AT&T (NYSE:T) announced a solid set of Q3 results October 23rd, thwarting fears of rising competition with strong postpaid net adds and improved margins. Revenues for the quarter increased by about 2.2% over the same period last year and net income by a faster 5.5% on effective management of subsidies and other expenses. Despite registering record third-quarter sales of 6.7 million subsidized smartphones, the company saw its wireless EBITDA margins improve by 40 basis points year-on-year. The top-line growth was driven by a solid 18% increase in wireless data revenues, with the company registering postpaid net adds of 363,000 during the quarter – more than twice as many as in the year-ago quarter. Increasing smartphone penetration as well as adoption of 4G LTE continued to drive AT&T’s postpaid ARPU levels, which increased by a healthy 1.5% y-o-y.
Over the past year, AT&T has gained significant ground with its LTE network, which now covers about 250 million Americans currently. However, it faces heightened competition, with Sprint (NYSE:S) and T-Mobile fast catching up with their respective LTE build-outs and Verizon (NYSE:VZ) leading from the front with its initial LTE build-out largely complete. Verizon’s LTE lead has so far helped it take market share away from rivals, and a resurgent T-Mobile is shaping up to do the same with its new ‘Uncarrier’ strategy and accelerated LTE roll-out. AT&T is therefore spending heavily on network upgrades – about $6 billion in the third quarter – and expects the high capital expenditures to sustain over the next two years at least. Following these strong earnings, we have increased our price estimate for the company from $36 to $38.
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AT&T benefiting from wider LTE coverage
AT&T’s lag in LTE coverage has been a concern over the past several quarters, with its postpaid net adds shrinking in comparison to industry leader Verizon. Last year, for example, Verizon added over 5 million postpaid subscribers, more than three and a half times of AT&T. So far this year that trend has continued, with Verizon’s postpaid net adds outnumbering AT&T’s 2:1. With this quarter’s net adds surprise, however, it seems AT&T is turning the corner. While Verizon’s postpaid net adds so far this year have declined as compared to last year, AT&T’s are improving. As compared to postpaid net adds of 685,000 in the first three quarters of 2012, AT&T has added about 1.2 million postpaid subscribers so far this year.
Partly, the reason for AT&T’s relatively strong performance this year was its promotional campaign in Q2 which hit margins but saw postpaid net adds improve. However, a sustained net add improvement in Q3 shows that AT&T’s increasing LTE coverage is helping it retain more subscribers as compared to last year. With coverage of 250 million PoPs, AT&T’s LTE network may still be behind Verizon’s but the lag has become less of a concern with each passing quarter. This time last year, for example, the difference in coverage was nearly 115 million PoPs, with Verizon’s LTE network covering nearly twice as many people as AT&T’s. The narrowing of the LTE gap between the two heavyweights has had a similar impact on their postpaid net adds as well. While Verizon’s postpaid net adds declined from 1.5 million in Q3 last year to about 927,000 this year, AT&T’s more than doubled. To be sure, AT&T is still losing market share to Verizon (Verizon added nearly 2.5 times as many postpaid subscribers as AT&T in Q3) but the loss isn’t nearly as drastic as last year.
ARPU growth driven by smartphone and LTE penetration
However, with the overall wireless market getting saturated, the bigger concern for AT&T is holding on to its existing subscriber base as well as monetizing it more effectively. It is therefore converting more of its subscriber base to smartphones, since these subscribers consume more data on average and have twice the ARPU of non-smartphone subscribers. Smartphones accounted for almost 89% of postpaid sales during the quarter, taking smartphone penetration of AT&T’s postpaid subscriber base past 75%, up from about 66% a year ago. A growing smartphone penetration helped AT&T post its 19th consecutive quarter of y-o-y postpaid ARPU increase, as postpaid data ARPU rose close to 17% and overall postpaid ARPU by 1.5% over the year-ago quarter.
Going forward, one of the big drivers of data revenues 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 16 million subscribers under the Mobile Share program, up by 23% since the end of Q2. 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, about 72% of AT&T’s postpaid smartphone base is on a tiered data plan (including Mobile Share), up from 64% two years ago.
As the adoption of Mobile Share plans increases and data usage goes up due to LTE, subscribers are moving up to the higher tiers of their data plans. About 30% 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. Of the tiered-data subscribers, about 22% have subscribed to the higher-data tiers – up from 9% a year ago. 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.