AT&T Shores up its Spectrum While Customer Costs Rise

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The second largest American mobile phone operator, AT&T (NYSE: T) reported a significant improvement in its earnings in its latest release. The company managed to reduce its loss by 42.2% from $6.68 billion in the same quarter in 2011 to $3.86 billion while sales remained flat at $32.6 billion. Although the sales were slightly above the estimate of $32.2 billion, AT&T’s adjusted earnings per share missed by a penny analysts’ consensus of $0.46 per share.  The improvement has come on the back of strong sales of subsidized smartphones -- 10.2 million total, particularly the 8.6 million Apple (NASDAQ: AAPL) iPhones sold.  AT&T’s relationship with Apple, while mostly working in Apple’s favor, certainly benefited the company during the iPhone 5 launch.  But those sales mean nothing if AT&T doesn’t have a network capable of serving those customers at full bandwidth.

Although AT&T managed to sell 780,000 contracts, 97,000 more than analysts’ estimates, it is still caught trying to catch up with Verizon Wireless (NYSE: VZ), which sold a record 2.1 million contracts in its last quarter taking its total customer base to 98.2 million. The two companies are out hunting for greater market share and aren’t worried about current operational losses. Both companies sell their smartphones at a loss to induce customers towards a multi-year contract. Therefore, achieving record sales volume directly hits the bottom line, but it guarantees a continuous stream of monthly income for at least two years. AT&T and Verizon both offer a new iPhone 5 for $649 without a contract or $199 with one. 

AT&T has been ramping up its 4G/LTE infrastructure in 2012, despite the setback in acquiring T-Mobile USA in 2011, as it aims to heat up competition with Verizon. It acquired shares of the struggling Qualcomm spin-off NextWave Wireless for $50 million and took over the company’s $550 million debt for its spectrum assets. Besides NextWave,  AT&T also made spectrum purchases (terms undisclosed) from Comcast and Horizon Wi-Com. The three deals were valued by industry experts at around $1 billion total. However, it is obvious that AT&T would need to spend much more that that to effectively compete against Verizon Wireless as the latter made a record $3.9 billion deal with SpectrumCo to double its bandwidth in the AWS-1 block, giving it the ability to grow into the expected 500% increase in wireless data traffic coming in the next few years. 

Just after its earnings release, AT&T announced that it was purchasing spectrum and other assets from Atlantic Tele-Network’s ‘Alltel’ for $780 million, which will be paid in cash. AT&T also announced that it has signed a massive spectrum purchase deal worth more than $1.9 billion with Verizon Wireless, the joint venture between Verizon and Vodafone Group. AT&T will be paying the $1.9 billion cash and spectrum licenses for several markets with a total of 42 million people in 18 states, such as Phoenix, Arizona, Los Angeles and Fresno, California and Portland, Oregon, for Verizon’s 700 MHz spectrum. The 700 MHz spectrum was originally meant for broadcasting analog television channels but the advent of digital TV made them obsolete for TV channels. However, they found their place in the growing 4G and LTE market, giving AT&T better long-range LTE coverage. The U.S Government then put them on auction in 2008, in which Verizon purchased block A while AT&T acquired most of block B. 

The current deal between AT&T and Verizon Wireless is a win-win for both, as the former is looking to expand its 4G and LTE base to 300 million people in the US by the end of 2014; the latter has been divesting its extra 700 MHz spectrum to optimize its operations following its deal with cable operators. 

<table> <tbody> <tr> <td> <p> </p> </td> <td> <p>AT&T</p> </td> <td> <p>Verizon</p> </td> </tr> <tr> <td> <p>Stock 6M</p> </td> <td> <p>-8.40%</p> </td> <td> <p>-4.96%</p> </td> </tr> <tr> <td> <p>P/E</p> </td> <td> <p>27.22</p> </td> <td> <p>138.99</p> </td> </tr> <tr> <td> <p>EPS</p> </td> <td> <p>1.25</p> </td> <td> <p>0.31</p> </td> </tr> <tr> <td> <p>Yield</p> </td> <td> <p>5.30%</p> </td> <td> <p>4.80%</p> </td> </tr> <tr> <td> <p>ROA</p> </td> <td> <p>2.99%</p> </td> <td> <p>3.61%</p> </td> </tr> <tr> <td> <p>ROE</p> </td> <td> <p>7.60%</p> </td> <td> <p>12.32%</p> </td> </tr> </tbody> </table>

The shares of both of these mobile giants have not participated in the rally in equities. However, they offer both attractive yields of more than 4% and have the resources and assets to stay on top of the U.S. wireless market for the foreseeable future.  The question is whether pricing leverage can be maintained the way things are now. I remain unconvinced since smartphone usage growth is moving away from subsidized handsets and towards pay as you go plans.  T-Mobile has embraced this model as have all of the MVNO’s.  High customer acquisition cost models run into the danger of not being sustainable once people are no longer chained to one service and the high cost is never recovered; just ask Netflix

PeterPham8 has no position in any stocks mentioned. The Motley Fool recommends Apple. The Motley Fool owns shares of Apple and Qualcomm. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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