AT&T (NYSE:T) received the final go-ahead for its acquisition of Leap Wireless Thursday, after regulators approved the deal with conditions in place to protect consumer interests. The acquisition gives AT&T a well-known prepaid brand in Cricket and high-frequency AWS (1.7/2.1MHz) and PCS (1.9MHz) spectrum assets to bolster its LTE network in key markets. However, it will have to divest some of the acquired licenses in 12 markets, mostly in Texas, to ensure that competitors have access to sufficient spectrum. In order to avoid spectrum hoarding, the FCC has mandated that AT&T deploy LTE services on the acquired spectrum within 12 months of closing. AT&T’s commitment to putting Leap’s unused spectrum to quick use, together with the agreed-upon spectrum divestitures, helped alleviate anti-competitive concerns that regulators had about the merger. The transaction has already received the consent of Leap’s shareholders in October 2013, and should be closed soon.
Once the deal closes, AT&T will look to leverage its wider LTE coverage and Cricket’s more-established prepaid brand to gain market share in the prepaid segment. More importantly, the acquisition gives AT&T high-frequency spectrum bands, which have higher data capacity than lower bands. This complements AT&T’s sub-1GHz spectrum holdings well, allowing it to boost its LTE data capacity in high-traffic urban regions and thwart rising postpaid competition from T-Mobile, Verizon (NYSE:VZ) and Sprint (NYSE:S).
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Focus shifting to prepaid
With the high-end smartphone market largely saturated and postpaid subscriber growth slowing, the top four in the U.S. wireless industry are increasing their focus on the prepaid market. While some are looking to consolidate the prepaid market, others are adding popular smartphones to their prepaid lineup and revamping their pricing strategy to gain market share. Over the past year, two big mergers have happened in the prepaid segment. Apart from AT&T’s acquisition of Leap, there was the T-Mobile/MetroPCS reverse-merger which was completed last year. Sprint started offering the iPhone on its Boost prepaid platform late last year, having already introduced it on its other prepaid brand, Virgin Mobile, in mid-2012. Even Verizon, which has traditionally focused more on postpaid and so far kept its prepaid plans 3G-only to avoid postpaid cannibalization, tweaked its prepaid pricing strategy to include lower data tiers and attract more prepaid subscribers. 
This has left many tier-2 carriers vulnerable as the bigger carriers leverage their wider network coverage to good effect. Last quarter, Leap lost around 92,000 prepaid subscribers to end the year with a subscriber base of just 4.55 million – down from about 5.3 million at the end of 2012. Meanwhile, Verizon, AT&T and Sprint all gained prepaid subscribers over the past year. AT&T’s acquisition of Leap will allow the carrier to leverage its bigger scale and nationwide coverage to stabilize Leap’s prepaid base as well as stave off competition from rivals such as T-Mobile, which has emerged a much stronger prepaid player following its merger with MetroPCS. While Leap’s network covers about 96 million people in the U.S., AT&T’s reaches about 308 million. In 4G LTE, the difference in coverage is even wider with AT&T’s network covering more than 13 times as many people as Leap’s. AT&T’s nationwide coverage gives the new Cricket brand a much better chance at gaining from the remaining wireless growth in prepaid.
Leap’s high-frequency spectrum to drive ARPU growth
However, the prepaid potential isn’t the biggest reason why AT&T has bought out Leap. AT&T’s merger with Leap will give it only 4.6 million prepaid subscribers and boost its prepaid share to 4% of the overall market. At its current ARPU levels, Leap will add less than $3 billion, or about 2.3%, to its top line. Moreover, Leap’s EBITDA margin in 2013 was about 14% – a good 25 percentage points less than AT&T’s. AT&T’s scale may allow the combined entity to potentially increase prepaid market share, procure handsets at lower costs and generate operational synergies in sales and advertising. But given that prepaid alone is a small part of AT&T’s business (less than 5% of overall wireless revenues by our estimates), the value addition from Leap’s prepaid business is relatively small. Where AT&T will be looking to derive the most value out of Leap is in the smaller carrier’s complimentary spectrum assets that it plans to put to use in bolstering its LTE network.
Leap has high-frequency spectrum assets in the PCS and AWS bands covering 137 million people – about 45% of the U.S. population. Almost a third of this spectrum with a coverage of about 41 million people, is currently lying unused. As AT&T transitions Leap’s customers to its own network and shuts down the smaller carrier’s CDMA service, it will essentially re-farm almost all of Leap’s spectrum for LTE purposes. Leap has started building out a LTE network but it covers only about 21 million people currently; so AT&T will incur significant CapEx in laying out the rest of the network and shutting down CDMA gradually. However, given the higher data capacity of the acquired spectrum bands, AT&T should realise the benefits of having a more robust data network in peak-traffic urban areas. With AT&T’s shared data plans seeing good adoption, the carrier will look to generate higher postpaid ARPU from the increased data usage that 4G LTE and the high-frequency bands should help drive.Notes:
- Verizon cuts prepaid prices, data allotments with new ‘AllSet’ plans, FierceWireless, March 3rd, 2014 [↩]