Will Investing in Prepaid Phones Pay Off?

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Barely a day goes by without some aspect of the mobile computing revolution appearing in the news. There are new phones, new features, the rise of Samsung, and so on. One aspect of the revolution is less glamorous and hence less talked about, but is likely more important from an investment perspective--the rise of the prepaid phone.

The rise of the prepaid phone

According to NDP group, smartphone sales grew about 9% in the second quarter of 2012. That growth is almost entirely attributable to growth in prepaid smartphones, however, which grew 91% year-over-year. In other words, the smartphone use in prepaid plans almost doubled in one year. This growth in smartphones helped to cause the overall growth rate to double in this sector. America's cell phone market is somewhat strange compared to the worldwide market in that it relies on a two-year contract model with subsidized phones. In most parts of the world, the majority of consumers purchase a phone and then bring it to the cell phone provider of their choice.

Prepaid plans are substantially cheaper than their postpaid counterparts -- often amounting to savings of $1,000 over the life of a contract even once the phone subsidy is accounted for (http://wallstcheatsheet.com). So why are consumers not flocking to prepaid phones in droves faster than they already are? First, consumers simply are not doing the math. They do not like the idea of paying several hundred dollars up-front for a phone, and as a result they can be suckered into paying substantially more per month. This will likely not change. The other two reasons will likely change however.

The first reason is consumer inertia. Consumers simply do not know about the phones and associate them with a budget, no-frills experience. This is changing, however. As more and more consumers adopt the technology, more consumers become aware of it. Furthermore, with T-Mobile's (NYSE: TMUS) recent switch to being an entirely prepaid carrier, prepaid will likely see a major increase in advertising support. The second reason is that these plans have typically been associated with no-frills phones. They usually did not get the nice smartphones as soon as the major carriers did. This is starting to change as well. For example, Virgin Mobile currently has the iPhone 4S and Straight Talk has the iPhone 5, while T-Mobile continues to maintain its offering of top-of-the-line phones including the Samsung Galaxy S IV. 

Sprint 

Sprint (NYSE: S) owns two of the major prepaid providers: Virgin Mobile and Boost Mobile. In the first quarter of the year, Sprint had 16 million prepaid customers and added 568,000 new prepaid subscribers to achieve a net yearly growth rate of over 12%. Furthermore, Boost Mobile topped J.D. Power and Associates' customer satisfaction survey for the third year running. Furthermore, both Boost Mobile and Virgin Mobile continued to grow in both subscription and revenue, reaching their highest levels ever. 

T-Mobile

T-Mobile is even more heavily invested in prepaid than Sprint is. As mentioned above, it has recently switched over to an entirely prepaid system. With the merger of metroPCS and T-Mobile, the company formed the third-largest prepaid provider by number of subscribers with 14.6 million, and also the largest prepaid provider by revenue with $1.6 billion (T-Mobile). Furthermore, the company recently managed to gain enough spectrum to compete with the other major players in a more even fashion. If it manages the expansion of its network well, T-Mobile is well poised for substantial growth. 

Verizon and AT&T

Verizon (NYSE: VZ) and AT&T (NYSE: T) are much further behind in the game. Verizon just recently launched its prepaid service, and it is far more expensive than many of the other carriers. For example, Verizon's cheapest smartphone plan is $60 per month, while Virgin Mobile's is $30. Furthermore, the company only has 5.3 million subscribers, about 1/3 of user base of Sprint. AT&T is in a similar position. Its cheapest smartphone plan is $65, and it currently has about 7.5 million subscribers (T-Mobile). Thus, neither AT&T nor Verizon has first-mover advantage in any sense of the word, and neither are competing strongly here. As a result, most new prepaid users will choose other companies.    

Conclusion

Both Sprint and T-Mobile have a great deal of catching up to do if they want to complete on an equal level with Verizon and AT&T. However, they are in a stronger position with regard to the fast-growing prepaid segment, and so will likely be able to improve their standings vis-a-vis those companies in the upcoming years.

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Paul Sangrey has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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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