Reality Check: Summer earnings relief – Sprint Nextel and Comcast assessment

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 summer is in full heat. Our lawn has gone dormant, but the vegetable garden is loving it.
Q2 earnings: Last week a slower week for earnings announcements, with the major reports from Sprint Nextel Corp. (S) and Comcast Corp. (CMCSA). To put Sprint Nextel’s earnings in an historical context (and to tie to last week’s Verizon Communications Inc. and AT&T Inc. analysis), let’s look at the following tables:
(Wireless subscribers in millions)
Carrier 12/31/2005 6/30/2010 Change
Verizon 51.3M 99.7M 48.4M
AT&T 54.1M 90.1M 36.0M
Sprint 47.6M 48.2M 0.6M
(Net Debt in $billions)
Carrier 12/31/2005 6/30/2010 Change
Verizon $35.7B $52.2B +$16.5B
AT&T $29.3B $68.2B +$38.9B
Sprint $15.0B $16.0B +$1.0B
As we mentioned last week, Verizon Wireless (VZ) and AT&T Mobility (T) have nearly doubled their base over the past four-and-a-half years, with Verizon Wireless growing their customer base 94% since the end of 2005 (Alltel Communications L.L.C. being the notable acquisition during the period, although most of this growth is organic). AT&T Mobility’s subscriber increase, again primarily from within the company, was also strong at 67%. Sprint Nextel, who was knocking on the leadership door with the Nextel Communications Inc. acquisition closed (especially with Nextel Partners Inc. in early 2006), barely grew their base over this period. As a result, their relative market share has fallen from .88 (meaning they are 88% the size of their largest competitor) to .48, and their market share of the “Big 3” has fallen from 31% to 20%.
Forty eight million customers is nothing to sneeze at, and Sprint Nextel has made many strides in service, handsets, and innovative pricing (Dan Hesse, Sprint Nextel’s CEO, articulated many improvements on the conference call, and postpaid churn reached a record low at 1.85%). Verizon, however, now faces a “low/no” debt situation with the Verizon Wireless joint venture (essentially meaning that they grew to 100 million customers while paying down debt). AT&T is still paying for Bell South Corp. and their stake of Cingular Wireless L.L.C., and also for Apple Inc.’s iPhone, which accounts for at nearly half of the 36 million gain in subscribers over the past 4 years.
Here are the headlines from Sprint Nextel’s earnings:
–Thanks to wholesale net adds, Sprint Nextel stopped shrinking (with the exception of Q2 2007, it’s pretty much been negative growth for the past 14 quarters).
–Post-paid churn is down to 1.85% (and they don’t want to see 2% again).
–4G service on track to have 120 million of the U.S. population covered by the end of 2010.
–They’re paying their debts as they come due (which should translate into higher equity value if you believe that Sprint Nextel has a long-term growth rate and hence a terminal value).
–$1 billion in handset subsidies in the quarter (and this will continue to rise with the shift to smart phones).
–Lower wireless earnings before interest, taxes, depreciation and amortization in the quarter with higher capital expenditures vs. Q2 2009.
–Post-paid average revenue per user stable; pre-paid ARPU showing signs of weakness due to the acquisition ARPU (Common Cents, Assurance Wireless).
Bottom line on Sprint Nextel: A very solid data point, and definitely one to build on throughout 2010. The next hurdle for Sprint Nextel is earning an operating profit while figuring out which hungry mouth to feed: the tax man (they haven’t been paying taxes), the hungry data customer (who is driving more bandwidth than anyone assumed when they installed the capacity in 2007), the start-up (Clearwire Corp.), or the transformation (the network RFP Dan Hesse referred to on their earnings call). Some of these pieces move together (data, Clearwire, new network), and Sprint Nextel will need to orchestrate change carefully. But they have oxygen.
Now to Comcast – the most under-appreciated 5% revenue growth story on the planet. Let’s take a look at where they have come in two years (again: this is a two year trend):
Description 2Q 2008 2Q 2010 Change
HSD subscribers 14.3M 16.4M 15% growth
Voice subscribers 5.7M 8.1M 42% growth
Video subscribers 24.6M 23.2M 6% decline
DVR/HDTV subs 7.0M 9.7M 39% growth
Commercial revs $131M $306M 134% growth
Revenues $8.6B $9.5B 11% growth
Operating cash flow $3.4B $3.7B 9% growth
This period (+ maybe a few quarters in 2007/2008) will likely be categorized as “The Great Recession.” With the exception of basic video subscribers, it’s hard to tell there’s a recession going on at Comcast. To be able to maintain a 40% operating cash flow margin in a consumer/consumption-oriented industry like cable during the last eight quarters is exceptional. Remember, they have no wireless to speak of – this is wireline growth.
Comcast has four headwinds, however: a) FCC relations, which impact; b) the NBC-Universal approval timeline and conditions and; c) broadband regulation (Comcast’s high-speed Internet gross margin was 94% in Q2) and; d) their ability to keep a content + bandwidth product pipeline strong after it is approved. It was clear from the tone of the Comcast executive team that they have control going forward, but their product must be one customers value. And, while their business growth is impressive, it isn’t even close to the growth of residential phone from 2005-2008. As this column has suggested in the past, Comcast needs to lead a TCG-like initiative to connect all DOCSIS 3.0 markets nationwide for medium to large business customers. That would throw special access revenues into play for the telcos and unlock billions of value for Comcast and Time Warner.
Many of you remember the column I wrote earlier this year called “A Tale of Two Waterfalls.” It compares the waterfall charts (made famous by Microsoft Corp.’s PowerPoint and probably one of the brand-name consultants) for the Telco and cable world. The shapes still hold, with the exception of one part of the cable chart: advertising. In 2008 and 2009, the bottom wasn’t low enough for advertising – not just in cable, but anywhere. It muted the impressive growth in video revenue
s (but not basic subscribers), Internet, and voice. Advertising started to recover in Q1 and now appears to be in full bloom
. If the Comcast trends hold (and they will this year thanks to the mid-term elections), we’ll see $100 million or so in growth across cable advertising this quarter. That’s pure cash flow for cable, and a trend that will be welcome to both the broadcasting, satellite and cable industries (and FiOS/U-Verse to a lesser extent).
Bottom line on Comcast: Despite the FCC’s bias against the company, Comcast must be doing something right. They are lapping the telcos on high-speed Internet, and continuing to gain share on phone. They are raising ARPU on video (although some of this is passed through expenses). They are the only company in the telecom space that has the cash and the vision to buy back shares at this time. While commercial services could perform even better, and wireless continues to falter, Comcast continues to build a more valuable company.
Next week, we get just about everyone else in the space. We will look to validate three hypotheses:
1. Sprint Nextel’s gains came from more than just T-Mobile USA Inc. (port-in/port-out comments on the Sprint Nextel conference call seemed to confirm this).
2. The advertising and high-speed Internet trends we saw with Comcast occur throughout the cable industry, leading to unexpected cash flow gains for the industry.
3. Leap Wireless International Inc. and Clearwire continue their Q1 trend and take 20+% of the net adds for the wired + wireless broadband segment (previous analysis can be found here).
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 at jim@mobilesymmetry.com.