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Reality Check: AT&T’s $61 billion promise

Editor’s Note: Welcome to our weekly Reality Check column where C-level executives and advisory firms from across the mobile industry share unique insights and experiences.

Last week we discussed the changing nature of handsets as well as Verizon Communication’s earnings. This past Wednesday afternoon, AT&T announced third quarter earnings. Generally they were well received, although some analysts searching for an “AT&T loses to T-Mobile US” story have been quick to point out that postpaid phone net additions were negative for the quarter (363,000 total postpaid net adds less 388,000 postpaid tablet net adds). This 25,000 net loss includes approximately 405,000 postpaid customers acquired through the Atlantic Tele-Network acquisition. Bottom line: excluding the ATNI acquisition, AT&T Mobility lost at least 425,000 postpaid retail customers.

AT&T was quick to explain that part of the decline was due to weakness in 2G products (the 25,000 loss includes 178,000 in smartphone net additions, meaning that there were 203,000 non-smartphone net losses), and that some customers may have moved from AT&T Mobility postpaid to AT&T Mobility prepaid products. AT&T Mobility added 192,000 net prepaid retail customers in the quarter, ending with a 7.4 million base. Of the 192,000 net additions, about 180,000 of them came from the acquisition of ATNI. So it’s very unlikely that these customers went to AT&T Mobility prepaid – it is likely that they went to another provider, perhaps StraightTalk (Walmart/Tracfone) or Virgin Mobile. Bottom line: AT&T Mobility lost all (or nearly all) of the postpaid base to their competitors, not to prepaid. AT&T Mobility’s prepaid retail gain came mostly from ATNI, not from GoPhone.

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As reference, here’s the historical net additions trend for the “big four” carriers. With Sprint and T-Mobile US left to report, it’s anyone’s guess as to the ending growth for the quarter, but connected device (particularly tablet) growth is much stronger than it was in 2012:

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If net additions didn’t raise enough eyebrows in the analyst community, this next table did:

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Data revenues grew 18% annually, but only a meager 2.9% sequentially. Voice, text and other service revenues declined as well in the quarter. The expectation was that sequential data would have been higher, not lower than the Q2’s 4.5% growth. Instead, it’s likely that AT&T’s organic data revenue was 2.5% to 2.7%, not the 2.9% reported. This stands in contrast to encouraging upgrade metrics cited by John Stephens, AT&T’s CFO.

It’s likely that AT&T’s sequential data growth will return to the 3% to 4% range in the fourth quarter, but, with Verizon’s anemic 2% retail service growth, there’s a distinct possibility that we have hit a consumer average revenue per user/average revenue per account wall. This is troubling for the entire industry as LTE capital builds are based on increasing ARPU/ARPA.

AT&T Mobility’s results clearly show a company in transition:

1. Less voice-centric retail devices and services.

2. Less/no 2G (GSM) services for voice or data customers.

3. More smartphones using the LTE network (40% as of Q3).

4. More shared data plans (see here for the announcement of the end of metered plans).

5. Leap acquisition (see here for the pre-announcement of the death of Aio Wireless brand).

6. More connected devices (719,000 net additions is the best in seven quarters).

7. Supply constraints in the third quarter for their best selling product (iPhone).

8. Less segment income, even with the ATNI acquisition.

9. Steady churn (1.07% postpaid churn, up from 1.02% in Q2 and 1.08% in Q3 2012).

10. More consolidated/total company debt ($6 billion more than the beginning of 2013).

Without the ATNI acquisition, the headlines would have been a lot different for AT&T in the third quarter. How will AT&T pull out of this rut?

The secret is in AT&T’s $61 billion Project VIP promise. When AT&T made this announcement in November 2012, we devoted an entire column to our analysis (see “AT&T goes organic.”). While AT&T’s estimated VIP spending has dropped from an estimated $65 billion to $61 billion, the organic growth requirements have not changed. As we said last year:

”The returns required for this new level of invested capital are daunting. Currently, AT&T has slightly more than $230 billion in net property, plant and equipment, goodwill and spectrum license assets. Assuming an 8% cost of capital expectation, that’s $18 billion-plus in net income required per year to achieve expectations (AT&T is currently earning slightly less than $15 billion on an annualized basis excluding special items). An additional $65 billion of spending, even with depreciation of the current base, would result in a new base of at least $260 billion by the end of 2015 (re: fiber, towers are longer-lived assets), which will require an additional $2 billion to $3 billion of net income (or $20 billion in revenue growth). Overall, after this plan has been implemented, AT&T, to achieve expectations of an 8% post-tax return on invested capital, will need to earn more than $20 billion annually and have revenues (at current profit margin levels) of more than $150 billion.”

To put the “more than $20 billion” revenue growth into context, U-Verse is now a $10 billion business. Mobile data is now a $27 billion business. They need to grow roughly another U-Verse and grow mobile data by 40% by the end of 2015 and preserve margins in the process.

As an update to the original writing, AT&T has $239 billion in net PP&E, spectrum and licenses as of Q3 2013. Net PP&E has grown $3 billion since the beginning of 2013, and licenses have grown $4 billion. The $10 billion in data revenue growth requirement is well underway, with $3 billion of annualized growth since Q3 201s. U-Verse is now a $12 billion per-year business, up $2 billion from the Q3 2012 level. There’s $45 billion or so left to spend, and AT&T has already achieved 25% of the revenue need to justify their bold project.

AT&T has clearly not chosen the easy path with Project VIP. It would have been a lot easier to partition and sell off those assets that had not been upgraded. Massive infrastructure upgrades are required to create an IP/LTE network, and LTE deployment resources were (and still are, to some extent) in short supply when AT&T made the VIP decision last fall.

It’s a harder but familiar road for AT&T, one that could present long-term upside for shareholders and bondholders alike. While the company has strengths in supplier and program management (Verizon and AT&T may be the best at deploying anything at a large scale. This is one of the reasons that President Obama has turned to Verizon to assist in the “tech surge” effort). However, AT&T must convince customers in these newly deployed regions that they have a more compelling video and high-speed Internet product than cable incumbents.

At the end of 2015, $61 billion in additional shareholder and bondholder monies will have been spent as a result of Project VIP. LTE coverage will top 300 million pops covered, U-Verse will have 8.5 million additional marketable homes, and one million additional businesses will have fiber connectivity. The opportunity to create sustainable competitive advantage will be significant. Will AT&T deliver? It’s not a leap to think it’s possible.

Jim Patterson is CEO of Patterson Advisory Group, a tactical consulting and advisory services firm dedicated to the telecommunications industry. Previously, he was EVP – Business Development for Infotel Broadband Services Ltd., the 4G service provider for Reliance Industries Ltd. Patterson also co-founded Mobile Symmetry, an identity-focused applications platform for wireless broadband carriers that was acquired by Infotel in 2011. Prior to Mobile Symmetry, Patterson was President – Wholesale Services for Sprint and has a career that spans over twenty years in telecom and technology. Patterson welcomes your comments at jim@pattersonadvice.com and you can follow him on Twitter @pattersonadvice.

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