AT&T (NYSE:T) announced a mixed set of Q1 2013 results on April 24. The carrier managed to grow earnings on strong smartphone adoption, but struggled to add postpaid subscribers in a saturated wireless market. The second largest wireless carrier reported an EPS growth of 8.5% over the same period last year, as data continued to be AT&T’s primary growth driver with revenues from wireless data and U-Verse services growing by 21% and 31% respectively, over the year-ago quarter. Wireless margins also recovered from the subsidy impact of last quarter’s holiday sales to more than 43%, up from about 29% in the previous quarter.
However, despite being higher than the same period last year, AT&T’s 296,000 postpaid net adds was less than half the net adds that Verizon (NYSE:VZ) reported for Q1 last week. A saturated wireless market has left little to go around in terms of subscriber growth, and Verizon’s early lead in LTE coverage seems to be hurting AT&T – a trend that was seen last year as well.
It is in this context that it is tough to see the reasoning behind lowering the capital expenditure guidance for 2014 and 2015. AT&T said that it expects capital spending to be about $2 billion lower than the earlier guidance of $22 billion. This, it expects, will help increase flexibility with regard to preserving capital for future share buybacks. However, with the LTE lag already affecting subscriber growth, the markets seems not too pleased with the lower network spending forecast. AT&T’s stock has fallen more than 5% since the earnings release. Still, considering that AT&T expects to be done with almost 90% of its initial LTE deployment this year and that 4G LTE is more efficient at handling data than 3G, the situation may not be as dire as some may think.
Our $40 price estimate for AT&T is about 10% ahead of the current stock price.
Saturated Wireless Market
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, highly tough for the wireless carriers. AT&T’s dismal postpaid net adds 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. While Verizon added close to 680,000 postpaid subscribers last quarter, AT&T did less than 300,000 in the same period. Last year as well, Verizon added over 5 million postpaid subscribers, more than three and a half times of AT&T.
With the wireless industry getting more saturated, AT&T’s focus has shifted from acquiring new subscribers to converting more of its existing base to smartphones and increasing ARPU. This is a big deal because AT&T’s smartphone users consume more data and pay on an average two times more than non-smartphone subscribers. Smartphones accounted for almost 90% of postpaid sales during the quarter. As a result, smartphone penetration of AT&T’s postpaid subscriber base increased to 70%, up from about 61% a year ago. A growing smartphone penetration helped AT&T post its 17th consecutive quarter of y-o-y postpaid ARPU increase, as postpaid data ARPU rose close to 18%, and overall postpaid ARPU increased 1% over the year-ago quarter.
Data Share Plans
At the same time, AT&T is exploring new growth areas in non-smartphone connected devices such as M2M, telematics, tablets and e-readers. One of the major reasons why wireless penetration in the U.S. has exceeded 100% is because of these connected devices whose market is growing really fast.
AT&T will therefore look to fuel the demand for these connected devices with the recent launch of data share plans that make it easier for users to add more such devices to the carrier’s wireless network. While this might decrease the average revenue per device seeing as these connected data-only devices consume much less data, AT&T revenues from each individual subscriber will rise as users connect more devices to its wireless network. Moreover, since their data consumption is low, it will help shore up the service margins for AT&T. The early adoption of AT&T’s Mobile Share plans has been encouraging with nearly 10 million subscribers signing up in a little over two quarters, since availability and more than a quarter going for the higher tier (>10GB) plans.
It is also likely that sometime in the future, AT&T, which has been a vocal critic of unlimited plans in the past, will follow in Verizon’s footsteps and prohibit its unlimited plan users from availing smartphone subsidies, in case they want to continue using their plans. We believe this, will be a step in the right direction since it will help AT&T to more efficiently manage its limited network resources and monetize every bit of data that is transferred on its pipes. (see AT&T Looks To Fuel Data Demand With Mobile Share Plans) The company said that its Mobile Share plans have encouraged more than a million unlimited plan users to switch to a tiered plan.
Accelerated LTE Rollout
AT&T said that its LTE rollout is ahead of schedule, and is therefore on track to cover about 20 million PoPs by the end of the year, up from 250 million as earlier expected. This accelerated deployment is part of the reason why it now expects to incur $2 billion less in network spending in 2014 and 2015. If AT&T’s plans go as forecast, Verizon’s coverage lead may not last long. However, with LTE adoption slowly increasing with the launch of the iPhone 5 and a slew of other LTE- capable smartphones last year, AT&T’s slow postpaid subscriber growth is likely be a concern for a few more quarters. But, longer term, AT&T may not miss out by a lot, so long as it continues to deliver on its current roll out plans.
An increased adoption of 4G in the long term will 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. Also, 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. Further, higher LTE speeds will see subscribers increasingly use data-intensive applications on their smartphones.
This will drive data revenues, thereby increasing ARPU levels for AT&T over the coming years. In the near term, limited LTE coverage may be a deterrent for many, 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.