– In the wake of T-Mobile/MetroPCS and Sprint/Softbank, new moves from AT&T and Sprint portend heightened rivalry that could threaten industry and cash flow and dividends.
– AT&T plans to boost CAPEX by $14B over the next 3 years, accelerating LTE, resuming investment in U-verse, and challenging Verizon to respond in kind.
– Sprint is buying assets from US Cellular, accelerating its challenge to VZ and T, while activist investors are pushing Clearwire to monetize its spectrum – with or without Sprint.
– Verizon’s trajectory of rising prices and falling CAPEX is unsustainable given an aggressive AT&T, more viable threats from Sprint and T-Mobile, and 4 more years of a Democratic FCC.
In four years as FCC Chairman, President Obama’s old law school friend Julius Genachowski advocated tirelessly for a more competitive US wireless industry, amongst other things, putting the kibosh on AT&T’s attempted take out of T-Mobile USA and gaining authorization to accelerate spectrum auctions by sharing the proceeds with the TV broadcasters that would be displaced. Here at the brink of the second Obama administration, the market certainly seems to be breaking Genachowski’s way. Last month, Deutsche Telekom cut a deal to combine its T-Mobile USA business with Metro PCS, closely followed by Sprint’s massive Softbank cash infusion, transactions that recast sad sack also-ran properties as potential threats to the sleepy Verizon/AT&T duopoly at the top of the food chain.
Together, AT&T and Verizon control over 64% of the US wireless market, Sprint and T-Mobile account for a bit less than 30%, with the rest divided amongst MetroPCS, Leap Wireless, US Cellular, and a motley crew of even smaller regional carriers. The big two each have spectrum depth in excess of 95MHz comprised of the most attractive and most expensive frequencies. In contrast, Sprint and T-Mobile each have about half of that spectrum depth, depending on higher frequencies that propagate over shorter distances and require more capital equipment and deliver less geographic coverage than do the leading networks. As a result, Verizon and AT&T have enjoyed rising prices, declining capital intensity, miniscule customer churn, healthy cash flows and, thus, very high dividend yields.
That record of dominance lit up the radar guns at the FCC and DoJ, attracting vigorous regulatory scrutiny. AT&T’s attempted purchase of T-Mobile was swatted back into its face, triggering a multi-billion dollar break-up fee. Verizon’s deal for spectrum held unused by a consortium of cable operators was allowed through after careful scrutiny and forced concessions. Meanwhile the T-Mobile/MetroPCS merger and the Sprint/Softbank hook-up will see a red carpet reception. While Verizon is continuing to act as though nothing has changed, the situation seems to have scared the bejeebers out of AT&T.
As the pilot fish to Verizon’s shark, AT&T is more keenly aware of the risks of consolidation down below. From this fear comes a plan: AT&T will boost its CAPEX by an incremental $14B over the next three years, with $8B going to accelerate its roll out of 4G LTE, and the remaining $6b targeted at restarting its U-verse high speed DSL broadband initiative. By extending its planned LTE build out from 75M POPs today to 300M POPs in 2014, vs. the previous 250M target, AT&T could leapfrog Verizon’s current network coverage plans. Part of the CAPEX plan is targeted at additional spectrum deals, necessary to address Verizon’s superior bandwidth holdings. Currently, AT&T is deploying LTE in inconsistent blocks of 12 to 24 MHz 700MHz band spectrum versus Verizon’s uniform 22MHz 700MHz C-blocks and 40MHz AWS. Because AT&T lacks a national footprint, it plans to augment its initial build-out with a variety of unusual frequency blocks, including some which do not have natural 2-way pairing and cannot be supported until the next version of LTE. The current spectrum hodge-podge makes it more difficult to provide coverage and to source equipment or devices.
Another aspect of AT&T’s capital spend plan will increase competition with cable companies, and to a lesser extent Verizon. The $6B wireline investment will expand U-verse, the fiber TV, Internet, and Phone offering, to 75% of homes passed in the 22 states or 33M homes where it operates wired franchises. According to the FCC, over 80% of broadband connections with download speeds in excess of 6Mbps are delivered via cable and 55% of households with access to those speeds have only one choice for high speed internet, a cable company. Though common telecom broadband technologies such as DSL are slower than cable, fiber based technologies can reach and exceed cable benchmarks. For instance, AT&T’s DSL service tops out at 6Mbps, slow for a broadband hungry household with multiple devices and frequent streaming video use, while cable companies average 18 Mbps. The Current U-Verse offering is available up to 24Mbs, though the new CAPEX investment will take that up to 75 Mbps. Verizon’s FiOS currently has the fastest available residential internet speeds in the US topping out at 300Mbps.
Both Verizon and AT&T ceased building out their fiber networks a couple years ago, targeting areas with favorable demographics where the cost of laying fiber could be easily recouped. The cost of wiring a single premises could cost in excess of $1500, an investment that would require a high ARPU for a reasonable payback. Despite targeting optimal areas, entry into cable dominated markets was marked with a fierce competitive response that also resulted in lower prices – great for consumers, not so great for cable companies. As cable companies struggle with increasing programming costs increase and price sensitive consumers, leverage over increasing ARPUs is further stymied by competition. As we warned in a previous blog post, carrier cash flows are sensitive to changes in ARPU, customer acquisition, and capital spending. The competitive environment will hamper T’s ability to maintain it’s already industry leading ARPU and the extra CAPEX will make an obvious dent in cash flow. It remains to be seen if the investment will pay in customer acquisitions.
With cash in hand from the sale of $3.1B in convertible notes to Softbank last month, debt-laden Sprint embarked on what is surely the first in a series of asset acquisitions to boost the strength of its network. Earlier today Sprint announced it would spend $480M to purchase some of US Cellular’s spectrum and customers, mostly in the Midwest and oddly including Chicago, the company’s headquarters. The deal will give Sprint 585K customers, boosting its sub count by just over 1%. Also, the spectrum is in line with current Sprint holdings in the 1900MHz PCS band. The 20MHz swath should be adequate for LTE. While this is a small deal, a soon to be Softbank controlled Sprint will likely hunt bigger fish.
Days after Softbank announced its acquisition of Sprint on October 15, Sprint gained a majority stake in Clearwire after making a deal with founder Craig McGraw for a special class of shares to boost its holdings of the company from 48.1% to 50.3% for $100M. We wrote more detail about a Sprint, Softbank, and Clearwire tie up previously, and fundamentally see Softbank as the key to capitalizing both Sprint and Clearwire who historically have been mired in debt. Sprint has struggled to compete with the VZ/T duopoly and Clearwire represents a chance to catch up via repurposing its spectrum for LTE. Conveniently enough, Softbank is building out its Japanese LTE network on the same band and same proposed LTE variant (TDD). Seems like a lot of synergy and firepower with the help of Softbank.
While we can expect a Clearwire deal to happen shortly after Softbank/Sprint is approved by regulators and closes, closing may be more complicated given the majority stake purchase raised the ire of other shareholders with large positions in the company. Both Mount Kellett Capital Management, which holds a 7.3% stake, and Crest Financial, representing a 6.6% stake, have voiced concerns to management about selling to Sprint at distressed prices. Mount Kellett, which originally filed an activist letter on November 1, called for auctioning off spare spectrum to the likes of AT&T, T-Mobile/MetroPCS, or Dish, which plans to offer mobile services pending a regulatory review and finding a viable partner. Crest followed up days later with a similar letter stating concerns with board’s fiduciary responsibilities and pricing of Class A and B stock that favors Sprint. With 7 of 13 board seats, Sprint is clearly in control of Clearwire. Then again, once the deal goes through, Softbank will be clearly in control of Sprint.
For our full research notes, please visit our published research site.