Which Will Be the Best Telecom Stock This Earnings Season?

Masam is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

During the upcoming 4Q12 earnings cycle, I will be analyzing three key topics, which are considered as the key for longer-term wireless market economics: wireless ARPU, handset subsidies, and the impact of M&A. I continue to view the US wireless industry as healthy but extremely competitive, with the two dominant players (discussed below) capturing the lion’s share of the value.

1. Wireless ARPU (Average Revenue per unit): How Are Tiering and Shared Plans Impacting Behavior? We’ll be looking for commentary on the behavior of customers who are actually facing variable wireless pricing (i.e., on tiered plans, and have reached their caps), as consumer willingness to actually pay more for larger amounts of data will be the key to industry's ARPU growth prospects.

2. Handset Subsidies: Looking Through the iPhone Cycle Noise. With the iPhone 5 launch, the subsidy costs are expected to rise sharply QoQ. It will be interesting to see if we find any evidence that the mix is shifting towards (lower-cost) Android devices, which would be a positive for the longer-term economics. In addition, I’ll be looking for commentary on the upgrade behavior of existing smartphone customers, and their propensity to not upgrade once their contracts are over.

3. M&A and Upgrade Impact: Can Deutsche Telekom AG’s (NASDAQOTH: DTEGF) subsidiary T-Mobile and Sprint (NYSE: S) take Share Longer Term? Better network capabilities at both Sprint and T-Mobile, combined with pricing below the AT&T (NYSE: T) and Verizon (NYSE: VZ) level, are likely to increase competition in the marketplace to at least some degree. Having said that, the street doesn’t expect either Sprint or T-Mobile to dramatically disrupt the US wireless market in the near or medium-term; the growth of family plans at both AT&T and Verizon Wireless (VW) are raising switching costs, and, in our view, lowering price elasticity.

Operating Expectations:  VW is expected to continue its strong operating performance, even with iPhone-related subsidy costs. I expect good, but not as robust, results out of AT&T. I believe Sprint operations will continue to be impacted by the ongoing Network Vision project and the drag from the iDEN migration, while any benefit at T-Mobile from new marketing strategies and network improvement are unlikely to be felt until well into 2013. Finally, I believe the results for Leap Wireless and MetroPCS will continue to be challenged by tough competition from Mobile Network Virtual Operator (MVNOs) and Sprint/T-Mobile prepaid offerings.

Let’s have a look at the subscriber trends:

SUBSCRIBER TRENDS

Postpaid

The 4Q12E results should show that tablets and hotspots continue to be the key driver of postpaid subscriber trends in the U.S. The four national carriers (AT&T, Sprint, Verizon and T-Mobile) are expected to add 2.1 million postpaid subscribers (vs. 1.3mn a year ago) and 832k prepaid subscribers (vs. 2.1mn in 4Q11) implying a 4Q12 postpaid net add share of 71.5% vs. 29.5% for prepaid net adds.

 The following table shows the expected net additions (adds) of four national carriers:



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Prepaid: Declining Net Add Trend

An expected 832k prepaid net adds in 4Q12E would mean a YoY decline of almost 60%. Prepaid net adds are still strained by overall macro weakness, which has more impact on low-income prepaid customers than postpaid customers.

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Verizon is expected to see comparatively stronger net adds (9% rise YoY), as its ‘Unleashed’ prepaid services, which include a monthly $80 smartphone plan, continue to gain traction. Sprint and AT&T are expected to witness a YoY decline of 84% and 6%, respectively. Leap and MetroPCS continue to face pressure on the subscriber front as the two companies continue to prioritize profitability over subscriber additions.

ARPU Trends

Postpaid – Growth Continues, Albeit at a Slow Pace

Postpaid ARPU continue to rise driven by higher smartphone penetration and growth in data. In 4Q12E I expect postpaid ARPU to rise 2.5%, 2.5% and 6.0% at AT&T, Verizon Wireless, and Sprint, respectively.

Prepaid – Minimal Growth:

The following table shows the forecasts on the prepaid side:

 

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The prepaid ARPU gap between prepaid pure plays and larger national carriers stems from a difference in target customers and usage profile. Prepaid plans at Leap and MetroPCS offer unlimited talk and text. In comparison, customers get higher-priced pay-per-minute products from full-line carriers, limiting usage, and therefore ARPU.

Service Margins Continue to be Driven by Scale & Subsidies

Service EBITDA margins continue to be driven by scale and handset subsidies. The following tables shows the expectations for 4Q:

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AT&T’s gain in service margins is being driven by the company’s cost improvement efforts.

In 4Q12E, AT&T is expected to activate 8.5 million iPhones (vs. 7.6mn in 4Q11), compared to 6.5mn (vs. 4.3mn in 4Q11) for Verizon and 2.2mn (vs. 1.8mn in 4Q11) for Sprint, driven by the iPhone 5 launch.

Foolish Bottom-Line

Verizon seems to be the best bet within the telecom industry given its superior subscriber and ARPU trends among its peers.


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