Clarifying Clearwire, Part II: Broadband Is the Growth Driver

by: Karen Mulvany

Recently, the perspective on the wireless industry has been changing. After decades of growth, subscriber penetration in the US has saturated, and analysts are turning negative on the wireless industry, highlighting the superior positioning of cable TV (see "Cable vs Wireless: Which Is Growing Faster?"). Much of the enthusiasm for cable TV derives from limited competitive pressures and its superior ability to deliver broadband data, compared to the wireless carriers.

That’s one way to look at it. But it is applications, not the transport media, that drive service growth. Today, the best demarcation for success isn’t between cable and wireless, it’s the exposure to and positioning in the fastest growing application, notably broadband data.

In contrast to broadband data, voice is flatling or even declining. So while it’s true that the leading wireless wireless carriers are subject to escalating competitive pressures, this because the biggest wireless carriers are overexposed to the fully penetrated, commoditizing voice business, which is now dampening overall results. Voice, in other words, is a market share game. Broadband data as an industry is growing, for both wireline and wireless carriers.

In this new data-driven world, the lower the exposure to voice and the higher the exposure to broadband data, the stronger the growth prospects. And, the more data that a carrier can deliver – the more broadband capability inherent in its spectrum holdings, wired plant and network architecture -- the better its competitive position in the increasingly data-driven market. This is true not only for wireless but for wireline as well.

That’s not to say that the media is entirely independent of the application. Wireless networks can service both fixed and mobile applications, whereas wireline networks, like cable TV, only serve fixed applications. So yes, in the wireline sector, cable TV carriers look to be best positioned for fixed broadband applications. In wireless sector, Clearwire (CLWR) argues that it is the best positioned for mobile broadband applications. Three leading cable TV companies, Comcast (NASDAQ:CMCSA), Time Warner Cable (TWC) and Brighthouse Networks, all of which invested in Clearwire at $17 a share last November, would seem to agree.

Earlier this year when the stock was trading at $2.53-$4.00 a share, Clearwire was highlighted as a cheap asset play that also offered a free option on the broadband wireless industry (see Clarifying Clearwire: A Value Proposition; Clearwire: Is There Opportunity Amidst All the Fear and Uncertainty?). Although up dramatically from earlier lows, the stock continues to trade below book value ($9.67 a share as of the end of June). Because the company remains in an interim period of high losses and capital expenditures, low 4G WiMax performance visibility and funding uncertainty, the short term financial scenario for Clearwire continues to concern many investors and analysts. Nevertheless, the business case for its broadband wireless strategy continues to strengthen. This is what has been driving the stock upwards.

The Wireless Industry: Broadband Data in the Driver’s Seat

The wireless industry is already data driven. Today, the demand for voice in the US, both wireline and wireless, is close to saturation, with wireless at 87%+ penetration and wireline voice now declining as users opt to rely on wireless alone.

Unlike voice, where bandwidth consumption is capped because human beings can only have one real-time conversation at a time, data is fundamentally a higher growth phenomenon. Data not only grows as the number of users grows and minutes per user grow, but also as applications expand their bandwidth usage to deliver a richer experience: think video, music, and multitasking on a laptop. Then think again about machine to machine wireless communications, expected to explode in the next decade, which will layer on top of people-centric data communications. The whole concept of measuring wireless markets by POPs will become obsolete. Consequently, wireless traffic growth will be propelled by data for the foreseeable future, while voice flatlines or declines. Wireless data traffic is projected to eclipse voice by 2011: Nokia Siemens Networks expects worldwide mobile data traffic to expand from almost 400 million gigabytes in 2009 to approximately 2 billion gigabytes a year by 2011, compared to 1.2 billion gigabytes for voice.

So far we’ve been talking about the number of bits and bytes, not revenue and profits. But, not only is voice traffic flatlining, its pricing and profitability is vulnerable. Many have predicted the commoditization of voice for more than a decade, but incumbent carriers have successfully parried this threat through bundling of high margin value added services and other tactics that have glued the customer to their particular voice service. Now, multiple industry and regulatory forces are at work to disrupt the voice business.

Through the upcoming launch of its Google Voice service which is now in restricted beta, Google (NASDAQ:GOOG), a strategic investor in Clearwire, is positioned to help drive the commoditization of voice by disaggregating plain old telephone service (POTS) from margin-generating value-added services such as voice email, caller ID and forwarding. In effect, users will be able to buy mobile POTS and enjoy value added voice services for free through the Google Voice platform, which is accessible from any browser-enabled smartphone or computer, and uses the internet – including the mobile internet – to deliver voice value-add, including free long distance, forwarding and voice mail. Your Google Voice mail will show up in an internet mailbox where it can be forwarded via email, and Google will even voice-recognize your voicemail and translate it to an email message if desired. Conceivably you will soon be able to port your existing mobile phone number over to Google Voice and use any mobile carrier you choose (see Quitting the iPhone, Moving on to Google Voice).

Even government forces are at work to unleash consumers from carriers: phone numbers are now legally required to be portable across service providers, and the binding of mobile handsets to a specific mobile carrier is being examined for anti-competitive implications by the US Justice Department and the FCC. Almost every element of today’s voice services that glues the customer to a given carrier and sustains higher voice margins is threatened. As with any industry subject to slowing growth and loss of differentiation between competitors, voice services, both wireline and wireless, are commoditizing. The focus of competitive differentiation is shifting to broadband data.

At the end of 2008, according to the CTIA, data wireless revenue was only 22% of the $148 billion US wireless industry, largely because voice bits are priced at huge premium to data bits. But the wireless market is changing, and data is quickly assuming a driving role. Strong positioning in broadband wireless has become a necessary prerequisite to success in the overall wireless industry. Of the public wireless carriers, Clearwire is the most heavily exposed to wireless broadband data.

Subscriber appetite for wireless broadband data is strong, illustrating the appeal of higher bandwidth service offerings. Clearwire is seeing usage double as pre-WiMax subscribers upgrade to 4G WiMax. Even in Russia, WiMax operator Yota reports that its 4G subscribers download 9.6 GB every month, twice the local figure for wireline data and more than 100 the local 3G (GSM) wireless average. In the US, existing 3G wireless providers are diverting subscriber traffic to WiFi in an effort to satisfy data demand that they simply can’t meet on their own networks. Cisco (NASDAQ:CSCO), in its January 2009 Mobile Data Traffic Forecast, projects that North American mobile internet data traffic will grow from 17 Terabytes per month in 2009 to 397 TB per month in 2013, a CAGR of 120%. At least in the near term, every carrier in the broadband wireless space should experience plenty of demand. The challenge will be accommodating all that wireless data demand, and doing so profitably.

Recipe for Broadband Mobile Success

So what will make a carrier well positioned in this emerging broadband data-driven wireless world?

1. Spectrum to deliver higher speeds and/or lower pricing. Because the industry is starting to bump into the theoretical ceiling of mobile technology as specified by Shannon’s law, increasingly over time, spectrum owned by your carrier will become the limiting factor that determines the speed of your mobile connection. Furthermore, because more spectrum is a cheaper way to deliver wireless broadband than less spectrum coupled with new technology and/or more towers, spectrum holdings determine carrier pricing (or profitability) too. Clearwire controls broad swaths of 4G spectrum – averaging 120 MHz of 2.5 GHz spectrum in the top 100 US markets, amounting to more than 43 billion MHz-POPs (a measure of spectrum value that takes into consideration the population coverage of the spectrum). This is at least 5 times the 4.5 - 8.5 billion MHz-POPs of 700 MHz 4G spectrum held by Verizon Wireless (NYSE:VZ) or AT&T (NYSE:T). Even including the incumbent’s legacy 2G and 3G spectrum, some of which could be repurposed for 4G, Clearwire’s holdings dramatically exceed those of the incumbents: 43 Billion MHz-POPs for Clearwire vs. 24 to 28 Billion MHz-POPs for AT&T and Verizon, respectively.

2. Net neutrality. Some incumbent wireless carriers such as AT&T do not permit the usage of VOIP applications such as Google Voice or Skype that would cannibalize their voice business or generate more traffic than their 3G networks can handle. Subscribers hate this. Given a comparable choice, they’ll flock to the wireless carrier that lets them use the applications they want over both WiFi and 4G. Again, applications drive service revenue: the more applications a carrier can profitably accommodate, the better its growth prospects.

3. Wireless Device Connectivity. Today, sales of most mobile phones are restricted to specific carriers with phone pricing subsidized by the carrier in exchange for two year service contracts, and hot devices are often tied up in exclusive deals with carriers for years at a time. Although this has been a key competitive advantage enjoyed by the wireless incumbents, it is starting to erode. Naturally, subscribers would prefer to be able to use any device they want on any network they want, without being locked up for years at a time. Clearly, to maximize their addressable market, handset manufacturers are motivated to sell their products across as many carriers as possible. Technology challenges that in the past restricted wireless devices to single carriers are being mitigated by the evolution of RF semiconductors and new SDR (software defined radio) and multimode, multiband solutions. And, US government regulators are examining the device-carrier connection with an eye towards achieving device neutrality. Technology, regulatory and market forces are aligned to eventually drive a wireless carrier to compete on the merits of its service, as opposed to the appeal of handsets for which it has struck exclusive deals.

Having said that, it’s portable platforms -- laptops and netbooks -- even more than handhelds, which are the most voracious consumers of mobile bandwidth. According to Cisco’s January 2009 study of mobile IP traffic, portable traffic is expected to exceed handset traffic by 54% in 2009, and continue as the largest source of mobile IP traffic through 2012. Consequently, the ability to adequately service those portable platforms will be critical to customer satisfaction and retention. Clearwire partner Intel (NASDAQ:INTC) is launching Evans Peak, a 65 nanometer wireless device that integrates WiMax, WiFi, GPS and Bluetooth, showcasing that the WiMax connectivity will shortly proliferate across Intel-powered netbooks, laptops and MIDs (mobile Internet devices).

Pending native WiMax connectivity in devices, Clearwire is enabling 4G WiMax service for any existing WiFi mobile device with the launch of the battery-powered, pocket-sized CLEARspot router which connects up to 8 WiFi enabled mobile devices to WiMax. Clearspot services WiFi-enabled devices of all sorts, including laptops, netbooks, book readers and mobile phones, which number about 600 million to date, according to the WiFi Alliance. More than 44% of existing smartphones embed WiFi, and WiFi has become a requirement for future phones sold by Sprint (NYSE:S) and Verizon. ABI Research predicts that shipments of Wi-Fi-enabled mobile phones will grow to 141 million in 2009, and to 520 million by 2014.

Indeed, the open WiFi standard and proliferation of WiFi access points is already driving dramatic change in the wireless industry, not only by giving users a taste of the broadband wireless speeds they’d like to enjoy on a mobile basis, but by breaking the leash binding wireless devices to incumbent service providers even before regulatory powers step in. Lastly, the emergence of routers that connect multiple WiFi devices to a 3G or 4G broadband wireless service are destined to further increase the load on carrier networks, since for the first time a subscriber may connect more than one device at a time. Imagine how much more bandwidth users will want from their wireless service provider when they can connect multiple phones, computers, gaming devices and book readers concurrently, at home or on the go.

What’s Next for Clearwire

What will drive Clearwire 4G momentum in the near term? In addition to Clearwire’s internal expansion plans, Clearwire partners Sprint, Comcast and Time Warner Cable will begin reselling 4G CLEAR wireless services to their customers this fall. Clearwire’s partners serve over 100 million US customers – about a third of the US population. Clearwire wholesale strategy will generate less revenue per user than its retail business, but because Clearwire’s partners absorb billing and marketing costs, it is targeted to be margin-neutral with the retail business. Clearwire’s new President of Strategic Partnerships and Wholesale, announced yesterday, was recruited to focus on this business. Both the wholesale and retail businesses are positioned to kick into high gear in the fourth quarter, as additional 4G markets are launched and pre-WiMax markets are converted to 4G.

Chief among near-term investor concerns is the company’s desire to obtain $2 billion in additional financing, which is the amount needed to expand network coverage from the 75 million POPs achievable with cash on hand to 120 million POPs, Clearwire’s near term goal. Although the company positions this as a transaction that will be done opportunistically under favorable market conditions, the street’s fear – a valid one -- is that a deal would be dilutive to existing shareholders. Selling stock below book value would not be appealing to investors, particularly the strategic investors that purchased stock at $17 a share late last year. On the other hand, at the current stock price, a $2-3 billion in straight equity (the most dilutive form of financing) would result in a pro-forma Clearwire market cap of roughly $7.6 - $8.6 billion, still leaving appreciable upside when compared to the $148 billion size of the wireless industry and Clearwire’s market-leading 4G spectrum holdings. Certainly the company is motivated to pursue a less dilutive deal structure. With the arrival of a new CFO just announced yesterday, we shall soon see if the stock has been under pressure more from the uncertainty surrounding the terms of a potential deal than from the reality of one.

Disclosure: Long CLWR.