s report, we able to validate several hypotheses:
1. Sprint Nextel Corp.’s (S) gains came from more than just T-Mobile USA Inc. (DT) (port-in/port-out comments on the Sprint Nextel conference call seemed to confirm this).
True: It’s clear from the T-Mobile USA earnings announcement (contract customers up 50,000 in the quarter) that they could hold their own even with lower losses at Sprint Nextel (who improved postpaid losses -991,000 in Q2 2009 to -228,000 in Q2 2010). As we will discuss below, T-Mobile USA’s FlexPay program is successfully holding customers in the contract segment.
2. The advertising trends we saw with Comcast Corp. (CMCSA) occurred throughout the cable industry, leading to unexpected cash flow gains for the industry.
Definitely true: Time Warner Cable Inc. (TWC) grew advertising $42 million year over year, Cablevision Systems Corp. (CVC) reported an advertising rebound, and Mediacom Communications Corp. (MCCC) grew advertising over $2 million. It’s safe to say that this resulted in a $100 million increase in operating profits for the industry this quarter and more in Q3 and Q4.
3. Leap Wireless International Inc. (LEAP) and Clearwire Corp. (CLWR) continue their Q1 trends and take 20+% of the net adds for the wired + wireless broadband segment (previous analysis can be found here).
Surprising, but true: It was a very unusual quarter for high-speed Internet adds, with cable growing ~275,000 net additions (this excludes Cox Communications Inc., Bright House Networks and Suddenlink Communications who are private) and DSL/telco fiber shrinking 10,000, leaving Leap (loss of 39,000) and Clearwire retail (gain of 127,000) to make up the rest. The 88,000 combined as a percent of total broadband additions represents 25% of the total. (Note that it also implies that Clearwire alone makes up more than 36% of the total broadband net adds, exceeding one of their owners, Comcast). Assuming some Sprint Nextel and Verizon Wireless (VZ) retail broadband card gains (not handset data gains), it’s still very likely that Leap + Clearwire represented more than 20% of the industry additions in Q2.
It’s hard for me to get my head around cable taking 100% of the wired net broadband additions for the quarter versus their telco partners. Didn’t DOCSIS 3.0 deployments raise a flag? It’s even harder to think about AT&T Inc. (T) shrinking their broadband base (this may also explain their recent price reductions this week). But it happened. Telcos are on their heels and playing defense (once again). While the second quarter represents a seasonally low point for the data industry (as kids leave college and disconnects rise), if the third quarter of 2009 repeats itself in 2010, we are in for a “game, set, match” quarter for cable.
Perhaps the biggest surprise when you add up all of the numbers is pre-paid. I’ve been around the pre-paid market for five years, and the second quarter always stinks for the traditional pre-paid segment. Thanks to our love of giving at the holidays, net additions usually spike in the fourth quarter (and, since pre-paid carries no contracts, it’s received better than a free phone with a $60 per month commitment – talk about the gift that keeps on giving!). Depending on whether the New Year hits on a weekend, the net add trend can carry over into January and impact Q1 figures. These phones get used, but not renewed (called “topping up” in the pre-paid wireless world) and sit dormant for a period of time. After a period of time (which varies by carrier) has expired, the phone is disconnected and a net loss is recorded. An example:
a. Phone activated on Dec. 24 (net add in Q4).
b. Phone used until Jan. 15 (dormant after that time).
c. Carrier has a 120 day dormancy limit on pre-paid phones.
d. Carrier records a disconnect in May (net loss in Q2 of the following year).
Provided that history holds, we should see this in most markets. Churn should rise, and net adds should fall, at least on a quarterly basis. Let’s see how it turned out:
We definitely saw a slowdown from Q1 to Q2 this year. With the exception of AT&T Mobility, everyone is down. What is surprising is the drop versus Q2 2009. Taking AT&T Mobility’s iPad growth out of the Q2 numbers, year over year growth is down 71%.
There are several reasons for this. First, because of the strong growth in pre-paid in Q3, Q4 and Q1 there is the “accumulation effect” – eventually churn will catch up with gross add growth. This churn could have occurred in March, April, or May.
Second, thanks to “apps attraction,” there is less switching out of post-paid into pre-paid (meaning no contract) compared to 2009. Tracfone Wireless Inc.’s (AMX) Straight Talk product ($45 unlimited 2G data, text and voice) had a distinct appeal. But that appeal will not carry over to all wireless customers, especially those who want a 3G experience (or BlackBerry, or Android).
Finally, and this may be closely related to the second point, there’s the “brand effect.” For $70 per month, I could get unlimited 3G data and messaging plus unlimited calls to any mobile phone from Sprint Nextel. And, if I switch to Sprint Nextel and buy at Wal-Mart (WMT), a phone using Google Inc.’s (GOOG) Android operating system with a keyboard is less than $70. This particular plan is a margin killer in the short run (see last week’s column), but it was the single source of net add improvement for the company (who, as mentioned above, improved their net add loss by 768,000 customers on a year-over-year basis).
Did “Any Mobile, Any Time” kill pre-paid in the second quarter? It was definitely a contributing factor. Look for more post-paid preservation tactics (e.g., T-Mobile USA’s $20 unlimited messaging for the whole family) as we enter the fourth quarter. As mentioned previously (T
hree headlines no telecom CEO wants to read), if pre-paid can drive Android and BlackBerry adopters to their networks by the end of the year, they should be able to grow their base at second half 2009 levels.
It’ll be fun to see how this shakes out. Stay tuned.
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 over eighteen years in telecom and technology. He welcomes your comments atjim@mobilesymmetry.com.