AT&T (NYSE:T) is set to announce its Q4 2012 earnings on Jan. 24, after the market close. During the earnings call, we will take a close look at subscriber additions to see how the carrier is performing amid an industry-wide saturation in wireless growth. Increasing smartphone penetration should, however, enable the company to post a sequential increase in postpaid ARPU levels, bolstered by data average revenue per user (ARPU). The company’s wireless margins will be of special interest given its record smartphone sales during the recent holiday season.
In addition to the company's financials, we will also take note of the uptake in LTE subscriber numbers as AT&T will look to promote LTE widely this year, challenging Verizon (NYSE:VZ) and Sprint (NYSE:S), in the wireless market. We feel much of the earnings call will focus on AT&T's acquisition plans for 2013 and its strategy for financing these deals.
In an interesting development, AT&T announced a $780 million all-cash acquisition of Atlantic Tele-Network’s rural retail business that operates under the brand name Alltel, just two days prior to the earnings announcement. Alltel has a rural presence spanning six states: Georgia, Idaho, Illinois, North Carolina, Ohio, and South Carolina. As part of the deal, AT&T will acquire the 585,000 existing subscribers along with wireless, network access and retail stores.
Profit Margin Pressure
In a prelude to the upcoming fourth quarter earnings release, AT&T announced it sold a record 10 million smartphones in Q4 2012, and we estimated around 8 million of these to be Apple's (NASDAQ:AAPL) iPhone (see "AT&T's Smartphone Sales Point To A Strong Holiday Quarter For Apple"). While this indicates a growing smartphone penetration, the impact on margins is considerable. An entry level iPhone without subsidy costs around $650, while AT&T sells the same for $200 under a two-year contract. This translates to a $450 subsidy on an iPhone or nearly $3.6 billion for Q4 just on iPhones. Carriers expect to recover this investment over the two-year contract period through higher internet revenue per subscriber. However, the resulting pressure on margins will likely continue as manufacturers continue to launch high-end smartphone models, and AT&T will be forced to subsidize them to hold its ground in a fiercely competitive market place.
Expensive Acquisition Is a Distraction
According to the Wall Street Journal, AT&T is scouting for an acquisition or merger in Europe. The company is looking at international markets as the U.S. wireless market is saturated, and with Verizon gaining market share in the wireless segment, the company is forced to look across the Atlantic for growth. The names of two potential acquisition targets have been floating around since the news broke. One is U.K.-based Everything Everywhere (EE) and the other is Netherlands-based Koninklijke KPN NV (OTCPK:KKPNF). EE is a 50:50 joint venture between France Telecom and Deutsche Telekom, it is rumored to be valued at nearly $13 billion. KPN has current market value of $8.5 billion. Either acquisition would be expensive for AT&T, which already has $60 billion of long term debt on its books. With competition in the U.S. heating up between AT&T and Verizon, coupled with a newly invigorated Sprint (S), and a potential DISH Network (NASDAQ:DISH) entry into the wireless game, we believe that AT&T would be better served investing further in the United States to defend market share, or return capital to its shareholders.
With increasing penetration and usage of cell phones, landlines are experiencing a painful decline. We expect this trend to continue, adding pressure to the wireless business to outperform. Margins have been deteriorating as the American consumer shifts from a traditional family landline to individual cellphones.
Disclosure: No positions.