AT&T (NYSE:T) announced a solid set of Q4 2013 results on January 28th, as healthy ARPU growth and cost controls helped the company post strong bottom-line growth despite rising competition. The carrier added about 566,000 postpaid connections during the quarter, sequentially higher by about 56% on strong smartphone sales during the holiday season. However, increasing competition from rivals in a saturated market took a toll, as AT&T’s postpaid net adds figure fell well short of Verizon’s (NYSE:VZ) 1.6 million and T-Mobile’s 869,000 for the quarter. Also, seasonally higher smartphone subsidies caused wireless EBITDA margins to decline by around 460 basis points over the previous quarter. The subsidy effect was, however, more than offset by the cost-cutting measures and subsidy controls that AT&T has put in place over the past year, as wireless margins improved by about 830 basis points over the year-ago quarter. The margin improvement was also driven by increasing smartphone penetration and adoption of 4G LTE, which helped AT&T’s data ARPU rise by 13% and overall postpaid ARPU by 2% over the same period last year.
In response to rumors that the carrier is preparing a bid for Vodafone, AT&T issued a statement denying any such offer and added that it has no further announcement to make regarding its European aspirations. Our $38 price estimate for AT&T remains unchanged and is about 15% ahead of the current market price.
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AT&T’s LTE Lag Less Of A Concern Now
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. In 2012, for example, Verizon added over 5 million postpaid subscribers, more than three and a half times that of AT&T. Last year, the trend continued, with Verizon’s postpaid net adds outpacing AT&T’s by 130%.
However, we estimate that AT&T added to its postpaid market share in 2013 following a decline in 2012, when its LTE coverage trailed Verizon’s by a wide margin. This time last year, for example, the difference in coverage was nearly 100 million PoPs, with Verizon’s LTE network covering about 90% of the total U.S. population. At 280 million PoPs currently, AT&T’s LTE coverage is still about 20 million behind Verizon’s, but the lag has become less of a concern with each passing quarter. While Verizon’s postpaid net adds in 2013 have declined as compared to the previous year, AT&T’s improved. Compared to postpaid net adds of 1.4 million in 2012, AT&T added about 1.8 million postpaid subscribers last year. To be sure, AT&T is still lagging behind Verizon in subscriber additions (Verizon added more than twice as many postpaid subscribers as AT&T in 2013), but its subscriber patterns are showing signs of stabilizing as the LTE gap between the two heavyweights narrows.
Margins Improve On Lower Subsidies
On the other hand, competition from a resurgent T-Mobile has become a lot more intense in recent quarters. T-Mobile’s aggressive posturing in the wireless market helped it add 1.5 million postpaid net adds in the last two quarters combined, more than 63% ahead of what AT&T managed in the same period. With competition increasing and the wireless industry becoming more saturated, AT&T’s focus has shifted from acquiring new smartphone subscribers to converting more of their existing base to smartphones and increasing profitability. Aside from controlling subsidies, AT&T has lengthened the handset replacement cycle from 20 to 24 months, as well as levied additional upgrade and administrative fees. (see AT&T Shows Focus On Profitability As Data Demand Surges) AT&T activated only 7.9 million smartphones during the fourth quarter, about 22% less than what it had in the same period last year. As a result, its Q4 wireless EBITDA margins surged to 37.4%, from about 29% in the year-ago quarter. Its new no-contract Next plans, which allow subscribers to trade in their existing handsets so as to be able to upgrade every year, are likely to boost AT&T’s margins in the coming quarters, since the carrier isn’t decreasing the price of its service plans by much and has the option of selling the refurbished phones back in the market.
Mobile Share Plans And LTE Drive Data Revenues
Most of AT&T’s new subscriber additions are coming from tablets and other connected devices rather than smartphones. Last quarter, over 77% of AT&T’s net adds came from branded tablets. Although service plans for these data-only connected devices have higher margins, they generate lower ARPUs than smartphones. Still, given that such connected devices are usually not the primary source of data consumption for most users and are hence purchased as an add-on to an existing smartphone account, increasing adoption of these devices will help AT&T generate more revenues per account. AT&T has been incentivising the addition of more devices to existing accounts through its Mobile Share plans, which allow users to share a bucket of data across mobile devices.
As of last quarter, AT&T had about 21 million subscribers under the Mobile Share program, up by 31% since the end of Q3. Increasing penetration of Mobile Share helped AT&T increase the number of postpaid smartphone subscribers on tiered-data plans to 38 million from about 32 million in Q4 2012. More importantly, AT&T saw its subscriber base transition more towards the upper tiers of their limited-data plans. The percentage penetration of the higher-data plans for AT&T rose to 24% last quarter from 13% a year ago. Within the subscriber base on shared data plans, the percentage is even higher at 30%. We expect this trend to only increase going forward as LTE adoption grows further. 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 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, thereby reducing maintenance and handling costs.