T, PCS, LEAP: Wireless Industry Trends Deteriorate, Says Bernstein

Bernstein Research’s Craig Moffett today reiterates a rather dour view of the U.S. wireless industry, writing that growth in “post-paid” subscribers in Q1 was just 0.2%, when stripping out mitigating factors, which he writes is “the lowest growth rate on record.”

Moffett writes in response to what he says has become the “Goldilocks” consensus on the U.S. cellular industry, a belief that while growth is slowing for the industry, what remains will be more profitable be because “carriers may be more disciplined about handset subsidies” that have eaten into profits in recent years.

That view has merit, he writes, but the problem is that growth trends, and pricing, are “more complex than they appear.”

Q1 saw the industry’s first-ever decline in post-paid subs, he writes, down 35,000, quarter over quarter. But when removing “internet devices” from Q1 results, writes Moffett, the drop in actual handset subs was worse, at 635,000.

Moreover, although average revenue per user (ARPU) overall was flat in Q1, “the best result in years,” it can’t last:

ARPU is rising as more and more customers add smartphones. But penetration of smartphones is now north of 50% in the U.S., suggesting that this tailwind to ARPU will fade. Underneath is something more troubling; the revenue being generated by each smartphone is falling, and rapidly so [�] The overall post-paid ARPU increase has been driven only by mix; by our estimates, at AT&T the ARPU of incremental smartphone subscribers added in 2011 was just $72, down -18% from $88 in just three years ago.

The non-handset devices, such as laptop cards, he adds, have “much lower ARPUs.”

Moffett also has lousy things to say about the “pre-paid” segment:

Underlying trends in pre-paid are equally disheartening. To gauge underlying growth, we look at the pre- paid market in two additional ways. First, we examine trends in “adjusted attributed pre-paid subscribers” by stripping out non-phone pre-paid devices. That takes pre-paid industry subscriber growth from a reported 15.7% to 9.3%. Second, we strip out Lifeline customers. Absent giveaway free service, core “traditional” pre-paid subscriber growth was just 6.1% in the most recent quarter. This backdrop of weaker underlying growth in traditional pre-paid segments goes a long way toward explaining the recent struggles for Leap Wireless and MetroPCS. We have taken down our numbers for the two companies to reflect their more challenged outlook. Given their high degrees of both operating and financial leverage, the changes to our models result in large changes to our probability-weighted DCF target price derivations.

Moffett maintains Market Perform ratings on AT&T (T), MetroPCS (PCS), and Leap Wireless (LEAP), and he cut his price target on PCS to $9 from $13, and cut his target on LEAP from $12 to $8.

Moffett rates Sprint-Nextel (S) and Verizon Wireless (VZ) Underperform.