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.
Second quarter earnings announcements are just around the corner, and having a closer look at Verizon, AT&T, Comcast and Time Warner Cable should help cement our theses for the telecommunications sector. While they share common characteristics of size and market share leadership in each of their respective products, each of these companies has different strategies to create shareholder value.
This week, we start with AT&T. As the chart shows, AT&T has enjoyed a stock renaissance in 2012.
On an equity market value alone, AT&T has created slightly over $30 billion in shareholder value in 2012, more than twice the value of Verizon, and more than 10-times the shareholder value created by Sprint Nextel over the same period. Add in a healthy dividend (AT&T pays out more than 2-times total dividends then Verizon), and total returns have been in excess of 20% for the first six months plus a few days of 2012. They stand tall among their telecom peers.
AT&T is a very large, sprawling company with several strategic items on their plate. Here are four of them:
1. How to resolve the data gap (and therefore competitiveness) between metropolitan and non-metropolitan areas for both their wireline and wireless units. AT&T has approximately 20 million access lines that will not see the current U-Verse offerings. Most of these lines are in secondary to tertiary markets. Here’s how access lines in general are performing (chart is taken directly from AT&T’s 10-Q report):
As a quick reference, four years ago (quarter ending June 30, 2008), AT&T had 55.4 million retail and 58.9 million total switched access lines in service, so a 40% drop (to 33.4 million and 35.4 million, respectively). Five million switched access lines per year have been lost for each of the past four years. U-Verse VoIP gains have offset only about 10% of the loss over this period. As a result, voice revenues for the wireline segment are down nearly $16 billion on an annualized basis (from $9.757 billion in Q2 2008 to $5.893 billion in Q1 2012). Data/DSL growth has made up for some of the loss (about $6 billion of the $16 billion), but the legacy product is quickly becoming obsolete.
The result is what is commonly referred to as a “Swiss cheese network.” In many smaller communities such as Lewisburg, Tenn., 20% of the homes have moved to cable’s triple play, and another 30% have cut the cord (only 40% of these have signed up with AT&T as their wireless provider). In total, AT&T has lost a previous voice relationship with at least 38% of their customers in Lewisburg. Given that there are only 4,500 households in the greater Lewisburg area, the pressure up the cost curve (meaning scale dis-economies) has to be significant. Comcast (in town) and Charter (out of town) are their primary cable competitors, which brings extra pressure to improve data speeds (if the household is not served by U-Verse, the best DSL speed is 6 megabits per second, half of Comcast’s standard offer). On top of this, Verizon has already introduced their LTE solution into Lewisburg.
AT&T is carefully considering their technology options, but they will need to move quickly to keep what network presence they have. Multiply this by 1,200 or so communities and you quickly get to the 20 million line opportunity.
2. How to maintain wireless profitability as the market quickly moves to data-based solutions. Countering the headwind of access line loss is the tailwind of continued smartphone growth. AT&T has perhaps their strongest line-up to date, with the iPhone 4S, HTC One X, Samsung Galaxy III and Nokia Lumia 900 devices in their portfolio. Paying for a faster processor and branded operating system has become a habit for tens of millions of AT&T customers, especially in the markets that have already deployed an LTE network.
Minutes are falling, however, and text message growth has continued to decelerate as Facebook, iMessage and Skype continue to become the messaging solutions of choice for younger demographics.
Here’s some data from AT&T’s latest quarterly report supplement:
As shown above, total data ARPU has grown $3.10 per user (and total number of smartphone users have grown steadily over this period), but total postpaid ARPU has only grown $1.83. While the $1.27 loss in voice ARPU is small, multiply it by 70 million postpaid customers and the annualized revenue effect is just under $1.1 billion. Overage/breakage charges tend to run higher in profitability, so it’s safe to assume that the segment income effect is in the $500 to $600 million range annually. Data must make up for this gap and provide enough segment income growth to satisfy shareholders.
Where will this growth come from? First, customers will continue to migrate to smartphones. That drives the average spending on wireless up by at least $20. Second, LTE network migrations will drive customers to spend more on data. This is true to a point, but if 10% of the base (7 million users) spend $10 more per month on data because of higher data consumption on the LTE network, that’s worth $1 in ARPU (I have been using AT&T’s network in Dallas over an HTC Vivid and it’s entirely possible that the entire voice gap above could be erased with data overage charges). Finally (and if I were AT&T I would wait a couple of quarters before responding to Verizon’s new pricing plans), there’s the opportunity to overhaul pricing plans. AT&T started this with the introduction of their Mobile to Any Mobile plan in February 2011, which was intended to stop the downsizing trend from unlimited to metered texting plans.
Growth will not come from the creation of new categories (except tablets), and it’s likely that significant growth will occur from revenue-generating applications over the short run. But managing a) smartphone adoption; b) LTE usage; and c) voice attrition will be critical to keeping the profitability picture bright. Having a couple of quarters before the next iPhone release (which reminds the investment community of the substantial iPhone subsidies) doesn’t hurt either.
3. Reviving the business/enterprise/global segment. As the economy recovers, AT&T has no excuse but to grow their business revenues. Again, from their supplemental financial data, here’s the eight quarter trend:
Stability has become the status quo for the business solutions segment, at least in the wireline business unit (connected devices for businesses are growing like gangbusters). There’s a lot of puts and takes to get to a stable number: a) VPN, video conferencing and advanced services revenues continue to grow; b) Ethernet services also continue to grow as an access medium; and c) other carriers need AT&T fiber-based backhaul services to cell sites (transport is about 27% of the total business solutions figure and is a good margin business). These are offset by: a) declining voice minutes (likely moving to video or VoIP); b) declining private line and other non-packet based transport solutions, c) international (especially Europe) revenue declines; and d) movement, especially at the small end of the curve, to wireless as the primary communications device.
Managing business growth is complex. Slow transitions do not work in the same manner as they used to. But competition from cable (and Sprint Nextel) is lower in the medium and enterprise sub-segments, AT&T has a national building network (with good landlord relationships) and everyone is looking at distributed computing and storage (a.k.a., the cloud). Figuring out how to quickly regain the pole position in global and enterprise business (perhaps with a strategic partnership with Equinix) is critical to satisfying shareholder needs.
There’s a lot more to write on AT&T but in the interest of brevity, we’ll stop with these three strategic considerations. They have a super strong management team (who is smiling at the recent stock price appreciation), an increasingly attractive balance sheet and technology legacy that is unmatched. However, driving out the next $50 billion to $60 billion in value will not be easy (this gets the stock price back to the 2007 heyday level). Strategic decisions are necessary, and they start with possible non-U-Verse divestitures, continued mobile leadership and business revitalization.