AT&T (NYSE:T) posted a strong set of Q2 2012 results on July 24th. The second largest wireless carrier in the U.S. reported a healthy 2% y-o-y growth in revenues, excluding the impact of its Yellow Pages business which was sold off during the quarter. Data continued to be AT&T's primary growth driver, with revenues from wireless data and U-Verse broadband and video services growing respectively by 19% and 38% over the year-ago quarter. More importantly, however, the carrier saw discipline in meting out handset subsidies and operational efficiency return to its ranks as wireless EBITDA margins came in at 45% and operating margins at a best-ever 30.3%.
On the subscriber additions front, AT&T was able to add 320,000 postpaid connections during the quarter, a sequential increase of more than 70% as the new iPad bolstered net additions despite a saturated wireless market. Increasing competition from rivals Verizon (NYSE:VZ) and Sprint (NYSE:S) in an increasingly saturated wireless market is gradually causing subscriber growth to slow, and the availability (or not) of LTE in certain markets could be key to attracting new subscribers as well as retaining old ones from hereon.
Focus on margins
More than 60% of AT&T's value comes from the wireless division, by our estimates. However, despite the promise of mobile data demand, a significant concern has been the carrier's burgeoning subsidy pressures on margins. For example, a basic iPhone 4S model costs around $650 for the carriers who then subsidize it heavily to sell for $199. Although this strategy held promise initially as carriers were trying to drive data demand, now that the purpose of the subsidies has largely been met, data demand is exploding and spectrum resources are not enough to meet that demand, it makes sense to start rolling back the subsidies gradually.
What this quarter has showed is that AT&T is getting serious about controlling its subsidies and the focus is back on profitability. Aside from lowering subsidies, AT&T is also trying to lengthen the handset replacement cycle by levying additional upgrade fees. Recently, AT&T doubled the upgrade fees it charges subscribers for smartphone upgrades to $36, a ploy that we believe has not only had a positive impact on margins but also lowered the number of handset upgrades. AT&T sold only about 5.1 million smartphones this quarter, down from the 5.6 million it sold during the same period last year.
ARPU rises on growing smartphone penetration
That was enough to increase its smartphone penetration within the postpaid subscriber base to 62%, up from 50% a year ago. With the wireless industry getting more saturated, business focus has shifted from acquiring new subscribers to converting more of the company's existing base to smartphones. AT&T said that about 77% of all postpaid device sales this quarter were smartphones, with the iPhone accounting for about 3/4 of all those sales.
Bolstered by increasing smartphone penetration, AT&T's postpaid data ARPU levels continued to rise strongly as smartphone users are usually heavy data users as well. As a result, AT&T's data revenues soared almost 19% and postpaid data ARPU grew more than 14% over the same period last year.
Despite a saturated wireless market, AT&T reported solid postpaid net adds of 320,000, just a tad shy of the 331,000 added in the year-earlier quarter but 70% higher sequentially. This was probably due to the sales of the new iPad which was launched in March. AT&T said that about three-fourths of the 219,000 tablets added this quarter were postpaid, leading us to believe that more than half the net adds in the postpaid category came from tablet sales. Tablets bring in a lot less revenue per user but are more profitable due to the lower subsidies on offer.
The future: LTE and shared data plans
With wireless penetration crossing the 100% saturation mark, most of the growth in the coming years will come from data-centric devices such as tablets, e-readers, M2M devices and telematics. It is therefore a good sign that AT&T will be launching data share plans this August and already has a leading >40% market share in the connected device category. While the shared plans would reduce customer churn as well as allow more number of mobile devices to connect to the network, thereby earning the carrier more revenues per user than earlier, AT&T may be passing up on the opportunity of charging more per device and increasing its ARPUs even further. However, the idea here is that as 4G LTE becomes the new standard, subscribers will eventually need to jump to higher tiers as they increasingly use data intensive applications and connect more wireless devices to the Internet.
An intensely competitive and saturated wireless market also makes it essential for AT&T to expand its LTE network into as many markets as possible, as LTE could increasingly become one of the key reasons why subscribers switch/choose one carrier over another. Currently, its LTE network lags much behind Verizon's, which covers almost thrice as many Americans as AT&T's does. However, AT&T can look to leverage its more widely deployed high-speed HSPA+ network to make up for that lag in the near-term.
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