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.
It took a strong stomach to just get through last week. In a single trading day, stocks lost 30% of their value. Stocks that had lost value in previous weeks dove in sympathy with last week’s news. Negative sentiment began to build against the prepaid market, which defies all logic if you look at the developments happening in the pre- and postpaid markets. Interestingly enough, costs rose because consumers (especially the under-30 “delirious for data” crowd) decided to use their data plans as they migrated to Android and iPhone products en masse. (Even more interestingly, none of their data/bandwidth suppliers had a good week either – check out CenturyLink Inc. (CTL), Windstream Corp. (WIN) and Frontier Communications Corp. (FTR).
The bottom line: Anything but really big telecom is in a state of “market leprosy.” Risk-takers are leaving the market as the big get bigger. Software and applications companies like Apple Inc. and Google Inc. have created more than $55 billion in market cap since the third quarter began. Collectively, the telecom providers have lost $30 billion in market capitalization, with about half of this coming from AT&T Inc.
Why is this happening? Three dynamics drove last week’s change:
1. Investors began to add up the costs for the “challengers” to quickly move to a data-focused network and concluded that the market expansion created by faster data would not emerge at the low end of the market. A combination of increased churn for traditional voice + text plans (driven by economic considerations), increased smartphone subsidy to reduce the aforementioned churn (driven by initial purchase affordability) and increased capital to support expected data usage is a recipe for risk.
What the market fails to realize is that the “gainers” above (Google and Apple, as well as Research In Motion Ltd. and Nokia Corp./Microsoft Corp.) need the broadest possible market base to build the next generation of applications (which will connect at the application and not the network level). If affordability is in question, will I be able to connect with all of my friends through a mobile Voice over Internet Protocol solution? Nope. Without a majority of the market using operating system-driven applications, the “common denominator” is voice and SMS/text. That’s not good for Google or Apple.
In-app is needed to control the customer experience. There’s no in-app control without smartphone adoption.
2. Investors began to question the ability for each “challenger” to transition from a 3G to a 4G network with increasing scale and profitability. This is a company-by-company issue. Is 9.1% penetration of their addressable markets enough to sustain profits at MetroPCS Communications Inc.? How will Leap Wireless International Inc. and Sprint Nextel Corp. compete against the new AT&T? How will all of the challengers compete against Wal-Mart Stores Inc. (who appeared as the real winner from the quarter)? What about other wholesale providers if/as Sprint Nextel, Verizon Wireless, and AT&T Mobility open up excess 3G voice capacity?
This is a significant but not new concern, especially for Sprint Nextel, MetroPCS and Leap. Sprint Nextel’s risk is that it has to integrate its 3G and 4G networks into those of LightSquared and Clearwire Corp. For MetroPCS and Leap, it’s a question of the size of the 4G handset “bet” with a specific device or manufacturer. The 4G market cannot grow quickly with the entry price at or above $200. But it can below $150 or $100 at a $60 monthly unlimited rate. It’s in Huawei Technologies Co. Ltd.’s, Samsung Electronics Co. Ltd.’s and HTC Corp.’s economic interests to make this a reality, but someone has to blink.
3. The reality of today’s AT&T Mobility/Verizon Wireless duopoly became clearly evident, even without the T-Mobile USA Inc./AT&T Mobility merger. Although the allocation has changed slightly, the adjusted quarterly cash flows (defined as adjusted earnings before interest, taxes, depreciation and amortization) still show AT&T Mobility and Verizon Wireless with a combined 80% of the industry profitability, down slightly from Q1, but still in the 78-82% range that it’s been in since the beginning of last year. With T-Mobile USA, the new duopoly would control 88% of the profitability of the U.S. wireless industry.
The short-term competitiveness of wireless boils down to a) smartphone purchasing power (no question AT&T Mobility and Verizon Wireless win here from sheer size of their current subscriber bases and the fact they are the only two U.S. carriers currently carrying the iPhone); b) ability to integrate their network into the next generation of low-latency applications (which, with tier-one IP backbone networks and data center investments should be easier for them to do); c) financial flexibility (a challenge to the entire industry, but ability to raise data prices starts with AT&T Mobility and Verizon Wireless); and d) regulatory and legislative influence.
That’s why the stocks fell. Investors looked to 2012 and 2013 for earnings and cash flow estimates and found more headwinds than tailwinds. The risk/reward equation turned upside down and panic ensued. Combined with the overall market volatility, it was a memorable week for telecom, one not seen since 2002. The only thing that can follow is more news – industry consolidation, Clearwire, iPhone availability, Federal Communications Commission. By September’s earnings, we will have it. Until then, grab the antacids and get ready for the rest of the ride.
Jim Patterson is CEO and co-founder of Mobile Symmetry, a start-up created for carriers to solve the problems of an increasingly mobile-only society. Patterson was most recently President – Wholesale Services for Sprint and has a career that spans over eighteen years in telecom and technology. Patterson welcomes your comments at:jim@mobilesymmetry.com.
