Editor’s Note: RCR Wireless News asked wireless industry analysts and executives to provide their predictions for what they expect to see in 2012 across their areas of expertise.
As we turn the page into 2012, we believe it is an opportune time to offer our own version of a Top 10 list to take a page out of Mr. Letterman’s playbook.
What will 2012 bring to the telecom sector? In summary: continued evolution and change.
In 2011, we clearly saw much convergence among the respective telecom/media/technology sectors. 2012 will continue to build on this trend, in our view. On the wireline side, we favor the fiber-based wireline players and carriers with significant free-cash flow generation. In our view, these should represent relatively safe havens if the market continues to prove choppy.
On the wireless side, valuations are close to historic lows. While we will continue to monitor pricing trends and the competitive landscape, we believe carriers should begin to see the average revenue per user benefits of robust 2011 smartphone sales and would expect M&A to be a large part of the wireless story in 2012.
In the attached discussion we have identified 10 key themes that we believe will be ones to watch over the next 12 months. Given the fact that the wireline vs. wireless lines are becoming quite blurred, we have incorporated both these sectors into the attached list.
Top ten telecom themes to watch for in 2012
No. 1: Wireless model will continue to shift away from subscriber driven more to ARPU driven.
Net sub growth in the traditional wireless voice sector will be difficult to come by in 2012 as U.S. penetration of wireless service has increased to greater than 100%. While customers may jump from one service provider to another, the fact is most individuals that want a wireless service already have it.
Wireless subscribers increased from 76 million in 1999 to 277 million in 2009 and are estimated to exceed 320 million at year-end 2011. As a result, the wireless business model has shifted away from a focus on grabbing share in a growing market to growing share of subscriber spend from other potential uses of disposable income. The carriers are using the appeal of the smartphone – and smartphone subsidies – to incentivize customers to subscribe to higher ARPU plans and add-on services (namely wireless data). Simply put, we are seeing the model continue to evolve from a subscriber driven one to an ARPU driven one. We are seeing the results of this effort in postpaid ARPU growth, which we estimate will increase 2.7% in 2011 and 2.4% in 2012.
No. 2: Industry needs to find a way to deal with handset subsidies (fixing the “Apple” problem).
Handset subsidies have been increasing as smartphone adoption has grown. The iPhone, which costs the carrier an additional $200 on average in subsidy expense, has been a major driver of this trend, particularly in 2011 with Verizon Wireless and Sprint Nextel both getting the device. To put this subsidy expense in perspective, we expect the three U.S. carriers that carry this device to see an average sequential margin deterioration of 913 basis points in Q4 2011, following the October release of the iPhone 4S device. We expect 2011 wireless margins of the Big 3 carriers that carry Apple to decline by 210bps vs. 2010 levels.
A major part of this was due to popularity of the iPhone 4S device (launched in October, 2011). Such margin declines are emblematic of the pressure subsidies are putting on industry today. While we expect handset subsidies to continue to pressure margins in 2012, we believe that there are longer-term trends developing that could help the carriers diversify away from Apple in some ways. A key part of this will be the “second act” per se of the current operating system platforms. We believe Nokia/Windows Phone and Research In Motion’s move to its BlackBerry 10 platform will be a critical part of this trend.
In 2012, we expect Nokia to begin shipping Windows phones in the United States in volume, which could increase the competitive pressure on Android and Apple and help the carriers. In 2012, we also expect LTE smartphones to gain scale and we expect to see greater affordability during the second half of the year, which should be particularly good for carriers dependent on lower priced LTE devices, such as MetroPCS.
It is clear to us, the major industry carriers want other OSs to grow and thrive. While Windows and RIM may seem down – we would not count them out just yet.
No. 3: Spectrum, spectrum, spectrum – more is better … but, where will it come from?
Spectrum was a big focus in 2011 and should continue to be focal point of the wireless industry in 2012. AT&T unsuccessfully pursued T-Mobile USA in 2011 in large part to gain access to additional spectrum. However, with the government essentially blocking the merger, AT&T is added to what is becoming a growing list of carriers who need to add to their longer term spectrum portfolio. While Verizon looks to be well-positioned with its recently announced acquisition of SpectrumCo’s AWS spectrum (expected to close by year-end 2012), AT&T, T-Mobile USA, MetroPCS and Leap are all in need of additional spectrum.
The players with possible surplus spectrum are Sprint Nextel/Clearwire, Dish and LightSquared, but each has its own set of issues and possible complications for any acquirer. In addition to industry players, the government has spectrum it could push into the markets, whether it be from the broadcasters, public safety, military or other sources, but this process has traditionally been very slow and difficult to predict.
We expect spectrum to receive much focus in 2012 from wireless participants. We expect to see many transactions in 2012 involving spectrum – whether it be outright sales, joint ventures or other partnerships.
One area where there has been recent activity and could see future activity is the 700MHz band. Leap recently acquired some lower A-Band spectrum in a swap with Verizon Wireless and AT&T just closed on its acquisition of Qualcomm’s 700 MHz spectrum. AT&T acquired 6 megahertz of unpaired nationwide spectrum in the lower D-Block and 6 megahertz of unpaired spectrum in the lower E-Block covering approximately 70 million potential customers.
In terms of future moves, it is worth noting Dish holds the remaining position in the lower E Block, which could be very interesting to AT&T, and a number of companies own pieces of the A and B Blocks that could be consolidated.
No. 4: Expect prepay to capture more share than postpay.
Prepaid subscriber growth has greatly exceeded growth in the postpaid subscriber base over the last several years. Specifically, in 2009 and 2010, prepaid subscribers grew 36.9% and 13.2%, respectively, versus 2.8% and 2.6% growth in postpaid subscribers. We are currently forecasting 7.9% in prepaid subscribers in 2012, and 2.2% growth in postpaid subscribers.
Driving this trend are a number of factors – greater credit challenges by many in the U.S. population; an allure to a “contract free” agreement with carriers; a more attractive handset portfolio (with many affordable Android smartphones); and popularity of the true unlimited plans. We expect to see the continuation of more postpay subscribers choosing prepay services in 2012.
For a fee of $55 per month users can get unlimited voice (including long distance), text and data (albeit slower than the Big 4 national carriers’ network). For the roughly 55% of the U.S. population that have not yet upgraded to a smartphone, the value of these prepay plans certainly offer appeal to the frugal or more cost-conscious former postpay subscriber. If this structural shift occurs it should benefit the likes of MetroPCS, Leap and Sprint Nextel (via Boost Mobile/Virgin Mobile).
No. 5: The year of 4G – we have only just begun.
We expect much 4G news to come in 2012 and all roads are leading to LTE. In 2011, Verizon Wireless took a clear head start. While the company is guiding to 185 million covered POPs with LTE by year-end 2011, we expect the actual number to be closer to 200 million-plus.
2011 also marked an interesting year for Sprint Nextel and its partner Clearwire. Both companies announced their formal move away from WiMAX and more toward an LTE upgrade path. While T-Mobile USA has no current plans for an LTE rollout (and limited spectrum to do so), it does have HSPA+ (its version of 4G) now available to 215 million POPs across the United States.
Last, AT&T Mobility will likely also ramp up its own LTE spending in 2012, as we expect it to double its footprint in 2012 vs. 2011 levels. Like T-Mobile USA, AT&T has a large footprint of HSPA+. We believe such exposure should allow for a more easier (and graceful) transition to LTE than some of the CDMA carriers.
We also note that the LTE rollout story is not just limited to the national carriers. Regional carriers including U.S. Cellular, Leap and MetroPCS have all announced plans to rollout LTE (note: MetroPCS already has LTE service live in its markets).
While LTE network expansion is a large part of the LTE story in 2012 – so too will be the growth of the ecosystem. Verizon Wireless currently has nine LTE handsets available to customers and AT&T Mobiloty has two currently available. With this growth in devices, we should get a greater supply of lower cost handsets. Lower price points should drive additional usage, in our view.
Obviously the big question for 2012’s LTE device lineup is if an Apple device (iPad or iPhone) will be included in this list. If so, this should be a clear game changer … and in our view, the carrier with the biggest LTE footprint (Verizon Wireless) will be best positioned.
No. 6: Wireline model continues to become less dependent on access line trends – more contribution from broadband and video initiatives.
The wireline model is becoming much less dependent on access line trends. In 2012, we expect the wireline model will continue to transition away from voice to broadband and, in some cases, video.
Verizon is a good example of this trend. During the third quarter of 2011, FiOS consumer revenue, which includes FiOS voice, video and data, was 62% of total wireline consumer revenue and grew 18.5% year-over-year. This compares to an 18.5% decline in non-FiOS consumer revenue.
We expect the average number of broadband and TV subscribers (combined) for AT&T and Verizon to be higher than the average number of access lines in 2012 for the first time. We expect this trend to continue as DSL is replaced by fiber at AT&T and Verizon and the RLECs continue to invest in faster DSL speeds to create competitive broadband and video solutions.
One of the implications of this trend is that different areas of focus are becoming more relevant to the telcos as video and broadband eclipse the voice business. In video, content costs are becoming increasingly important as this revenue stream increases for Verizon, AT&T and smaller players pursuing video (i.e. CenturyLink). We expect content costs and retransmission rates to become bigger topics for telecom in 2012.
In terms of broadband, although we expect fiber/copper-based solutions will continue to dominate and wireless broadband substitution may become a great part of the conversation in 2012 as both LTE speeds and capacity improvements are seen. We believe this is a trend (while still very early) to be watched in 2012, especially in our RLEC universe.
No.7: Continued evolution toward IP and strategic services.
While we were hoping for a better economy in 2011 vs. 2010, one trend we did see in 2011 was the continued transition to IP services and a more tangible growth in strategic services. While wholesale and enterprise revenue is declining at a slower rate than in the past few years, it is still in the red.
Strategic services, however, while only a small portion of carriers’ revenue (note: strategic services represented 9% of AT&T’s and 18% of Verizon’s wireline revenue year-to-date), is continuing to show accelerating rates of growth. We expect this trend to continue in a more meaningful way in 2012 – even with clear macro issues still weighing on the economy.
While strategic services typically make for a longer sales cycle than legacy enterprise-type revenue, these services can help improve the efficiency of businesses and typically provide “stickier” type of revenue stream for the carriers themselves. In 2011, carriers made large bets on this segment. This was most clearly seen with Verizon’s purchase of Terremark (April 2011) and CenturyLink’s purchase of Savvis (July 2011).
We believe carriers are correctly recognizing the fact that the dynamics of the “old” enterprise revenue drivers have clearly changed. While strategic services (which includes such segments as managed hosting, cloud, storage, IP) is still somewhat in its infancy those carriers which only, or primarily, service this niche (such as Abovenet) are well positioned to realize robust growth – even in a weaker macro environment. This is due to the fact that unlike AT&T and Verizon, which still have revenue that is more vulnerable in an IP transition, these carriers have no legacy business to protect and thus should allow for a higher organic top-line growth story. We saw this in 2011 and we would expect this trend to continue in 2012.
No. 8: Expect declining wireline capital expenditure trends as AT&T and Verizon wind down respective consumer fiber builds.
We expect wireline capital expenditures to decline in the aggregate in 2012 due in large part to the completion of AT&T and Verizon, as well as the partial expiration of bonus depreciation. As of year-end 2011, both AT&T and Verizon had finished the bulk of their respective fiber-to-the-home builds, with Verizon’s FiOS now surpassing 17 million homes and AT&T’s U-Verse passing 30 million homes.
We expect the trend in declining wireline capital expenditure in 2012 to be partly offset by increased spending by CLECs and RLECs on fiber-to-the-cell. Mobile data growth is generating strong demand for fiber backhaul and many carriers are increasing investments to capture this opportunity. Despite this offset and considering the size of AT&T’s and Verizon’s capital budgets, we still expect aggregate wireline capital expenditure to decline in 2012.
We would also note that accelerated depreciation has incentivized carriers to invest in 2011 and we would expect to see some payback in 2012 as the bonus depreciation is cut to 50% and then expires in 2013.
No. 9: 2012 = Very good year for towers (many drivers seen).
Although wireline capex in aggregate will likely be lower in 2011 vs. 2012 (see No. 8 above), we do not believe that will be the case for wireless. In summary we expect 2012 to be a year of healthy wireless capital spend.
Driving this thesis are several factors. Some of these include: carriers aggressive rollout of LTE (see No. 5), the lack of available spectrum to help support data usage (see No. 3), the rollout of smaller networks/het-nets/DAS systems to support the expected increased demand on the wireless networks as more smartphones get in the hands of users, and the rebirth in spending patterns from the likes of Sprint Nextel, Clearwire and T-Mobile USA.
Simply put, carriers can gain additional capacity either through more spectrum or more cell sites (cell splitting). As mentioned, there is a large shortage of additional spectrum coming to carriers. As a result, we believe carriers will be very focused on rolling out smaller networks – with a greater density of cell sites.
One theme we expect to hear more of in 2012 is the greater emergency of heterogeneous networks (aka “het-nets”). The idea of incorporating small cells – whether microcell, picocell, femtocell, distributed antenna systems (DAS) or Wi-Fi – into the macro network is not a new concept. But with the lack of availability of other sources of spectrum, it is widely regarded as the most cost-effective way to speed deployment and enhance mobile broadband coverage and capacity. Such a trend should benefit the towers in 2012, in our view.
The move to 4G will be an important theme for towers in 2012. As discussed, many carriers are only in the early stages of their LTE rollouts. LTE related capital spending and network expansion bodes well for towers’ amendment revenue. While LTE sites do not require a separate new antenna, they do require enhancements to the current antennas on the towers. Additional weight on the antenna translates into additional amendment revenue (which can range from an incremental revenue of $300 to $1,000 per month). Such revenue is essentially 100% margin as there are no additional operating expenses for tower companies associated with this enhancement.
While Verizon Wireless is significantly further along than its peers with its LTE buildout, its LTE coverage footprint has been described by one of the tower companies as “a mile wide but an inch deep.” Put simply, while Verizon Wireless’ 3G spend is likely behind it, we would expect much of its 2012 spend to be focused on “fill in” areas in its 4G LTE network footprint. Additionally, as mentioned, carriers such as Sprint Nextel and Clearwire, which have been in virtual spending pause for the past year and a half, have recently raised capital and have a stated goal for a network upgrade in 2012 and 2013. This too bodes well for the towers, in our view.
Last, our checks show that both T-Mobile USA and AT&T Mobility have recently increased spending and planning since the breakup of the merger in late December.
No. 10: Expect M&A to be major theme in 2012 (yes … we said major).
We expect 2012 to be a significant year for mergers and acquisitions in both the wireline and wireless sectors.
There was much activity in the CLEC/fiber area in 2011. We expect this trend to continue in 2012. There still exists many private regional fiber players who we believe would be willing sellers at the right price. In late 2010, we saw many transactions occur driven by financial sponsors/private equity players which were looking for an exit strategy. We would not be surprised to see some similar moves in 2012.
In the managed hosting/data center space, we believe Verizon could look to build around the Terremark assets, which it acquired in 2011. At a recent conference, Verizon’s CFO indicated that they would look to purchase more data centers in the international market place (which complement the Terremark assets) as well as look to other areas in the international arena which offer greater cloud and security capabilities.
We also believe we could see other players (including AT&T and CenturyLink) add to their capabilities in this area, possibly through a purchase of an outside player. While CenturyLink has Savvis, we would not be surprised to see it look to further grow this segment as it attempts to diversify away from its RLEC roots.
Finally in terms of wireless, 2011 was an unusually quiet year for M&A. While there certainly was the big (and very much unexpected) announcement in March of the AT&T/T-Mobile USAmerger – the industry seemed to go into a lull following this as players were planning their next move based on the outcome (and possible divestitures from) that merger.
While the regulatory headwinds were too strong for AT&T to get the deal done, we still believe Washington, D.C., would approve mergers of smaller industry players (note: we define “smaller” players as any carrier smaller than AT&T Mobility and Verizon).
All eyes should focus on the Germans! We believe what T-Mobile USA’s parent company – Deutsche Telekom – does here is going to be very significant in determining how the U.S. wireless landscape will look a year from now. If they stay or go will have an impact on the industry overall. If they stay, T-Mobile USA will need spectrum if it is to have a real LTE strategy. We would not be surprised if T-Mobile USA were to look for a possible spectrum partner (Clearwire could be a possibility). T-Mobile USA could also look toward a joint venture/spectrum sharing partnership (DT has shown a willingness to do this in other countries). If it chooses to go down this path, Sprint Nextel could be a serious candidate for a potential partnership. Wholesale revenue opportunities are a large part of Sprint Nextel’s Network Vision model and it clearly has shown an affinity for T-Mobile USA prior to AT&T’s bid.
Separately, we would expect to see consolidation among some of the smaller industry players. We have seen (and lived through) this movie before. Although the list of public regional wireless carriers has significantly shrunk in recent years, names to watch include: Ntelos, Leap and MetroPCS.
