Reality Check: Is 2011 the year of prepaid?

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.
“This time, it’s for real.” If I have heard that phrase once, I’ve heard it a thousand times this week to describe how the prepaid carriers are going to take over the low end of the wireless market. I wrote about the role of pre-paid carriers and did a fairly detailed analysis of the economics a little less than a year ago. The economics certainly make sense at the individual (and, in the case of MetroPCS Communications Inc., at the family) level.
But can the prepaid carriers (in this case, Wal-Mart/Tracfone Wireless Inc., MetroPCS, Leap Wireless International Inc./Cricket Communications Inc., and the divisions of T-Mobile USA Inc. and Sprint Nextel Corp.) really make an impact for the entire year? Can they hold on to gains made in a particular quarter (usually the fourth or the first) through subsequent quarters? And, with handset availability being driven to new heights (MetroPCS now carriers a Samsung Electronics Co. Ltd. Galaxy handset for $299), and the Chinese vendors more than willing to develop Android handsets for double-digit retail (subsidized) price points, can this part of the wireless industry really shine?
The short answer is no. 2011 is a set-up, not a breakout year. 2012 is – “for real!” This year, Android matters, but LTE matters more. A new network, post-paid handsets and compelling monthly price points equals gains for several carriers.
Let’s have a look at this part of the wireless industry and see what makes them money. The most important thing about the prepaid segment is that it’s growing. Sprint Nextel added 2.1 million net prepaid subscribers in the past year; MetroPCS 1.6 million; T-Mobile USA 670,000; and Leap just over 500,000. Wal-Mart, which usually counts in the carrier wholesale/reseller figures, added at least 2 million customers in the past year. With Wal-Mart, it looks like 6.9 million prepaid net additions in the past year, versus 3.6 million postpaid. Bottom line: Lots of growth, almost two-times post-paid.
Average revenue per user, meanwhile, is steady to growing for each carrier as smartphones become a larger part of the sales mix. The prepaid carriers are receiving $10 more for smartphone plans, and another $5 to $10 for 4G (MetroPCS only). With the movement to smartphones, however, comes the increase in subsidy. Sprint Nextel and Leap/Cricket both reported increased handset subsidy activity related to smartphones. Suffice it to say, however, the subsidy is nothing compared to postpaid on a per-unit or absolute basis.
Profitability is harder to determine. The profitability king of prepaid is MetroPCS, with a 27% earnings before interest, taxes and depreciation margin (up from 26% a year ago). MetroPCS now earns slightly more per dollar of revenue than T-Mobile USA. Sprint Nextel and Leap bring up the rear in profitability, although Sprint Nextel’s overall profitability picture continues to improve, thanks in large part to postpaid data plan price increases. Profitability is largely a function of two factors: Smartphone migration, which drives dilution in the handset-decision quarter, but should drive 40% margins for the remaining life of the contract; and data consumption. Given Sprint Nextel’s ownership of a tier-one IP backbone, and their direct connections to major carrier hotels and data centers around the globe, it is baffling that Sprint Nextel’s profitability is not greater.
Outside of profitability concerns, the next historical hurdle the prepaid providers have had to overcome is handset availability. Even with last year’s column (see link above), the “advanced” handset was the LG Electronics Co. Ltd. Touch. Thanks to ZTE Corp. and Huawei Technologies Co. Ltd., and the pressure that they will place on LG, Kyocera/Sanyo and Samsung, we’ll have Android (and perhaps another operating system?) handsets available at lower price points for the foreseeable future.
Here’s the challenge: The four prepaid providers plus Wal-Mart have about 46 million subscribers, and about half of them will be upgrading to a new device (likely Android) this year. That’s 23 million total new devices sold in the prepaid channel, and 12 million of those are Android smartphones. AT&T Mobility and Verizon Wireless have 152 million postpaid retail subscribers, and half of them will be out of contract this year. Judging from the latest reports, about two-thirds of the base that is upgrade eligible will upgrade to a smartphone. That leaves 152 million smartphones sold into the postpaid channel this year. Assuming Apple Inc. takes 50% share of smartphone decisions, that leaves 25 million non-Apple smartphone decisions for the remaining handset makers for AT&T Mobility and Verizon Wireless (40 million if you include T-Mobile USA and Sprint Nextel). The handset makers are seeing at least one-third of the opportunity coming from the emerging carriers, and with Apple out of the picture (for now), establishing a beach head is probably a good investment.
Two years ago, the thought of having a postpaid smartphone for free was preposterous. Now you can go to T-Mobile USA and get a Samsung Fascinate with a 1 Ghz processor or a BlackBerry Bold for free (this weekend only – yeah, right). We saw similar offers on the Verizon Wireless Droid product line through Wal-Mart.com in December. Is it impossible to think about a $49 Android smartphone from MetroPCS or Leap with a decent (600 MHz or 800 Mhz) processor for December? How about a 4G model for $199 in 2012? MetroPCS seems to think so – here’s their quote from the earnings call this week:
Philip Cusick – JP Morgan Chase & Co.
… And to that end, how do you expect the sort of retail price of 4G handsets to go this year? Right now we’ve got one at $300, that’s the older. We’ve got the Android at $400. Could we see this sort of sub-$200 by the end of the year?
Roger Linquist, CEO of MetroPCS
I don’t think that you can see that this year. I do very well think you will see that next year.
Linquist later clarified in the transcript that he was speaking about the pre-subsidized cost, not the offered price to the end consumer. If the consideration is a $199 premium smartphone from Verizon Wireless or Sprint Nextel vs. a $199 1 Ghz smartphone from MetroPCS, will the decision be difficult for an individual user? Bottom line: The closer the “walk out costs” converge between postpaid and prepaid offerings, the higher the probability of success for the prepaid providers.
So the market is growing (40 million subscribers, growing 1.25 million per quarter), the ARPU is growing as the mix of customers change, the handset manufacturers are highly interested in the volume provided by an industry churning at 40% to 50% per year, and distribution channels remain strong thanks to simplified pricing. What’s next?
Of course, it’s the network. Historically, prepaid has been treated as a segment specific element of the existing 2G and 3G network structure. Need to sell to credit challenged? Go pre-paid. The wild card now is 4G – when consumers have to make a choice about a new network technology, who will win? The $110 per month Sprint Nextel plan with the 1 Ghz processor Android phone or the $60 per month MetroPCS 4G plan with the 1 Ghz Android processor phone?
Every dollar that Metro and Leap pour into their already efficient network structures adds additional instability to both Sprint Nextel and T-Mobile USA and eventually AT&T Mobility and Verizon Wireless postpaid models. The differences between “Angry Birds Rio” at 900 kilobits per second and 5
megabits per second is immaterial – as we have discussed in several columns, the “fast apps” revolution has not even started yet, even with Apple. As long as the 300,000 apps in the Apple and Android apps stores are written for minimal network interaction, the need for 5 Mbps becomes less compelling – video calling, perhaps, once you have re-trained FaceTime users to use your network as opposed to Comcast Corp.’s Internet connection. By that time, well tuned OoVoo, Fring, QiK and FaceTime servers will be in place in most metro areas. There’s a great debate occurring between the applications and the carrier community already starting on this topic and others, and the subject of many future Reality Checks.
However, until 2012, we have the year of Android. 2012 could be a “dual year” with both Apple products and LTE. That “two-fer” could spell the end of the post-paid market as we know it.
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 commentsatjim@mobilesymmetry.com.