Latest Barrons gets everything wrong article (long article on wireless service providers. AT&T Wireless is "great," Sprint PCS not good. No understanding of extreme cost and difficulty and questionably of AT&T Wireless's evolution path, etc.)
I have not yet read the article, but my wife has, and already warned me with one of those "Wait 'til you read what Barrons had to say about wireless this week (groan) ... "
How many of us are going to write letters to Barrons, or the S.E.C. (or both) ?
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February 18th, 2002
Heating Up
Who will survive the latest phase of the U.S. Wireless Wars?
By Andrew Bary
After five years of strong growth, the wireless industry has put cellular phones
in the hands of 130 million Americans-nearly half the population. But it is under
fire from an increasingly unforgiving Wall Street because its growth hasn't
generated substantial earnings for the six players in the brutally competitive field.
The stocks of the three major public cellular players, AT&T Wireless, Sprint PCS
and Nextel Communications, have been hit hard lately, leaving them way below
highs set two years ago. AT&T Wireless, at 10.12 Friday, was off 30% this year;
while Sprint, at 9.27, was down 62%, and Nextel, at 4.86, had tumbled by more
than 50%.
Helping to batter Sprint PCS's stock late last week was a wave of worry about
that company's liquidity. The fear was fanned by the problems of another telecom,
debt-burdened Qwest Communications which said it will draw down its $4 billion
bank credit line to pay off over $3 billion in commercial paper.
Sprint PCS is one of two tracking stocks
under the Sprint Corp. umbrella -- the
other is Sprint FON, representing the
company's long-distance and local
operations. Sprint has an estimated $3
billion of commercial paper outstanding,
but had only about $330 million of cash
on its balance sheet at year-end. While the
company said Friday it has adequate
liquidity, it may have to draw down its
bank credit lines to redeem its commercial
paper. Sprint PCS has $17 billion of debt
outstanding and a $2 billion funding need
this year. Friday, after the close of
trading, the company said it would trim
9% of its workforce in a cost-cutting move.
Wall Street's worst fears may well be overblown. "Sprint PCS is not a company
with viability issues," asserts Luiz Carvalho, an analyst at Morgan Stanley.
Carvalho says Sprint may face some near-term liquidity ills, but he believes it will
get the $2 billion in outside financing its needs for 2002, albeit at relatively high
cost.
Welcome to the latest episode in The Wireless Wars, a melodrama that has taken a
stark toll on many investors' wallets. Amid the gloom, however, there could be
opportunity, especially if there's consolidation among the six national companies.
Until recently, Wall Street was happy if
wireless operators posted strong
subscriber growth and generated rising
pre-tax cash flow. The reasoning,
reminiscent of the dubious Internet
"land grab" strategy of 1999, was that
a growing subscriber base ultimately
would produce ample profits. But the
Street's attitude has changed amid
signs of abating growth as U.S.
cell-phone penetration nears 50%,
although still shy of the 60%-80%
common in Western Europe.
Fourth-quarter results for several
cellular operators, including Sprint PCS, were disappointing. "Revenue growth is
no longer good enough. Investors want evidence that companies can continue to
grow profitably," says Carvalho. "The childhood phase is over. These companies
have to act like normal businesses and make money." Or at least generate strong
free cash flow, which can be a harbinger of better days ahead and which
investors, worried about some of the companies' viability, are clamoring to see.
Suddenly, a once-fawning Street is talking about the bear case for wireless: It's a
maturing industry, laden with heavy capital expenditures, excessive marketing
costs, fragmented technology standards, high customer turnover and little pricing
power. Add to that uncertain prospects for its great electronic hope: the
much-hyped third-generation data services known as 3G, due to be rolled out later
this year.
The big fear is that wireless will follow
the downward path of the
long-distance phone industry without
generating the profits that business
once enjoyed.
The wireless wipeout has hit a broad
swath of companies, including
Alamosa and Airgate PCS, which sell
wireless services on behalf of the
majors to customers outside big
metropolitan areas. Airgate, which is
linked to Sprint PCS, has crashed 73%
this year, to 12. Cell-phone tower
operators, such as American Tower,
have been crushed. American Tower recently was changing hands at 4.41, off
54% this year.
Wall Street would welcome merger activity because the U.S. industry is less
concentrated than its counterparts in Europe and Japan, resulting in keener
competition and lower margins. The biggest American cellular company, Verizon
Wireless, a 55%-45% joint venture of Verizon Communications and Britain's
wireless giant, Vodafone, has 29 million subscribers, giving it a 22% market share,
while Japan's leader, NTT DoCoMo, has a nearly 60% share.
The most likely merger pairings are
AT&T Wireless and Voicestream
Wireless, a unit of Deutsche Telekom,
or Cingular and Voicestream.
Cingular, a 60%- 40% joint venture of
SBC Communications and BellSouth, is
the second-largest wireless company,
with 21.6 million customers. AT&T
Wireless is third, with 18 million.
As for Voicestream, it's the likeliest
merger candidate because it's the
smallest of the national players, with
fewer than seven million subscribers
and it's generating the worst results among the Big Six with negative pre-tax cash
flow. A key issue is whether debt-burdened Deutsche Telekom, which grossly
overpaid for Voicestream in 2001, shelling out more than $30 billion, will unload it
for a fraction of that amount.
There's a good chance of a big merger this year, owing to tough industry
conditions and AT&T Wireless's new ability to pursue a combination because the
six-month anniversary of its spinoff from AT&T passed in January. A deal now
wouldn't jeopardize the spinoff's tax-free status.
To regain investor confidence, wireless operators may have to change their ways.
"Churn" -- customers switching from one company to another, to get better deals
-- runs at nearly 3% a month industrywide. It will have to come down, and
customer acquisition costs (commissions, cell-phone subsidies and advertising)
also must drop, given that new subscribers tend to be less profitable than older
ones. Acquisition costs now run about $350 per subscriber, three times what
European operators pay, while the average monthly U.S. wireless bill is around
$60.
Certainly, not all is misery.
John Zeglis, AT&T Wireless's chief, bristles when critics equate his industry's
woes with those of the long-distance carriers. "Long distance is fully penetrated
and has low barriers to entry. We have high barriers and our usage is increasing
hand over fist. We have a place to take customers even after voice needs are
sated," he said last week. "This industry has a longer runway than voice telephone
and is just starting to roll down it."
Agrees Rob Donahue, an analyst at Salomon Brothers Asset Management: "There
are real barriers to entry in wireless. These businesses have real franchise value
and are trading near historically low levels."
Both he and Carvalho view AT&T Wireless as the best bet among the major
publicly traded outfits. For one thing, it has the industry's best balance sheet and
its stock trades at book value. For another, it fetches a modest seven times
projected 2002 earnings before interest, taxes, depreciation and amortization
(EBITDA) of $4.1 billion.
EBITDA valuation analysis has its drawbacks because it doesn't reflect interest
costs and capital expenditures. But in the absence of appreciable reported
profits-or the presence of outright losses -- it's a defensible yardstick for
assessing wireless operators. (A company's EBITDA multiple is calculated by
dividing its enterprise value -- equity market value plus debt -- by EBITDA.)
Zeglis ticks off
his company's
strengths:
"We've got a
great balance
sheet, so cash
isn't an issue.
We're
independent, so
we can move
fast. We've got
more spectrum
than anyone in
the industry,
and we're
putting on
customers
without
lowering credit
standards," he
said.
One of the knocks against AT&T Wireless is that its TDMA technology is inferior
to CDMA, used by Verizon Wireless and Sprint PCS. But Zeglis says that issue is
becoming moot because AT&T, like Cingular, is moving toward the GSM
standard dominant in the rest of the world for 3G. Voicestream already uses
GSM. (TDMA stands for time division multiple access, CDMA for code division
multiple access and GSM for Global Standard for Mobile communications.)
AT&T Wireless earned a nickel a share in 2001 on revenues of $13.6 billion,
generated EBITDA of $3.1 billion and is likely to net a dime a share this year.
Sprint PCS, the fastest-growing cellular outfit, is more expensive than AT&T
Wireless, trading around 10 times estimated 2002 EBITDA of $2.8 billion. Sprint
PCS has a similar enterprise value to AT&T Wireless. But the latter has a stronger
capital structure, with just $3 billion of net debt, compared with Sprint PCS's $17
billion. In addition, Sprint PCS has a controversial growth strategy geared toward
customers with weak credit.
Based on its franchise value, the company does look more attractive because it
probably would be impossible to recreate its nationwide network and customer
base for anything close to its current enterprise value. Sprint PCS also boasts a
national digital network and has a less expensive path to upgrade its services to 3G
than does AT&T Wireless. However, Sprint's tracker structure would make it
hard for any company to buy Sprint PCS without shelling out for Sprint's other
businesses as well.
Several analysts and institutional investors advise avoiding Nextel stock, even at its
depressed price, because the heavily indebted company, known for the
walkie-talkie feature on its phones and high customer loyalty, may be headed for a
restructuring that could wipe out or dilute current shareholders' stakes.
"There's enough risk in the wireless sector without layering on the unique risk at
Nextel," maintains John Bensche, wireless analyst at Lehman Brothers. He
complains that Nextel's proprietary IDEN technology complicates the job of
upgrading its network for third-generation services and that the company has too
much debt. Bensche presciently downgraded Nextel to "sell" last month when it
was at 10. He thinks it may fall to as low as 4.
The best way to play Nextel may be via its battered junk bonds, which now yield
about 20%. Its 9 5/8% paper due in 2009 was trading last week at about 60 cents
on the dollar, suggesting that Wall Street anticipates a debt restructuring.
Nextel stock, in contrast, trades around seven times projected EBITDA, using the
company's recent 2002 estimate of $2.5 billion of EBITDA and an enterprise value
of $17 billion, reflecting $4 billion of equity value and $13 billion of net debt.
Nextel bond buyers effectively can purchase the company for less than four times
projected 2002 EBIDTA. Here's why: With its bonds trading for less than 70 cents
on the dollar, the debt market effectively is saying Nextel is worth under $10
billion ($13 billion times 0.70) with no value left for shareholders.
The company disputes any notion
that it's in financial distress, noting
that it had $4 billion in cash on
September 30 and has a "fully funded" business plan. Nextel undoubtedly will
address growing investor concerns when it releases fourth-quarter results this
week. It reported some preliminary results for 2001 earlier this month, saying it
generated $2.5 billion in EBITDA and added two million customers, boosting its
total to 8.7 million.
In response to a written query from Barron's, Nextel's chief financial officer, Paul
Saleh, e-mailed this reply: "Today, Nextel has the best 2.5G network in the world
and we have most profitable customers in the industry. We believe our current
network and planned improvements from Motorola will keep Nextel at the
forefront of the products and services that the best customers demand."
Nextel, Sprint PCS and AT&T Wireless all are expected to have negative cash
flow -- about $2 billion this year for AT&T Wireless and Sprint PCS, and $1.3
billion for Nextel -- in part because of high capital expenditures to expand and
maintain their networks. Their cash flow is unlikely to turn positive until 2004, or
2003 at the earliest.
Nextel's woes are a comedown for a company that once sported a $50 billion
market value and was courted by AT&T Wireless and WorldCom. Nextel now has
no obvious merger partner, due to its debt load and unique technology.
Of course, depressed conditions are evident throughout the telecom business.
Wireless companies command seven to 10 times projected 2002 EBITDA, while
the Baby Bells, SBC, BellSouth and Verizon, trade for six to seven times. For
investors, the choices aren't pretty, says Rob Gensler, who runs the T. Rowe
Price Media & Telecom Fund: "You're looking at monopoly providers with no
growth" -- the Bells -- or a "six-player mess with modest growth."
WorldCom, at 6.73, trades for five times projected 2002 EBITDA, while the
telecom part of AT&T fetches about half that. In comparison, cable-TV operators
like Cox Communications and Cablevision Systems trade at 12-14 times estimated
2002 EBITDA. Why? Because they're virtual monopolies with reasonable growth
prospects. Sprint PCS, meanwhile, has made a nearly complete roundtrip to the
price at which it debuted over three years ago. Sprint PCS has a net loss of 45
cents a share and EBITDA of $1.5 billion in 2001 on revenues of $10.8 billion.
To reclaim the good graces of investors, Sprint PCS may need to scale back or
scrap its "Clear Pay" plan, which lets people with weak credit ratings get a
wireless phone without making a deposit.
The plan has increased Sprint PCS's churn rate and bad debt. Clear-Pay users
made up as an estimated 25% of its year-end subscriber base of 13.5 million and
have accounted for much of its growth in recent quarters. Zeglis says that AT&T
Wireless dropped a similar plan because it wasn't profitable. And Bensche, the
Lehman analyst, adds: "If Sprint had fewer but higher-quality subscribers, that
would be what the doctor ordered."
The Sprint program does address one of the industry's challenges. U.S. wireless
subscribers totaled 130 million, as of December 31, up from 44 million five years
earlier. To boost market penetration beyond the 45% it had at year-end 2001,
cell-phone operators must target people with bad or limited credit histories,
including virtually all teenagers and many young adults. European wireless
companies have profitably served these groups with prepaid plans, but these
haven't been big hits in the U.S., partly because Americans feel there's a stigma
attached to them.
The current competitive landscape is great for consumers, who routinely switch
from one wireless operator to another as more attractive calling plans emerge.
Monthly churn of 3% means wireless companies have to replace over a third of
their subscribers a year, just to stay in place.
Voicestream has generally been the most aggressive discounter, although AT&T
Wireless recently began offering a program of 600 "anytime" minutes for $39.99 a
month, breaking what had been a 10-cent-a-minute barrier for prime, daytime calls
among the five carriers, aside from Voicestream. The AT&T plan works out to
less than seven cents a minute.
Lehman's Bensche says the industry has maintained average subscriber revenues
at $60 a month by giving customers such bonuses as unlimited night and weekend
minutes and free call waiting. He fears that until 3G arrives the industry will
continue to be very price-competitive.
As the table on page 16 shows, data services account for just a tiny fraction of
industry revenues, but that portion is expected to grow sharply in 2003 and 2004
as wireless data-transmission speeds rise. The big question is whether demand will
justify the cost of upgrading the technology.
As noted above, consolidation is coming, with the most likely pairings being
AT&T Wireless/Cingular or Cingular/Voicestream. Voicestream would be valuable
to either AT&T Wireless or Cingular because of Voicestream's GSM technology.
AT&T Wireless and Cingular are shifting from TDMA to GSM. Buying
Voice-stream would make the transition easier and cheaper.
If AT&T Wireless and Cingular mated, their offspring would be the industry's top
dog, with 40 million subscribers. It would save on capital expenditures. But such a
combo could spook antitrust regulators because of its sheer size.
Egos also may stand in the way of such a deal because neither AT&T Wireless
nor SBC, the dominant partner in the Cingular partnership, may want to cede
control. Cingular is slightly larger with 21.6 million subscribers, versus AT&T
Wireless's 18 million.
Egos also might preclude a merger between AT&T Wireless or Cingular and
Voicestream because Deutsche Telekom's embattled chief executive, Ron
Sommer, may not want to admit defeat by selling Voicestream to Cingular or
AT&T Wireless at a fraction of its cost. He may not have much choice if
Deutsche Telekom can't bring public T Mobile, its global wireless properties,
which will include Voicestream. Deutsche Telecom, burdened with $58 billion of
debt, has seen its American depositary shares sink to 13 from a 2000 peak of 100.
There's an incentive for AT&T Wireless or Cingular to act because the industry's
first merger is apt to get a more receptive hearing from antitrust regulators than
the second deal.
Verizon Wireless and Sprint PCS are potential partners because both use CDMA
networks and are pursuing similar network upgrade paths to 3G. Such a deal,
however, could prompt antitrust objections because of the size of the combined
companies.
All the likely scenarios leave Nextel, with its proprietary technology and leveraged
balance sheet, out in the cold.
While not yet public, Verizon Wireless is the industry's class act. Its network is
unrivaled in coverage and calling quality. Verizon Wireless's EBITDA of $6 billion
last year was tops in the group, and the company was the only major player that
generated free cash flow.
The company's CEO, Ivan Seidenberg, recently said that Verizon Wireless
ultimately will go public, but that there's "no rush" to do so, given the industry's
depressed share valuations. Verizon Wireless might be valued at $60 to $65 billion.
Back in 2000, it probably would have fetched 50% more.
In sum, with Wall Street no longer willing to indefinitely finance the industry's
growth, the Wireless Wars are entering a phase that ultimately may leave a
much-altered -- but less perilous -- battlefield for the winners... and for investors.
E-mail comments to editors@barrons.com
February 18, 2002 12:01AM |
