Over the weekend, I received Q4 2006 Wireless Market Trends Report from Chetan Sharma. Here is a link to the report. The objective of this post is not to repeat the content of the November post, but rather to see if there is any support of the thesis I proposed three months ago. As a side note, it appears Clearwire (CLWR) is marching towards pricing their IPO this week and Alltel (NYSE:AT) is looking to further accelerate consolidation in the service provider industry.
Does anyone else find the dichotomy interesting? An emerging wireless broadband service provider (i.e. Clearwire) using a pre-WiMAX standard technology is going public and a very successful wireline/wireless service provider (i.e. Alltel) wants to sell out? Alltel is the fifth largest wireless provider in terms of subscribers, covers a generally rural geographic area and has a market capitalization of $21B. Clearwire has less then 200,000 subs, is undercapitalized (hence the IPO) and has a technology solution seeking a market.
Update of November 2006 ARPU Thesis
Back in November, I wrote:
"A person does not need an empirical study to know that there is a large stable of venture backed companies in the wireless market for FMC, backhaul, mash applications, content streaming, MVNO and on and on. We learned many lessons from the wireline (i.e. optical) market correction that occurred from 2001 to 2004, are any of these lessons applicable to the wireless market? In the words of George Santayana, 'Those who cannot remember the past are condemned to repeat it.' Today, I am thinking: what are the lessons from the wireline market correction that can be applied to the wireless market while we are still in the happy times? In short, what is the contrarian view to the excitement people feel when they think of their mobile device as the remote control of their life? A remote control that still drops calls! Here are my thoughts:
1. Market share is owned by a four primary service providers.
2. Subscriber growth is slowing.
3. Data revenues are growing, but voice revenues are declining. These three points suddenly make me think that we are analyzing the local access and long distance revenues from the wireline providers of the 1990s. Hmm...?"
It appears the trend in the US market is further consolidation as noted in the first paragraph and there are companies who are selling into the FMC/wireless backhaul market that noted end of year softness in service provider spending. As such, I see no new data points that would suggest a revision of the first three points. According to Chetan Sharma, US market penetration for mobile phones is at 78%. He reported the following subscriber growth numbers for 2006: VZ +7.7M, A&T +6.9, TMO +3.3M, Sprint +1.6M and Alltel +1.56M. I updated the ARPU charts from the November post with extrapolated Q4 2006 numbers. Here are the trend lines:
I still need another 3-6 quarters of statistics before I can be certain of my supposition, but I think enough information is available to make a warning call for investors. I believe in the assumption from the November post that "when revenue growth slows, the market and the players in the market will begin to act differently. The market structure will no longer be reflective of a growth market and it will seek an equilibrium point. Choose wisely when this time comes." As such, a market (1) entering 80% penetration levels, (2) consolidating and (3) faced with technology choices that negatively pressure the primary revenue generator (i.e. voice) is a market that investors need to consider wisely. When these trends converge, typically the market share is distributed between two to three very large companies and the rest of the competitors are niche players focused on the remaining 10-15% of market share.
Mobile ARPU Trends Supposition
I took the ARPU trend graphs from above and extrapolated a deeper curve for voice revenue erosion and a flatten data trend line. For voice ARPU I used 10% decline in 2007 and 15% decline in 2008. For data ARPU I assumed 20% growth in 2007 and 11% growth in 2008. I used 11% percent in 2008 because this yielded a magical $10 ARPU. If a DSL line can be contracted for $11.95 a month on a one year contract, and VoIP is $15-25 per month in wireline, the $10 component for data ARPU seems correct. Note the use of the word "seems." This is a blog - not a quantitative model of the wireless industry produced by an analyst inside Goldman Sachs who is attempting to use the GPS capability in all mobile devices to accurately model the precise churn rate and location of all mobile devices on Earth with real time positioning data overlaid on Google Earth. I am simply exploring the question if voice ARPU trends follow the historical trends of voice in the wireline industry, what would that mean for service providers? The dividing line in the following separates historical data from my supposition data. See my prior post for historical trend charts for wireline voice.
"This strategy is a price war death match. Before Joe Nacchio left for Qwest, he was the chief strategist for AT&Tâs LDD price war against MCI and Sprint (NYSE:S). His premise was: AT&T has the stronger balance sheet thus we will crush the weaker players on price and drive them out of business. History has shown that when revenue growth ends, it occurs faster and the impact is deeper then projected. When a services market reaches a customer saturation point, history has also shown that service providers use price as competitive weapon as there are few aspects of their service that enable service providers to maintain pricing power in the market. When there is a group of companies with undifferentiated services, one will eventually break from the group and offer a lower price to retain or add customers. It is simply easier to offer better and better pricing for a longer term contract commitment with early termination fees to suppress churn - then to invest capital in enhanced, unproven revenue applications. The challenge with the price war strategy is the warring parties will consistently drive the profitability of the market lower."
My supposition states that with market penetration rates reaching the upper percentiles and market share dominated by a handful of companies; this will become a game of capital. Undercapitalized companies will die. Investors need to consider if they have the heart to endure the pain and cycle of a price war in wireless if one of the players starts a war.
"History has shown us that the end is merely a spreadsheet exercise when the price war death match begins - meaning the financial teams run the company by producing a projected revenue model and they already have in mind two important data points: (1) the point in the future that subscriber growth ends and (2) the point at which they will need to use a price war to retain customers and drive the financially weaker players from the market. Unfortunately, the price war winner often realizes too late that their victory is really a Pyrrhic victory. The thesis of this entry is to ask are we seeing an early indication that we are entering a new market phase for the mobile industry in the US."
How would an ARPU price war start?
Here are four ways I could see a big war can be started:
1. TMO, Sprint and Alltel were the subscriber laggards for 2006. Alltel is not going to take any action to disrupt the market structure; they are looking to be acquired. Sprint is a big company that "maintained its leadership in terms of raw data ARPU at $8.75. In fact, its CDMA data ARPU topped $12" according to Chetan Sharma. What if the executives in Kansas City decided that being #3 during the 80-90s LDD wars and being #3 in wireless subs is not a path to victory? What would be their plan of attack? How about launching a voice rate war to move more subs onto their network with a strong data ARPU trend?
2. AT&T (NYSE:T) is watching the Clearwire IPO this week. What action could they do to help give the offering a haircut on the first day? Launch a price war. Welcome to the big leagues.
3. Verizon (NYSE:VZ) has shown a strong ability to attract subs. In a year from now, they decide it is time to cripple a few competitors and let them know that playing with the big boys is not for the faint of heart.
4. TMO is the #4 player who has performed well. What if TMO decides it is time to really accelerate sub growth and they get the green light from Bonn to start a voice ARPU war?