Wireless carriers take divergent paths
As AT&T announces an ambitious plan to expand its wireless and fixed broadband networks, smaller rivals see little reason to engage in a spending war.
Continued consolidation in the wireless communications sector presents investors with a changed landscape heading into 2013. Investors need to understand how mobile carriers are assessing their investment strategies and what each is doing to address the vexing question of how to serve high-data-load users of smartphones and tablet devices.
Recent announcements from the largest carriers in the United States indicate that competing theories are emerging over how to handle -- and profit from -- soaring demand from users of Web-enabled devices.
AT&T (T) last week unveiled an ambitious "Velocity IP" plan to bolster its nationwide 4G LTE network. The company also announced an annual capital spending budget of $22 billion through 2015, with 60% allocated to building out its wireless network. The bet appears to be that spending on network and service improvements is the way toward subscriber growth and long-term earnings.
Chairman and CEO Randall Stephenson said: "We have the opportunity to improve AT&T's revenue growth and cost structure for years to come, and create substantial value for shareholders."
Competitors like Sprint-Nextel (S) and recently merged MetroPCS (PCS) and T-Mobile appear to see a slightly different path to profiting from the proliferation of smartphones and tablets. Sprint continues to see unlimited data plans as its value proposition, sufficient, at least for now, to lure subscribers to a network with less wireless coverage and services. From a pocketbook perspective, Sprint's unlimited data plans compare favorably with the tiered data plans of AT&T and wireless division of Verizon Communications (VZ); however, consumers need to take a leap of faith on coverage, data speeds and the company's improving financial picture.
Sprint also is in the process of completing its nationwide 4G network, called Network Vision, though its allocation of capital pales in comparison to what AT&T recently said it would spend on network upgrades. This even after Sprint was effectively recapitalized in a merger with Softbank of Japan.
Meanwhile, the biggest announcement from a recently merged MetroPCS and T-Mobile (the deal has yet to close and faces regulatory reviews) is that T-Mobile will finally start to carry the iPhone after years of rejecting Apple's (AAPL) highly subsidized smartphone.
So it's no surprise that T-Mobile, the subsidy-averse U.S. arm of Deutsche Telekom (DT), will carry the phone in an unsubsidized manner that may break new ground in passing handset costs on to consumers.
The three aforementioned plans to handle smartphones illustrate the biggest issues facing the telecom sector -- capital spending, data pricing and handset subsidies. After this year's reshuffle, telecommunications companies are approaching the future with increasingly divergent strategies.
While AT&T's plan may seem expensive to investors, the real question is whether competitors like Sprint are realistic in theirs.
Can costs ever be recouped?
Bernstein Research analyst Craig Moffett highlighted the tension in a recent review of AT&T's higher-than-expected spending plan and the impact it's likely to have on the sector. Notably, Moffett argues that when faced with a choice of spending, subsidies or service pricing wars, AT&T appears to see its comparative advantage in using a fortified balance sheet to invest tens of billions in its wireless network and outrun competitors.
In the face of AT&T's options and its comparative financial and network position, Moffett writes, "Starting a spending war is AT&T's best option," of the company's wireless capital expenditure budget through 2015.
The numbers are striking, according to Moffett's calculations. In 2013, AT&T is expected to spend more than $12 billion on its wireless network, roughly 30% more than competitor Verizon and 176% more than Sprint, which is already playing catch up when it comes to network strength.
Meanwhile, between 2009 and 2013, AT&T is projected to spend $57 billion cumulatively, compared with $54 billion at Verizon, $17 billion at T-Mobile and just $14 billion at Sprint.
For investors who have recently cheered AT&T's growing profit margins, free cash flow and returns of capital, the consequences may be negative.
Subsidizing the buyer
Meanwhile, the issue of iPhone subsidies -- an earnings drain that Moffett has been worrying about -- looks to rear its head in the fourth quarter. AT&T now expects to sell 10 million smartphones in the fourth quarter, and this forecast augurs poorly for wireless profit margins. Citing larger-than-expected smartphone sales, Guggenheim Partners analyst Shing Yin cut his price target on AT&T shares and noted that the sale of roughly 8 million subsidized iPhones could reduce the company's wireless margins for the year below 40%.
On the surface, it would appear AT&T is headed down a misguided path of spending and more spending when it comes to Apple smartphones and tablets. That would miss Moffett of Bernstein's wider point.
In spite of what appear to be diverging strategies and earnings profiles heading into 2013, Moffett sees reason to believe AT&T is simply being forthcoming about the true capital costs telecoms face as they prepare for growing smartphone and data usage.
The bigger question for investors may be whether strategies, for instance Sprint's unlimited data plans and smaller-than-peer wireless network spending, reflect reality.
"Capital spending per post-paid equivalent subscriber, already much higher at AT&T than peers, is pulling away. And once again, Sprint's chronic under-spending over the past four years is striking, particularly in light of its open courtship of super heavy users as a consequence of its heavy promotion of its 'unlimited' data plans," writes Moffett of the differences between AT&T and Sprint.
"This raises obvious questions about the widely held expectation that capital spending can return to below-industry levels after just two years of (Sprint's) Network Vision," the analyst adds.
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