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 we are feeling very “red” after last Tuesday’s elections. We’re just about at the point to wrap up the third quarter, and, after a few hours of catching up on this week’s earnings, I am more convinced than ever that we are headed for a very stormy 2011. Some of the lightning flashes have already started to appear with T-Mobile USA Inc. leading off the Q4 advertising season taking on both AT&T Mobility and Apple Inc. And they did it with applications, in this case FaceTime (there are so many Reality Checks that deal with this trend – perhaps the most poignant is “The Tweet guarantee” but a good second is “The iPhone without a contract”).
The fissures in the industry start to appear when the cold front of dim earnings prospects meets the warm front of incumbency. Depending on the contrast (and we’ll demonstrate below that the contrast is becoming clearer), the storms can be docile or ferocious.
The T-Mobile USA ads are Act 2, Scene 1. Act 1 started last year with the “red vs. blue network” ads. Interestingly, no such ads this year. (Hmmm … ) They will be followed by aggressive handset pricing (already seeing it) and applications bundling/credits (which will start when Verizon Wireless releases their app store this month). Then something new will appear – it’ll have something to do with last week’s topic – creating “home field advantage” – can’t put my finger on it yet, but it’ll change the way we are entertained. And wireline storms will be as ferocious as the wireless ones in 2011.
Now for the numbers. First, a summary examination of operating income before depreciation and amortization concentration in the third quarter:
“Handset subsidy meets scale” might be an appropriate title for this table. Seventy-four percent of the wireless industry profits are generated by the top two carriers. This is quickly heading to 80%. About 20% of the industry profits are generated by Sprint Nextel Corp. and T-Mobile USA (far less if you consolidate Clearwire Corp.’s losses). This is heading to 15%. While they are making inroads on subscribers, MetroPCS Communications Inc. and Leap Wireless International Inc. (and the lone independent U.S. Cellular Corp.) generate mid single digits of total industry profitability.
Most importantly, only Verizon Wireless and MetroPCS improved their profit picture. Remember, the third quarter forms the basis for the budget setting process. No one, save Verizon Wireless, has a sunrise to wake up to. It’s red skies for everyone else. And, for the smart phone contenders Sprint Nextel and T-Mobile USA, the impact of moving 8% to 10% of the base each quarter to smart phones (and, in Sprint Nextel’s case, the annual nature of this subsidy for most of their customers on the Sprint Premier plans) isn’t a “phase” or a “transition” but rather a multi-year reality. As long as 1 GHz processors become 1.2 and 1.5 and 1.7 GHz processors, the subsidies will continue. And that’s handsets – we still have $300 to $400 tablet subsidies coming.
Bottom line: Industry profit concentration will continue. The picture is bleak for everyone except Verizon Wireless, thanks to scale and data plan requirements put in place in early 2011. It’s definitely less bleak for AT&T Mobility than Sprint Nextel and T-Mobile USA, but as the handsets becomes less of a dialer and more of a computer, the pressure on subsidy will continue.
The second storm: High-speed Internet (wireless and wireline)
As many of you will recall, the data picture for the telco wireline providers was very bleak in Q2. There was some recovery in Q3, but not much. Here’s the three quarter assessment of net adds for high-speed Internet:
As we have discussed in many Reality Check columns, the primary contributor to wireline profit growth in 2010 will be high-speed Internet. With gross margins well into the 90% range, no other product comes close (except switched access revenues and cell-site backhaul, but neither of these could be classified as a primary contributor).
Case in point: Comcast increased operating cash flow by $252 million Q3 2009 to Q3 2010. The gross margin on high-speed Internet increased $244 million during the same period. In fact, absent increases in high-speed Internet and advertising (up ~$100 million year-over-year), OCF would likely have decreased $50 to $75 million. We’ll tackle advertising next week along with local voice services and commercial, but, suffice it to say, the CFO of Comcast (and every other cable and telco company) has his eye on high-speed Internet growth.
What’s surprising is the role of Clearwire and Leap in the industry’s net adds. Call them bottom trollers, non-carrier quality, etc., but the retail net adds shown above (Clearwire’s numbers exclude wholesale) are real. Albeit on different bases, Clearwire is close to having lapped Verizon and AT&T on high-speed Internet net adds in 2010 (and, with New York City just added to Clearwire’s footprint, they just might do it). Leap has struggled with churn, but still managed to hold on to 105,000 of subscriber growth this year, which is extremely impressive given its footprint size. One of every five net adds is coming from Clearwire and Leap, and this trend is going to continue. Two of every three net adds in the traditional wired high-speed Internet arena are going to cable – this trend will likely continue. And 2011 brings with it the “Arctic cold front” of Verizon Wireless’ LTE product – guaranteed to generate some thunder and lightning as early as this month.
There are storm clouds on the horizon. Next year will not be one of clear skies in the telecom industry – it will be full of severe weather. Profit expectations (which should form the basis of stock prices) are high, and so are smart phone conversions. The only meaningful source of profitability for wired communications is facing two separate cold fronts of competition – Clearwire/Leap, and Verizon Wireless LTE. Time to get out the foul weather gear – it’s about to get very stormy.
Next week, we’ll look at the continued dismal picture in local phone service revenues, as we as prognosticate on 2011 recovery in business revenues.
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 [email protected].
