AT&T’s Q2 Earnings Dip Despite Record Postpaid Adds, U-verse Gains

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AT&T (NYSE:T) reported a mixed set of Q2 2014 results on Wednesday, July 22, which highlighted the wireless major’s transition away from the postpaid subsidy model, in line with its peers in the U.S. The country’s second largest wireless carrier added over 1 million postpaid subscribers during the quarter, its strongest gain in nearly five years and almost double the figure from a year ago. The carrier’s strategy to combat T-Mobile’s ‘Uncarrier’ initiatives with equipment financing plans of its own worked well, as Next accounted for 50% of its postpaid smartphone gross adds and upgrades in Q2 – up from 40% in Q1 and 15% in Q4 2013. However, its overall revenues grew by only 1.6% year-on-year (y-o-y) to $32.6 billion, which was below the Thomson Reuters-compiled analyst consensus of $33.2 billion. The slow revenue growth was attributed to the transition to no-subsidy plans, which shift revenue recognition from service to equipment (handsets), and a higher proportion of bring-your-own-device (BYOD) gross adds.

On the cost side, the carrier’s EBITDA margin in Q2 was almost flat year-over-year at 42.6% as pressure from strong sales and promotional activities offset most of the gains due to a subscriber shift towards the no-subsidy model. Pricing pressures due to rising competition and higher tax expenses impacted net income, which declined over 7% to $3.5 billion in the quarter.

We have a $37.50 price estimate for AT&T, which is about 5% ahead of the current market price.

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Mobile Share and Next Drive Wireless Postpaid Adds

The number of AT&T’s Mobile Share accounts have almost tripled year-over-year in 2014 to reach 14.6 million. The take rates of its higher-data tiers were especially impressive, as penetration of 10GB+ data plans increased significantly, from 27% of its Mobile Share base at the end of the fourth quarter last year to 49% in Q2. By discounting higher data usage, AT&T is counting on subscribers adding more mobile devices to their shared data plans and shifting to the higher data tiers. Growing LTE adoption should also help drive the trend, now that AT&T is nearly done with its initial LTE buildout and is also rapidly adding data capacity in high-traffic areas. This will help AT&T offset the impact of the pricing discounts on offer and defend its long-term data potential.

Usually, in a quarter that AT&T shows impressive postpaid net-add figures, the carrier also suffers from margin compression due to subsidies. However, the increasing adoption of Next helped AT&T avoid the impact this quarter. This is because the carrier is able to recognize a greater portion of the device’s upfront cost as revenues when subscribers finance their devices through Next’s installment plans. The carrier reported a 45% increase in device revenues in Q2, although service revenue declined slightly (1.4%) year-over-year. The accounting change helped the carrier maintain its high margin levels, as Next sales surpassed expectations and accounted for 50% of gross postpaid smartphone adds during the quarter.

However, the discounting of service plans with Next resulted in a decline in AT&T’s ARPU levels over the prior year quarter. AT&T’s phone-only postpaid ARPU declined by about 8% in Q2 2014 as compared to same period last year, but when combined with Next monthly billings (a more apt metric for comparison with the traditional subsidy model), the decline in ARPU moderated to about 4.5% y-o-y.

Going forward, we expect the trend of rising data usage and margin expansion to continue as LTE adoption grows further. Increased adoption of 4G will reduce dependence on AT&T’s less cost-efficient 3G network, and incentivize higher data usage on tiered data plans. 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.

U-verse Drives Wireline ARPU

U-verse, AT&T’s fiber-optic based triple-play communications service, continued its solid performance in the second quarter this year. Overall U-verse revenues increased by about 25% y-o-y on the back of solid growth in U-verse TV, Internet and Broadband revenues. U-verse TV added 190,000 subscribers in Q2 to take its total user base to 5.9 million and U-verse high speed Internet added 488,000 new subscribers in the quarter to take its total to 11.5 million. This rise in subscriptions helped the company improve its proportion of U-verse subscribers to total broadband users to 70% in Q2 2014 from 55% in the year-ago quarter.

An important factor in the consistent and solid expansion of the U-verse business is its triple-play functionality. This is reflected in the fact that its triple-play bundled accounts have significantly lower churn compared to accounts opting for standalone services, according to the company. [1] In addition, more than 97% of the company’s video users subscribe to bundled services which helps drive the average revenue per user (ARPU) as well. ARPU for triple-play customers continues to be over $170 per month and overall wireline ARPU increased by 6% y-o-y in the second quarter this year.

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Notes:
  1. Q2 2014 Presentation, AT&T []