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After years of adding more subscribers, buying more phones and using more services, telecom stocks are starting to show some exhaustion.
Many of these stocks are headed for a tough 2013, based on three powerful trends in the coming quarter that I’ll tell you about in just a moment. First, let’s take a look at the current wireless-communications landscape.
Here in the U.S. this week, Leap Wireless International Inc. (LEAP) declared disappointing financial results for the second quarter. In the previous quarter, the company’s customer turnover rate was 4.4% compared with 4.2% in the prior-year’s quarter. This took down Leap’s stock price by more than 10% to $4.92 per share.
Last month over in Europe, KPN, the biggest Dutch phone company, cut its 2012 dividend by 61% after reporting shrinking demand in its home market. Telefonica of Spain (TEF), Europe’s largest telecommunications operator, canceled its dividend and share buyback to conserve cash for repaying debt.
As I’ve been saying for a while, the wireless phone represents the fastest emerging-market consumer product. But even emerging markets are not immune.
For example, NII Holdings Inc. (NIHD), the wireless carrier that operates the Nextel brand in Latin America, tumbled 24% after the company cut its profit and sales forecasts, citing mounting competition and network spending.
These reports of weaker earnings growth may signal that we may be reaching the limits of primary demand-driven growth and entering a much-more-competitive secondary stage where picking the right stocks will be more-critical.
Looking at the results I see three major trends playing out this quarter in this sector:
Trend #1—
Shift in Business Model
The wireless model will continue to shift away from subscriber-driven more to average-revenue-per-user (ARPU) driven.
It may seem like common sense, but the focus is turning toward getting more money per client — a novel idea for an industry that is still valued by some investors based on customer counts.
Net subscriber growth in the traditional wireless-voice sector will be difficult to come by in 2013, as places such as the U.S. reach full market penetration levels.
While customers may jump from one service provider to another, the fact is most individuals who want a wireless service already have it.
As a result, the wireless business model has shifted away from a focus on grabbing more customers to increasing the amount current subscribers spend on additional services.
The carriers have been using the appeal of the smartphone — and smartphone subsidies — as incentives for customers to subscribe to higher-ARPU plans and add-on services (namely wireless data).
There are some signs this creates marginal revenue growth, but it’s a tough battle …
AT&T (T) and Verizon (VZ) are seeing drops in iPhone activations as the excitement around the latest model, the iPhone 4S, has cooled.
AT&T activated 5.1 million smartphones in its latest quarter — down from 5.5 million a year ago.
And AT&T admits that more than half of the new subscribers were tablet users, who pay less than smartphone users.
On the other hand, Sprint Nextel (S) reports it was successful in persuading smartphone subscribers to pay up for unlimited data service. Plus the company is seeing continued interest in iPhone activations during the quarter.
Unfortunately that’s still not generating profits, as Sprint reported a widening net loss of $1.4 billion, with negative earnings per share of 46 cents in the most recent quarter.
Yet Sprint’s stock is up on the potential that earnings could go positive in 2014 or that it might become a buyout candidate in the meantime.
Trend #2—
Shift to Prepaid Services
Prepaid services will capture more market share than postpaid (billed) services.
Faced with higher prices and more charges for services, it’s natural for consumers to react by reducing what they purchase or limiting their risk.
Prepaid subscriber growth has greatly exceeded growth in the postpaid subscriber base over the last several years, with the lower-priced market growing at 2-3 times the growth in postpaid subscribers.
Driving this trend is a number of factors: Greater credit challenges by many in the U.S.; the allure of a “contract-free” agreement with carriers; a more-attractive handset portfolio (with many affordable Android smartphones); and the popularity of truly unlimited plans.
For the roughly 55% of the U.S. population that have not yet upgraded to a smartphone, the value of these prepaid plans certainly offer appeal to the frugal or more-cost-conscious, former postpaid subscriber.
As competition stiffens in the pay-as-you-go wireless market, America Movil’s (AMX) TracFone unit seems a likely survivor of an expected shakeout.
TracFone’s success continues to come in at the low end of the wireless market as two other prepaid carriers, MetroPCS Communications (PCS) and Leap Wireless, target higher-spending smartphone users.
With 21.34 million U.S. subscribers, TracFone has quietly amassed the most prepaid customers of any carrier in the United States.
Trend #3—
More Mergers
Mergers will continue to be a major theme in 2012 and beyond.
Let’s face it. Unlike the Internet startups that begin in college dorms, it takes serious money to be in the phone business.
Cutting corners is not an option, although at least one company has tried this …
Shares of Brazilian phone company TIM Participacoes (TSU) slipped as investors worried that the phone company may face penalties for service complaints.
Punitive action by the government could be a drag on the company’s revenues at the same time it is required to increase investment, an analyst said.
But what if you could create a virtual or limited-services phone company with distribution agreements and modest acquisitions?
TracFone sells wireless plans through the Straight Talk and Net10 brands. But its Simple Mobile purchase gives TracFone a new marketing weapon …
Simple Mobile doesn’t sell phones. It sells prepaid SIM cards that are plugged into phones. Customers take the SIM cards out of their AT&T or other service-provider phones and insert Simple Mobile’s.
So as low-cost services like Simple Mobile surface, carriers could be forced to merge as the only way to grow.
There you have it. It seems out of all this commotion a new strategy is arising — less is more, something the wireless consumer is soon catching on to.
Best wishes,
Rudy
