AT&T Takes Margin Hit As It Spends For Data Hungry Subscribers

by Trefis Team
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AT&T (NYSE:T) announced a mixed set of Q2 results July 24 as the company’s efforts at soaring up postpaid net adds bore fruit but margins took a hit on higher subsidy costs. The second largest wireless carrier in the U.S. exceeded guidance by adding around 551,000 net postpaid customers in Q2 on several successful promotions that it ran during the quarter. The net adds figure is a good 86% higher than the previous quarter and over 72% more than the number of subscribers it had added in the year-ago quarter. The high cost of promotions and subsidies on smartphones sold however caused margins to shrink by about 300 basis points over the same period last year. By spending heavily on subsidies and marketing, AT&T is looking to offset the impact that its near-term lag in LTE coverage (as compared to Verizon) has had on its postpaid net add figures.

The margin compression should not be much of a concern to investors since the carrier has in return for the subsidies locked its subscribers into a two-year postpaid contract. The near-term margin hit will therefore be more than compensated for by the regular service fees that the subscriber is obligated to pay AT&T over the term of the contractual period. Bolstered by the recently released Mobile Share plans and the rising demand for data, AT&T’s postpaid service ARPUs increased by a strong 1.7% over the previous quarter. Going forward, we expect the strong momentum of shared data plans to continue and LTE adoption to increase, helping AT&T reap benefits of its high-speed network.

Our revised $39 price estimate for AT&T is about 10% ahead of the current market price.

See our complete analysis for AT&T here

AT&T Making Up For LTE Lag

The U.S. wireless market has become increasingly saturated recently with wireless connections having exceeded the population in mid-2011. This has made the acquisition of new subscribers, especially those that pay for the higher-margin data plans, very tough for the wireless carriers. AT&T’s dismal postpaid net adds in recent quarters is to an extent reflective of this industry-wide phenomenon, but Verizon’s comparatively much better performance shows that LTE coverage is the differentiating factor here. Last year, Verizon added over 5 million postpaid subscribers, more than three and a half times of AT&T. Even in Q2, when AT&T has done a lot better, Verizon’s postpaid net adds outnumber AT&T’s 1.7:1.

As the first carrier in the U.S. to start 4G LTE deployment, Verizon has raced ahead of rivals with LTE coverage in about 500 markets currently – more than 99% of its 3G footprint. With its initial LTE deployment phase nearly done, the carrier is gearing for a second round of LTE deployment that will see it use its recently acquired AWS airwaves from the cable companies. In comparison, AT&T expects to complete its initial LTE deployment only by the end of 2014 – a full year and a half after Verizon. Currently, AT&T’s LTE network is available in about 336 U.S. markets and will cover about 270 million Americans by the end of this year.

ARPU increase driven by data demand

It was in a bid to counter Verizon’s early LTE lead that AT&T spent aggressively in Q2 to add new smartphone users and increase ARPU levels. The move paid off as the carrier added as many as 1.2 million new smartphone users – subscribers that consume more data and pay on average two times more than non-smartphone subscribers. Smartphones accounted for almost 88% of postpaid sales during the quarter, taking smartphone penetration of AT&T’s postpaid subscriber base past 73%, up from about 64% a year ago. A growing smartphone penetration helped AT&T post its 18th consecutive quarter of y-o-y postpaid ARPU increase, as postpaid data ARPU rose close to 17% and overall postpaid ARPU by 1.7% over the year-ago quarter.

Going forward, one of the big drivers of postpaid ARPUs will be the increasing adoption of AT&T’s Mobile Share plans which allow users to buy a bucket of data to be used across mobile devices. AT&T said that it now has about 13 million subscribers under the Mobile Share program, up by 30% since the end of Q1. More importantly, AT&T is seeing more of its unlimited subscriber base transition to one of its shared data plans, thereby enabling it to better monetize its subscriber base. More than 15% of AT&T’s shared data plan users have switched over from unlimited plans. Currently, more than 70% of AT&T’s postpaid smartphone base is on a tiered data plan (including Mobile Share), up from 45% two years ago.

As the adoption of Mobile Share plans increases and data usage goes up, subscribers are moving up to the higher tiers of their data plans. More than 25% of AT&T’s shared data plan users are subscribing to the higher data tiers – a trend that will only increase going forward as LTE adoption grows. An increased adoption of 4G in the long term will also reduce dependence on AT&T’s 3G networks, which are under great strain due to the heavy data usage of smartphones such as the iPhone. Further, LTE as a network technology not only supports higher speeds, but is also more efficient than current 3G networks at handling data, reducing maintenance and handling costs. In the near term, limited LTE coverage may be a deterrent for some, but a fallback option in the form of the carrier’s HSPA+ network, which provides higher speeds than 3G and has a wider coverage area than its LTE network, should offer an interim solution.

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