WSJ -- 'Cricket' Still Clears Bar for Leap [Wireless] ...................................
December 26, 2006
'Cricket' Still Clears Bar for Leap
Wireless Carrier Secures Niche Targeting Low-Income Callers, But Rapid Launches Cut Margins
By AMOL SHARMA
Shares of Leap Wireless International Inc. have risen sharply this year and some investors are betting that they are in position to jump higher.
To gain traction as a tiny carrier in the crowded cellphone industry, Leap took an unconventional approach. Under the brand name "Cricket," it targets niche markets overlooked by larger carriers: young, low-income and ethnic customers. Leap doesn't require credit checks or contracts, and it offers flat-rate service rather than charging for minutes.
That formula has paid off. The San Diego-based company has attracted two million subscribers at a time when more than three-quarters of Americans already have cellphones. Shareholders have been rewarded: The stock is up 58% this year to $59.65 on Nasdaq.
The question now: Is the startling run over or will Leap sustain its fast-paced growth as it enters new markets, fueling more gains?
The answer could be continued growth, if investors are patient.
Today, Leap's stock looks expensive, trading about 11 times estimated 2007 earnings before interest, taxes, depreciation and amortization. That is well above the figure of about 6 for Sprint Nextel Corp. and about 7 for Alltel Corp. But the company's model has proved efficient so far. Many investors and analysts say its recent market launches have driven up costs and dragged down profits in the short term, but eventually will deliver significant returns.
Manny Weintraub, managing director of New York-based hedge fund Integre Advisors, sold off about half his Leap holdings earlier this year but is hanging on to the remaining 280,000 shares. He says Leap has shown it can add customers in existing markets even as it launches new ones. "The wild card is executing on that growth, and they've done a very good job of executing so far," he says.
Another positive: Leap could eventually be acquired by MetroPCS Communications Inc., a closely held operator with a similar business model that is said to be considering an initial public offering. MetroPCS operates in fewer markets, mostly big ones that don't overlap with Leap's territory, and has a slightly larger user base. The two carriers previously considered a deal, and analysts say a union is almost inevitable.
Leap Chief Executive Doug Hutcheson says he is open to a merger. A spokeswoman for MetroPCS couldn't be reached.
Leap has a checkered history. Spun off from cellphone-chip maker Qualcomm Inc. in 1998, it racked up losses and debt before filing for Chapter 11 bankruptcy protection in 2003. The company emerged from bankruptcy protection a year later by paying creditors in stock.
This time around, the carrier has been more disciplined, limiting costs and debt and painstakingly evaluating markets. Leap added 14 markets this year and now offers service in a total of 50, including small ones like Lincoln, Neb., and Eugene, Ore., as well as larger ones like Houston, San Diego, Phoenix and Pittsburgh.
"We were able to be prudent and thoughtful about how we went after this expansion," says Mr. Hutcheson.
Leap has aimed its "Cricket" brand at customers who can't afford expensive plans, don't want to bother with contracts and credit checks and don't travel much. Its customers' average annual income is about $32,000, the company says, half that of big carriers' customers.
For $40 a month, Leap customers get unlimited minutes, text messaging and picture messaging. To mitigate risk, Leap requires subscribers to pay for each month in advance. If they don't pay, they get cut off. For $5 more, subscribers get caller ID and voicemail, too; for another $5, they can browse the Web on their mobile phones.
The catch: Consumers pay steep roaming charges outside their home areas. "We're not all things to all people," Mr. Hutcheson says.
Leap's strategy limits costs. Customer calls cost it 1.4 cents a minute, roughly a third of what they cost major carriers. It spends less on marketing and doesn't offer big discounts on handsets, which list for between $100 and $300. It costs Leap about $170 to acquire a new customer, versus $300 to $400 for major providers.
That business model has led to rapid growth. In 2006's first three quarters, Leap had $822 million in revenue, a 20% increase over the same period last year. The carrier's earnings over that span were $35.2 million, up from just $7.5 million last year.
Rapid-fire launches this year are taking a toll on profit margins. In the third quarter, revenue grew quickly, but operating margin shrank because of higher costs. For the year, margins are expected to be about 27%, down from 34% last year. But there are promising signs in new markets like Fresno, Calif., and Houston, which are on their way to profitability.
Goldman Sachs analyst Marje Soova, who initiated coverage of Leap last month with a 12-month target of $75, wrote that the carrier will grow more quickly than others. She expects Leap to double its subscriber base within three years and increase service revenue an average of about 30% annually; large U.S. carriers are expected to see revenue grow at closer to 5%. (Leap is a Goldman Sachs investment-banking client. Ms. Soova doesn't own shares.)
As Leap grows, its niche markets could see increased competition from larger carriers. Because it doesn't use contracts, the company loses about 4% of customers each month -- double the rate of large national carriers. So new competition would be a significant threat.
In 2007, Leap plans to focus on adding customers in existing markets. In 2008, the company plans more launches using the radio spectrum it recently acquired for nearly $1 billion in a Federal Communications Commission auction. By 2009, the company hopes to add big markets like Washington, D.C., Baltimore, and Las Vegas, and have service available to 75 million consumers, up from 46 million now.
Write to Amol Sharma at amol.sharma@wsj.com
Copyright © 2006 Dow Jones & Company, Inc. All Rights Reserved. |
