T-Mobile May Go After Spotify Before It Goes After Cable-TV

| About: T-Mobile US, (TMUS)

Summary

T-Mobile has placed an emphasis on various music services this year in its Tuesdays giveaway program.

Music is a popular service with consumers and may be T-Mobile's next content initiative after Netflix, and before cable-TV more broadly.

If T-Mobile does incorporate a music service into its consumer offering, AT&T and Verizon would have to respond. This would be another pressure on wireless margins.

Most music services would not be severely impacted, but Pandora and Spotify would be more exposed. Spotify might come out worse than Pandora, however.

This week will be a somewhat sad week for many T-Mobile (TMUS) subscribers, who are about to have to go back to paying for music subscription service again after getting the last three months on the house. They can thank John Legere’s T-Mobile Tuesdays customer rewards program for that. It offered three free months of Pandora Premium, the on-demand version of the iconic streaming radio company, in mid-September.

Pandora (P) has admittedly fallen on some hard times lately. Doubtless that played a role in their decision to offer three months to T-Mobile subscribers, at what I’m sure was a substantial discount. But the service and its price taste no less sweet to T-Mobile subscribers for that.

T-Mobile’s acquisition of Layer3, and its consequent implications for T-Mobile’s TV ambitions, have understandably been the focus of most of the analyst commentary on the company this past week. But TV is for 2018, and we’re not even sure what exactly T-Mobile is planning, how it will be structured, or how it will be priced. Meanwhile, it seems that T-Mobile is also considering another potential content move. And this one we can actually see and evaluate.

An Ongoing Trend

Admittedly this doesn’t merit much notice at first glance. T-Mobile runs promos every week, and after a while the free stuff they give out expires or runs its course. So a giveaway is expiring. So what?

However, T-Mobile may have been doing more than just leaping at opportunity when it cut its deal with a struggling Pandora. It appears to have adopted a conscious decision to target music periodically in its Tuesday giveaways, and to do so in a rather more comprehensive manner than its occasional movie giveaways.

The trend first began in March, when T-Mobile offered one free month of Slackr Radio’s ad-free option as part of T-Mobile Tuesdays. Then in June, T-Mobile offered two free months of Amazon’s (AMZN) Music Unlimited - along with a $4 movie ticket for Wonder Woman, hands down the most successful movie it has partnered with to date. And finally it offered three free months of Pandora Premium.

Altogether, in mid-December with the free Pandora expiring, T-Mobile has covered six of the last nine months worth of premium music subscription costs for its customers. No word yet on what comes next, but it wouldn’t surprise me if they run another promotion soon.

Network Benefits

Assuming that T-Mobile is adopting a persistent approach to music, why would it be doing so? What is it about music that makes T-Mobile want to make sure its customers don’t go too long without it? Premium music services actually have a couple of beneficial attributes from a wireless carrier’s perspective.

First, it is a downloadable content service. This has been something of a pet peeve of mine for a while, as any of my followers well know. Wireless carriers benefit immensely from the penetration of downloadable content because it reduces peak usage on their networks, which is the key driver of their capital spending needs.

While not all Pandora Premium users will download, downloads are not even an option on regular, ad-supported Pandora, so anything that converts users of Pandora’s free service - still the largest digital music service in the US - into Premium users can only have a beneficial impact.

Music As A Service

That’s almost certainly just a side benefit, however, especially since T-Mobile could not be sure how many people would take advantage of Pandora’s download option, and music only accounts for about 10% of network traffic, far below video’s 60%.

Probably more significant is what this means for T-Mobile’s future as a content platform, and by extension other wireless carrier’s prospects in the same vein. Less than two months removed from T-Mobile’s latest Un-Carrier move to incorporate free Netflix (NFLX) into every family wireless plan, it appears to be seriously experimenting with another complimentary content offer for subscribers.

Premium music services go for around $10 per month, so they are in the same pricing neighborhood as streaming video services - Netflix charges $11, Hulu $8-$12, and Amazon $8-$11 - and would presumably require similar financial outflows to sustain over the long-term. It is unlikely T-Mobile wants another outlay that large as a recurring expense. It only charges $40 a month per line for four lines, with tax included.

At the same time, subscription premium music services are growing very strongly, and customers seem to value them highly. In fact, there are currently about as many premium music subscriptions in Apple (AAPL) and Spotify (MUSIC) as there are Netflix subscriptions worldwide. So customers value this and T-Mobile could probably attract quite a few of them. If it could find a more affordable way of paying for them.

Music Has No Moat

T-Mobile’s Tuesdays experiments therefore seem to me to be more than just another giveaway. Rather, T-Mobile appears to be trying to coax music services into a sort of “internal market” for music services on the T-Mobile platform. T-Mobile would offer consumers a menu of several premium music services, each of which would agree to charge considerably less than its headline rate for T-Mobile customers. T-Mobile might pick a winner each month or quarter, or it might simply let each customer pick for themselves from whoever qualified to be included.

There may be considerably broader scope for this with music than with video. Streaming video services are not very fungible, since each has exclusive content agreements that the others don’t have. AT&T’s (T) HBO offer, for example, has a fundamentally different value proposition to consumers than T-Mobile’s Netflix offer. One is of no help to those who want Game of Thrones, the other is no good for those who prefer to watch Orange is the New Black.

But music services all make agreements with the same music rights holders, charge about the same price, and offer about the same services and features. This has allowed T-Mobile to spend the last nine months playing various services off against one another as they jockey for position in the increasingly crowded premium music space. The customers may not be 100% indifferent between them, but they are sufficiently similar that if one offers considerable cost savings over the other they are more likely to be willing to switch.

Competitive Positioning

Switching music services is still not hassle free, of course. It requires starting over with regard to playlists, user data, interface familiarity, etc. But as I said, for a substantial savings many customers would still be tempted. Assuming T-Mobile could produce such an “internal market,” it might be able to exert sufficient downward pressure on pricing to make the giveaway more affordable. Essentially, music services would have to “bid” for T-Mobile’s customers.

Amazon already offers a 20% discount to Prime members for Amazon Music Unlimited, and then it offers a $20 discount on top of that for those who prepay for a year. It is well-suited to such a price war if it starts. Pandora, Apple and Spotify haven't yet matched those offers and, for Apple, perhaps it would have no interest in doing so since the primary purpose of Apple Music is to sell iPhones, not music subscriptions.

Pandora and Spotify, however, might have a considerably harder time staying out of the fray. Especially if, like Slackr, T-Mobile also dallied with smaller operators trying to get off the ground who could use a couple million subscribers as a launchpad. It seems quite feasible that T-Mobile could get a three- or four-way price war going, and fashion for itself a new cudgel to use against AT&T (T) and Verizon (VZ) in the wireless wars, which I still think are only in a temporary lull, not a permanent ceasefire. And at considerably less cost than what it cost it to bring Netflix on board.

Market Implications

Music is not going to single-handedly vault T-Mobile into the lead over Verizon and AT&T, but the popularity of such services and the fact that everyone is moving to bundle content and wireless in this way suggests it would be a potent weapon, in combination with other existing T-Mobile services.

AT&T and Verizon would probably have to respond. At first, they would probably bleed some subscribers to T-Mobile. Then, they would eventually be pushed to respond, as happened with unlimited data and optimized video streaming. The end result would be a shift of some number of subscribers away from the Big Two to T-Mobile, followed by a revenue decline/cost increase of supplying free music at all three carriers.

The implications for the different music services of such a price war are a little more varied. In my opinion, Spotify, not Pandora, is the big loser, despite the latter’s ongoing difficulties in the market right now. Spotify, like Pandora, is burning large amounts of cash, and unlike Pandora premium subscriptions are its main product, the product it is counting on to produce meaningful cash flow. While Pandora could continue to use its industry-leading advertising engine to supplement its income, pricing pressure on subscriptions threatens to erode Spotify’s margins far more severely, since that is where all its profits come from.

Analysis Summary

T-Mobile may already be sitting on another content weapon in the wireless wars, even before it makes the jump to TV. And unlike a TV service that may or may not appeal to customers already drowning in high-priced pay-TV offers, this appears to be something that customers really want. And would therefore value more highly any wireless carrier who offered it to them.

We won’t know how adding Netflix impacted T-Mobile subscriptions until next month when it reports results, and without that data its a little speculative to say how big the impact of a free music service would be. But assuming that eventually everyone moved to match it, the end result would likely be very good for consumers, but see music services and wireless providers splitting the hit to their own bottom lines as $10 a month disappeared from their combined incomes.

I see the wireless sector as remaining intensely competitive, and the cease-fire of recent months as only temporary. I believe that wireless competitive pressure remains intense and that adjoining industry sectors, like TV and music, will also continue to feel downward pricing pressure.

Investment Recommendations

As I’ve noted before, I consider Pandora to be a buy. It has made a few missteps, but the market has punished it overly severely for them and is now valuing them at little more than the cash they carry on their balance sheet, despite continuing to grow revenues. I consider Verizon a hold, as the stronger of the Big Two, and AT&T a sell because of its outsized exposure to Pay-TV. I have also called Apple a hold, since its stock run-up has removed a large share of the discount its shares were trading at. I am long on Amazon, as I believe its future profit potential remains under-appreciated.

As for T-Mobile itself, I have long been worried it lacks the spectrum position to carry the heavy network loads it invites consumers to place on it, but recent moves to make network management more flexible and continuing success in raising capacity have me reconsidering that position somewhat. For now, I remain a hold on T-Mobile, rather than a buy. But my optimism is slowly growing.

Disclosure: I am/we are long P.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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