Buying opportunity?
Wireless stocks have hit the skids 2002-02-13
Some analysts think the sector could slip further, but others call this a rare buying opportunity.
by Dave Sterman, equity research columnist
Here we go again. Wireless stocks have hit the skids, reminding some of the industry’s painful sell-off in 1996 and 1997. At that time, the group sank on fears of increased competition. This time around, slowing growth is the industry bugaboo. Of note, sector valuations went on to more than triple from their 1997 nadir. This time around, analysts are divided on where the sector will head next. Some argue that the sector could slip further, while others call this a rare buying opportunity.
RBC Capital Markets’ Jonathan Atkin is among the bears. He recalls that the sector bottomed in the second quarter of 1997. This time, he sees the sector going even lower because industry news could remain negative in the quarters to come.
Companies mentioned in this article
AT&T Wireless (AWE)
Sprint PCS (PCS)
Nextel Communications (NXTL)
For Atkins, the sector is suffering from a lack of clear positive catalysts. "Absent near-term M&A activity, it will require a stabilization of churn and growth parameters at several carriers, and consistent performance toward 2002 guidance and 2.5/3G-related plans, before investors regain comfort with the sector and we see a sustained lift in share prices," he says.
Other analysts argue that the sell-off has been overdone, noting that this is still a growth industry. J.P. Morgan’s Thomas Lee points out that industry revenues have been growing at a double-digit clip. As the accompanying table shows, AT&T Wireless (AWE), Sprint PCS (PCS), and Nextel Communications (NXTL) all grew sharply in 2001. Industry sales are expected to rise 13.5 percent, even as the overall economy remains weak. In contrast, the wireline RBOC (regional Bell operating company) industry is expected to post growth of less than 1 percent this year.
Friedman Billings Ramsey’s Alex Rygiel adds that 47 percent of all U.S. residents use wireless phones. In contrast, penetration rates in other countries are now approaching 65 to 70 percent. He thinks the United States is about to catch up, rising 10 percent a year over the next four years. "At this rate, wireless penetration in the U.S. would be approximately 66 percent of the total population by 2005," he predicts.
Reports for further inquiry
Sector Valuation Thoughts and 1Q02 Update
AWE: Building a Network for the Next Generation
AWE: Higher Peak Minute Buckets Could Increase Price Competition, Lower ARPU
NXTL: Pre-Announces Solid Q4:01; Positive 2002 Outlook
Industry Commentary: How Much Lower Could Wireless Valuations Go?
Wireless Pricing: Significant Sequential and Y/O/Y Rate Declines in the Higher Usage Levels for January
“NXTL” The Best Offense is a Strong Defense: Push-to-Talk Differentiates NXTL from Peers
That revenue growth is coming at a cost. Slower growth is changing the industry’s marketing practices. When growth was strong, carriers found it easy to find new subscribers and were content to maintain their pricing structures. Now, with growth slowing, they’re trying to poach customers from one another with more attractive pricing programs. By offering more minutes for the same price, carriers generate less revenue overall. In its most recent quarter, AT&T Wireless’s average revenue per user (ARPU) fell 8 percent from year-earlier levels.
AT&T lowered pricing again in late January, causing RBC’s Atkin to conclude that ARPU could decline further. That’s because carriers often bag high-margin profits when customers exceed their allotted bucket of minutes. "Overage could become a less significant contributor to ARPU," says Atkin.
Those new pricing programs are causing industry churn to tick up to uncomfortable levels. (See accompanying table.) Four years ago, when shares prices in the sector were also retreating, churn for most players was below 2 percent. Customer churn ultimately boosts marketing costs and makes it harder to post growth on an absolute basis. To minimize churn, carriers are making customers sign up for multi-year contracts.
Rygiel sees the industry’s more competitive pricing and a slightly falling ARPU as understandable at this phase of the growth cycle. Until now, carriers focused on building out their national infrastructures. But going forward, "as coverage becomes more consistent across the larger players, we believe the most successful wireless providers will offer a differentiated product to achieve higher profitability and growth than their competitors," he says.
Rygiel is particularly enamored of Sprint PCS, predicting that the company will gain market share thanks to its CDMA platform. He thinks CDMA is more efficient than competing GSM and TDMA methods, and will require fewer capital requirements to upgrade to future 3G networks. That will give Sprint PCS "the opportunity to be the low-cost provider."
Nextel Communications has been the poster child for the sector sell-off, falling some 80 percent in the last year, but some analysts think the company’s emphasis on corporate customers leaves it in a better position. Corporate customers typically generate higher ARPU (see table) and lower churn. Nextel’s customers are also a better credit risk, "as 90 percent of its subscribers’ monthly bills are paid by their employers," says FBR’s Rygiel.
Nextel bucked the trend in the fourth quarter, pre-announcing respectable growth rates. Nextel added 501,000 new subscribers in the quarter, 26,000 ahead of estimates. The company had planned to release results in February, but rushed out the news early after its shares fell anew in sympathy with the broader sector. The company’s stock is now the cheapest in the group by far on a price-to-sales basis. This is despite the fact that its churn rate and ARPU are significantly stronger, as the accompanying table shows.
Shares of wireless stocks could well trend lower in the coming weeks in the absence of any positive catalysts, but over the remainder of 2002, the sector could well come back into favor as growth rates rebound.
Name Recent Price (1) 52-week Range (2) Market Cap. ($bill.) (3) Price/ Sales (4) ARPU (5) Analyst Rating (6) 2001 Sales Growth (%) (7) Monthly Churn (%) (8)
Sprint PCS (PCS) $11.99 29/10 11.8 1.24 $60 1.6 64.9 3
AT&T Wireless (AWE) $10.60 24/9 26.8 2.16 $61 1.9 30.4 3.1
Nextel (NXTL) $5.50 34/4 4.4 0.63 $70 2.3 35.1 2.1
(1) Stock price as of February 12, 2002
(2) 52-week range of stock price
(3) Market capitalization in $billions
(4) Market capitalization/trailing 12-month sales
(5) Average revenue per user
(6) Average analyst rating: 1=Strong Buy, 5=Sell
(7) Growth in sales in 2001 from year-earlier levels
(8) Percentage of subscribers that cancel service each month |
