The Sunday Brief: Third Quarter Results – Tricks or Treats?
21 October 2012
Greetings from Paris (France, not Texas) and Dallas (Texas)
where storefronts are full of Hallow-Holiday themes (mixing
celebrations has always been a source of frustration – let’s
observe/ celebrate one thing at a time, please). Third quarter
earnings poured in this week, with AT&T, Sprint, Apple, Amazon
and Comcast adding to the earlier reports from Google and
Verizon. For the most part, investors were delivered treats, but
we were not without a few tricks as well.
To start with last week’s column (which generated about 100 emails – my apologies for late responses
to many of you), I was reminded that Clearwire is technically not under Sprint’s voting control, but is
now under Sprint’s economic control with the purchase of the Eagle River interest. I too succumbed to
poor reporting from the New York Times on the topic. Here is the table showing the difference between
the Class A common stock and the voting share for Clearwire (this is taken from the Sprint filing which
can be found here on the Clearwire website).
Because Sprint delivers so much of Clearwire’s economic production, Clearwire still needs to be
responsive to Sprint even though Sprint does not have voting control.
With that correction, on to this week’s Sunday Brief. I was reading a column on the presidential debates
where one analyst broke out debate performance into three categories. First, the analyst rated the
performance of the candidate in the debate. Second, after fact checks, spins, snap polls, “walk backs”
and Tweets, the post-debate performance was blended into the actual debate results. Finally, the
aggregate three (or four including VP) debate performances were reviewed.
There are very clear corollaries between presidential debate analysis and quarterly telecommunications
earnings releases, the presentation and interpretation of those results, and the aggregate positioning
and competitive positioning that occurs as a result of earnings. In fact, the clear and consistent
messages given by AT&T and Verizon (in which they exposed their warts yet delivered clear milestones
to address them) stand in contrast with the tone and tenure of the Sprint conference call (which
conveyed generally in-line earnings but lost the post-debate performance).
First, Verizon demonstrated their role as the momentum-building incumbent. They had treat-worthy
wireless performance, thanks to changes in their upgrade policy which slows down the rate of 4G LTE
smartphone upgrades (and their associated subsidies) as well as changes in the mix of traffic carried (4G
traffic makes up 35% of the total wireless data consumed on all Verizon Wireless 3G and 4G networks).
Where Verizon really shined, however, is in the mix of smartphones it sold during the third quarter.
Think of the third quarter as being as much about “Back to School” as it was about the iPhone 5 launch.
Both the seasonal trend (e.g., what happened in July and August) as well as the specific launch event (in
September) matter. Here is a comparison of AT&T, Verizon and Sprint smartphone sales by operating
system:
As the chart shows, while there were supply
constraints for the iPhone5 (and they continue to
(all amounts in millions)
Verizon
AT&T
Sprint
exist as of the time of this writing), Verizon has
Total smartphones sold
6.8
6.1
n/a
the advantage of a new offer: A Free iPhone 4.
- of which: iPhone
3.1
4.7
1.5
This is a big deal for both Verizon and Sprint as
- of which: Android
3.4
1.0
n/a
- of which: BB, Windows
0.3
0.4
n/a they look to beef up their family plan portfolios.
AT&T has had a free iPhone in their portfolio for
% iPhone to total smartphone
46%
77%
n/a two years – this price point exclusivity has been
lost, and was one (small) reason why AT&T’s postpaid net additions suffered in the third quarter.
3Q 2012 Smartphone Sales By Operating System
On top of this, however, as we analyzed a few weeks ago, is the Droid franchise. Verizon has a welldeveloped alternative to the iPhone, and a heritage of actually being anti-iPhone. The Android
represents power, LTE speeds, and (sometimes) value. Only the iPhone5 brings those to the table for
Apple, and supplies are limited. With store employees focused on having customers leave with a
working device on the most powerful and highest yielding network available, the iPhone may be a
tougher sell in the fourth quarter unless supplies are plentiful. (Verizon disclosed that only 651,000 of
the 3.1 million iPhones sold in the third quarter were the iPhone 5. With supplies continuing to be
constrained well into November, one has to think that Samsung and Motorola might be in for a 4G LTE
windfall).
Supply constraints led to a pretty dramatic gap in postpaid net additions between carriers. The table
below charts the last seven quarters of net additions for each of the “Big 4.”
Postpaid Net additions (000s)
Big 4 comparison
(see T-Mobile note)
Description
Verizon Wireless
AT&T Mobility
Sprint
T-Mobile
Big Four
Big 4 (rolling)
3Q
1,535
155
(456)
(475)
759
2,529
2012
2Q
888
320
(246)
(557)
405
2,538
1Q
501
187
(192)
(510)
(14)
3,084
4Q
1,207
717
161
(706)
1,379
3,378
2011
3Q
2Q
882
1,257
319
331
(44)
(101)
(389)
(536)
768
951
1Q
906
62
(114)
(574)
280
last 4 qtrs 7 qtr chg
4,131
7,176
1,379
2,091
(733)
(992)
(2,248)
(3,747)
2,529
4,528
Notes:
1. T-Mobile 2Q estimate
2. T-Mobile net additions do not include M2M
Over the past seven quarters (think of this starting point as both a marker for Verizon’s introduction of
their 4G LTE network as well as the introduction of the iPhone), Verizon has added 1.7 net postpaid
customers for every AT&T net add. Over the past four quarters (think of this as the effect of two
additional iPhone introductions as well as AT&T’s loss of the “free” iPhone price point), this number has
grown to 3.0.
These gains are not accidental, but are part of a planned effort to balance suppliers with network
choices. Verizon has determined that it can achieve enough balance with a focus on the Android and
Apple franchises. To overcome Verizon’s dominance, AT&T will need to redouble their efforts with
Android and perhaps even (gasp!) Windows.
The world is not crashing around AT&T, however, and they were very calm and collected on their call
last week as they delivered up many treats for the analyst community (I had the chance to listen to the
replay this weekend and they actually sounded aggressive and upbeat on all portions of the call except
for Enterprise). They have reason to be aggressive with wireless data growing at an annual rate of just
over 18% (a $26 billion business based on the last four quarters of revenue). They also have record low
postpaid churn (1.08%) and have managed upgrades under 7% of the base even with the iPhone5
release (this will undoubtedly rise as more iPhone5 supply becomes available in the fourth quarter).
Most importantly, they have been able to generate cash from their wireless data scale: $11.5 billion in
cash flow for the quarter and $6.5 billion in free cash flow will be able to fund future debt reductions,
share buybacks, and dividends.
With LTE deployments well underway, smartphone penetration at 64%, and 68% of the smartphone
customer base on usage-based plans, AT&T’s focus needs to turn to Enterprise. Yes, there are issues
abroad, and yes, there is some anxiety about future corporate tax increases and depreciation benefit
reductions. But both wireline and wireless performance in the business segment has been lackluster.
Given limited competition domestically in the integrated wireline/ wireless space (Verizon is the only
other carrier who has scale comparable to AT&T), they should be better positioned at this point in the
economic cycle. In fact, as the chart below shows, they are shrinking less with their largest wirleine
accounts than they are in the small business segment.
AT&T Business Solutions Revenues
Wireline
Three Months Ended
Dollars in millions
4 qtr
decline
12/31/10
3/31/11
6/30/11
9/30/11 12/31/11
3/31/12
6/30/12
9/30/12
Operating Revenues
Global Enterprise Solutions
Small Business & Alternate Channels
Wholesale & GEM Solutions*
$3,529
1,966
3,979
$3,516
1,952
3,816
$3,466
1,937
3,857
$3,490
1,930
3,906
$3,497
1,903
3,938
$3,515
1,898
3,797
$3,473
1,874
3,773
$3,460
1,866
3,755
-0.9%
-3.3%
-3.9%
AT&T Business Solutions
$9,474
$9,284
$9,260
$9,326
$9,338
$9,210
$9,120
$9,081
-2.6%
Unaudited
*GEM = Government, Education & Medical
You cannot blame Europe for the decline in small business or wholesale channels. And while there is
exposure on certain international minute-based business within the wholesale segment, there’s also
plenty of growth in cell site backhaul (and soon in-building solutions) to offset the cash flow (EBITDA)
impact. Both AT&T and Verizon have missed opportunities here, and as a result have sown the seeds of
cable and alternative fiber provider competition. AT&T needs to address cable’s competitive threat and
their 12-24 month response in their upcoming Investor Day on Nov 7. This response is more than UVerse but now must include small business and enterprise Ethernet offerings.
Finally, we get to Sprint, a company in transition. They had a tough gross adds quarter with both prepaid and post-paid customers (they missed analyst expectations on both). They improved operating
margins versus expectations largely because they brought fewer customers in the door (and as a result
has less handset subsidies and other acquisition-related expenses). They are missing their overall
Network Vision goals by about 90 days, which is not a big deal other than the fact they went to great
lengths on the previous earnings call to demonstrate their confidence in the build (even going so far as
to detail how many sites would be network ready once nesting birds had completed their nesting
patterns).
Overall, Sprint has a good story to tell, especially with Softbank’s funding, but they are reacting far too
much to the analysts. They are becoming (President Obama’s press secretary) Jay Carney in the current
telecom saga, a veritable media punching bag, yet they deserve analyst credit for the changes they are
implementing, especially the takedown of the iDEN network.
This was extremely clear in their conference call (access that here). Sprint delivers a very upbeat
presentation describing in detail how they will transition from one network to another. They talked (as
they have done in the past) about how they will fund these changes (a lot easier thanks to the $3 billion
convertible note and some well-timed refinancings). But they were unprepared for the transition
question (full exchange below – sourced from Seeking Alpha):
Brett Feldman - Deutsche Bank AG, Research Division
And kind of a follow-up here. Dan, you were talking about some of the temporary advantages that Verizon has in the market
right now. But when you take a step back, and I think it's fair to say that Verizon and AT&T have some permanent advantages
that have worked for them for a considerable amount of time. As someone who competes with them day-to-day and you look
at someone like Verizon getting the highest share despite having the highest prices, why do you as a competitor think they have
been able to sort of achieve that? And in light of your vastly improving financial condition, what are the types -- just
qualitatively speaking, what are the types of structural improvements you'd like to make in Sprint's business to kind of
permanently close some of that gap?
Daniel R. Hesse - Chief Executive Officer, President, Director and Chairman of Executive Committee
Well, thanks for the question. And again, kind of going back to our original disclaimer. I don't want to talk too much about what
the new company could potentially look like and what we might do after a transaction might be closed with SOFTBANK. But
there clearly are scale advantages they have that we believe that we can mitigate going forward. There are other internal
investment opportunities, we believe, we have that we have had to forgo in past quarters, as well as it's taken us a while
because of our scale. We were late, not only in terms of, we'll call it, having the financial wherewithal to invest in LTE 4G, but
late with the iPhone. We're just -- the iPad has been hugely successful for both Verizon and AT&T. And we have not had that in
past quarters and will have it going forward. So we have -- we've constantly been playing catch-up. We are good at playing
catch-up. We closed the gap very quickly, but we believe with additional financial resources, that we can do that much more
effectively. And we have some thoughts and plans, but we're not going to share those today. But I appreciate your questions.
They do have some structural advantages, and we intend to try to mitigate those over time.
Perhaps Sprint is out of practice answering the question “How will you compete?” as they have been too
busy addressing “How will you survive?” They need a fundamentally better response than the one
above. Perhaps something like the following: “We will focus on one network – LTE. We will become
the best at operating LTE networks, regardless of who owns the underlying spectrum. We will gain
share because of our easy to understand pricing plans, our world-class IP backbone, and our in-store
experience. We will take a long-term view of the business, and reinvest our free cash flow into network
expansion and an improved service experience. And we will create innovative partnerships that change
the way people look at communications and their network service provider.” Catch-up is not a core
competency. “Intending to try” is not a strategy that instills confidence.
Sprint has done a good job, with good execution of what is a very difficult network transition. Their
responses, however, to analysts who have turned the survival page, do not convey confidence about
their leadership potential. They delivered a trick that should have been viewed as a long-term treat.
Most importantly, they lost the post-debate conversation. This call slowed the momentum they gained
earlier in October with the original Softbank announcement.
Next week, we’ll head into our quarterly wireline analysis after Time Warner Cable and Cablevision
announce earnings. As always, we welcome your comments and questions. If you have friends who
would like to be added to this email blog, please have them drop a quick note to
sundaybrief@gmail.com and we’ll add them to the following week’s issue. Have a terrific week!
Jim Patterson
Patterson Advisory Group
jim@pattersonadvice.com
(816) 210-0296 mobile
Twitter: @pattersonadvice