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.
Greetings from a warm but rockin’ Kansas City (Paul McCartney and the Manchester United visit on the same weekend). This week marked the beginning of the telecom earnings season, with Apple reporting Tuesday, AT&T reporting Thursday, and Verizon reporting Friday. Between AT&T and Verizon, they now control just over 182 million wireless connections (90.1 million for AT&T and 92.1 million for Verizon), a staggering number considering AT&T and Verizon (pre-acquisitions) served 105.4 million wireless connections at the end of 2005. It’s not quite a duopoly yet, but with the vast majority of growth going to two companies, it’s close.
Duopoly characteristics should yield profitable results for shareholders. However, as this column has noted, even though both Verizon and AT&T missed the 2008 equity bounce back, both stocks have participated in the volatile market conditions of 2010 (AT&T down 9% and Verizon down 15% year-to-date. Total combined equity value lost in 2010 = $29 billion). Are AT&T and Verizon being blacklisted from the markets for no apparent reason? Have we hit bottom?
For some answers, let’s look at several key common themes that both carriers shared in their earnings releases and on their conference calls.
1. Data is the primary (only) growth driver in wireless. AT&T wireless data growth was 27% (wireless data ARPU growth 22%); Verizon wireless data growth was 24% (ARPU growth up 17%). Surprisingly, even with the iPhone, AT&T trails Verizon in ARPU. Interestingly, AT&T grew data revenues $936 million year-over-year and overall segment profitability $819 million. Data revenue growth was 76% of AT&T’s total revenue growth. Verizon grew data revenues $935 million and overall segment profitability $383 million. Not surprisingly, Verizon’s total service revenue growth was smaller than data growth due to the Alltel market divestiture ($935 million data growth, $697M total revenue growth). While the Verizon revenue statistic also reflects an accrual catch up, suffice it to say that voice made up less than 25 cents of every dollar of revenue growth for both Verizon and AT&T.
As we noted in the assessment of Verizon’s mandatory data plans for every new 3G (multimedia) and smart-phone device, the full effect of their announcement wouldn’t be felt until the second quarter. Verizon’s sequential data revenue growth (Q1 to Q2) was $350 million. They reported on the conference call that 20% of their current post-paid retail base (approximately 18 million customers) have smart phones and 15% of their base has multimedia devices (approximately 9 million devices). The 35% data attachment is up from 31% in 1Q and 26% from the beginning of 2010. That’s 7.5 million or so new data ARPU additions since the beginning of 2010, at $20/ mo. and you quickly get to $350 million in growth for the quarter. In fact, with some additional analysis, I think we will be able to conclude that data growth (which requires new capital) is accelerating voice ARPU declines. More on that in a future Sunday Brief.
2. Both AT&T and Verizon cannot shed employees fast enough. Employee reductions were the big story in 2Q, although few media outlets made it a headline. Consider the overall employee trends at AT&T and Verizon:
AT&T Employees Full-Year Revenues ($M) Revenue/ Employee ($K)
2007: 309,050 $118,928 $385K
2008: 302,660 $124,028 $410K (6.5% increase)
2009: 282,720 $123,018 $435K (6.1% increase)
2Q 2010: 272,450 $123,000 $451K (3.7% increase)
VZ Employees Full-Year Revenues ($M) Revenue/ Employee ($K)
2007: 235,000 $93,469 $398K
2008: 223,900 $97,354 $435K (9.3% increase)
2009: 222,900 $107,808 $484K (11.3% increase)
2Q 2010: 210,800 $108,000 $512K (5.8% increase)
Note: 2010 revenues are pro forma based on first half 2010 actual revenues.
VZ and AT&T started with essentially the same productivity (revenue per employee) at the end of 2007. Since then, Verizon has improved productivity by 29%, and AT&T by 17%. And, with 3Q reflecting the spin of the GTE properties to Frontier, it’s likely that Verizon’s productivity will continue to improve (9,000 have been transferred and will be reflected in 3Q results). As context, Qwest employed 30,000 employees as of the end of Q1 and had a productivity per employee ~ $410K.
This is an interesting period to cover as it reflects a) massive growth in wireless revenues (doubling since 2005), b) the entry of cable and wireless substitution as a threat to traditional phone service revenues, c) M&A activity, d) the entry of cable companies into video and e) changes from circuit to packet switching and all IP networks. Did the acquisition of Alltel get in the way of Verizon’s productivity goals? Nope. Did AT&T’s acquisition of Bell South result in meaningful work force reductions? It’s not apparent.
Looking at employee productivity is difficult as it reflects changes in business mix (more wireless, less wireline), changes in labor agreements, geographic density (more “windshield time” per call = more technicians) and overall economic conditions. There are many simultaneously moving variables. Clearly, however, an untold Verizon story is their focus on productivity – they have clearly used their employee base to drive more growth than AT&T. If AT&T had Verizon’s productivity focus, it would result in at least $2 billion in additional bottom-line savings each year (29% improvement from the baseline = $497K in revenues per employee = 247,000 employees = 25,000 employee savings = $2 billion annualized at $80,000 salary per employee).
3. The incredible shrinking pool of customer relationships. Everyone has (over) analyzed the lack of growth in the post-paid wireless pie. Thanks to some poor post-paid ARPU protectionist policies, Verizon, AT&T, and to some extent Sprint opened the door to Metro PCS and Leap Wireless (which will end 2Q with a combined 13 million subscribers after less than five years of operation).
Losing a customer on a tower, however, is a lot different than losing a customer at their home. The investment, as well as the corresponding subsidies, are different. Also, customer relationships cost money (perhaps a lot of money) to re-establish. Let’s look at AT&T’s customer relationship trend:
In the past 13 quarters (if we can call the real estate peak at Q1 2007, this is a peak figure), we have seen a loss of nearly 7 million in-service household relationships. Note: this is not access line loss, or U-Verse loss, or DSL loss, any of which would allow for some revenue and cash flow to cover the investment. This is a loss of a wired household relationship. And it is likely a stranded asset.
Using a conservative $1,100 un-depreciated capital view, this likely leaves about $7.5 billion in capital investment from which AT&T is earning no cash today.
One of the few concerns in the AT&T quarterly earnings release was that the loss of household relationships actually increased in Q2 2010 after two quarters of decline (to its highest level since Q4 2008). As we have noted in this column (and as others have noted), the costs to serve regions/ cities do not decrease on a variable basis. It is likely that the 6.8 million lost home relationships cut a “Swiss Cheese” path through AT&T’s markets. As AT&T moves back up the scale curve, the cost increase per line will be driven by its slope.
These three items support a stronger earnings outlook. There were plenty of signs that Q1 was a financial but not necessarily an operational metrics bottom for wireline. Wholesale and now IP revenues are p
rofitable, while the remaining channels/ product lines a
re suffering from scale inefficiencies. Wireless minutes of use are stable to falling, leaving some opportunity for incremental cash creation (Verizon’s reseller results continue to be strong). And, most importantly for Verizon and AT&T, neither Sprint nor T-Mobile pose a threat to their family plan and business near-duopoly structure.
Bottom line: We have reached bottom. But the journey back to the top is not a straight shot, and without valuable customer relationships, reaching the “good ol’ days” of $40 share prices will be impossible to attain.
Now for five you may have missed:
1. Wired Magazine has an expose on the AT&T and Apple relationship. Not a lot of real news here, but plenty of drama.
2. $45 billion. That’s the total cash + short-term + long-term marketable securities on Apple’s books as of the end of 2Q (see page 3 of the hyperlinked 10-Q). Cue the “Three headlines no telecom CEO wants to read” article.
3. LightSquared’s $7 billion bet on a wholesale wireless network got some headlines this week with their $7 billion order placed with Nokia Siemens Networks.
4. Dan Schulman leaves Sprint to go to American Express. Mark Angelino, another former Sprint executive, makes headlines as he winds up at HP. Good luck to both of them!
5. August 13. It’s not famous because it’s the day I’ll be in St. Louis presenting the benefits of a cloud-based mobile directory, but because it’s the day the really good EVO battery goes on sale.
Next week, we build the bigger picture on broadband with results from Comcast and Sprint. Thanks for your comments and future article suggestions.
