YOU ARE AT:Archived ArticlesOperating expense metrics improving, but at cost?

Operating expense metrics improving, but at cost?

The wireless industry’s drive for cost efficiencies has seen marked improvements during the past several years as many carriers have begun posting operating profits after years of racking up huge debts. Those improvements have been bolstered by greater operating efficiencies as carriers have balanced out the cost of operating their networks against increased usage, though some argue that balance may be shifting too much away from maintaining operational quality.

“Carriers have made great strides on a number of operating metrics over the past several years, but some metrics associated with operational costs have lagged others,” said American Research Technology telecommunications analyst Albert Lin.

Wireless carriers have generally noted that a main component of their operating expenses has been network costs that are typically associated with subscriber usage. Those numbers have increased dramatically over the past several years as consumers have migrated their telecommunications needs to wireless networks.

According to a report from N. Moore Capital Ltd., the industry’s average monthly minutes of use have increased more than 27 percent during the past year-from 568 minutes per month during the first quarter of 2004 to 722 minutes per month during the first quarter of this year. Some carriers that offer flat-rate unlimited calling plans, like Leap Wireless International Inc. and MetroPCS Inc., have reported subscriber MOUs in excess of 1,500 minutes per month.

The strong usage growth has pressured the industry’s return per minute, which has fallen from 9.4 cents in early 2004 to 7.5 cents during the first quarter of this year.

Despite the dwindling returns, most carriers have had their hands full supporting both their rapid customer growth and increased network usage.

Cingular Wireless L.L.C.-which has been saddled with a number of capital-intensive programs such as network migrations and spectrum and carrier acquisitions-surprisingly has not reported increased operating expenses during the past several years, but recently recorded a spike in operating expenses. The carrier’s $11.7 billion in operating expenses for 2001 jumped a modest 5.6 percent to $12.4 billion in 2002 and another 6.6 percent to $13.2 billion in 2003. However, Cingular’s operating expenses surged a whopping 35.4 percent in 2004 to $17.9 billion, which analysts attributed to additional costs associated with its acquisition of AT&T Wireless Services Inc. last October.

Verizon Wireless has posted a more linear increase. The carrier’s operating expenses increased 28.1 percent from $12.1 billion in 2000 to $15.5 billion in 2001, 3.2 percent in 2002 to $16 billion, 15.1 percent in 2003 to $18.4 billion and 18.6 percent in 2004 to $21.8 billion.

Sprint Corp.’s operating expenses increased a modest 4.4 percent between 2002 and 2003 and a still-low 8.6 percent between 2003 and 2004. Those numbers are expected to increase next year as Sprint is planning to invest around $1 billion to upgrade its network with CDMA2000 1x EV-DO capabilities as well as complete its pending acquisition of Nextel Communications Inc., which will require the combined company to operate two separate networks.

Analysts also noted that while the industry in general has made improvements in operating efficiencies, many have done so at the expense of other metrics. Lin cited industry’s ability to lower customer churn as a positive, but said those improvements have come with increased cost per gross addition and cash cost per user results that have a marked impact on a carrier’s operating expenses.

“By looking at the numbers, carriers appear to be getting much better efficiencies out of their networks,” Lin said. “They are getting those efficiencies either through improved technologies or by starving the networks of investments.”

RBC Capital Markets telecommunications industry analyst Jonathan Atkin noted that since carriers tend to differ in what they include in their operating expenses reporting, a more compelling metric is a carrier’s earnings before interest, taxes, depreciation and amortization margins.

“EBITDA margins is still not a perfect way to compare between carriers, but it does allow for a better view of how efficient a carrier is operating,” Atkin said.

According to N. Moore Capital, EBITDA margins among the top North American carriers have declined the past year from 33.3 percent during the first quarter of 2004 to 32.9 percent this year. N. Moore Capital President Jeffrey Hines attributed the decline to higher net customer additions across the industry, and predicts those margins will remain below 2004 results through the end of this year.

Lin also noted that margins have been impacted by the flattening of backhaul costs that carriers increasingly are relying on to support more advanced services. Lin explained that the wireless industry operated in sort of a bubble over the last several years as backhaul providers flooded the market with excess fiber that was expected to be needed to support the dot-com boom.

“Carriers were spoiled by these backhaul providers who were more than willing to sell access to their networks at a loss just to have some traffic on their networks,” Lin said. “But that drove many providers out of business, and those that are left are not offering such cut-rate pricing.”

Lin added that with fewer wireline companies in the market providing backhaul capabilities and increasing usage of wireless data services by consumers-that has helped bolster average revenue per user results-carriers will have to see pressure on their margins.

“Backhaul expenses are becoming a more important component for carriers looking to control their operating expenses,” Lin said.

ABOUT AUTHOR