NORTH AMERICA SPECIAL: Disrupting the mobile market status quo
31 October 2013 | Gary Kim
A flurry of M&A activity could soon lead to disruption in the US mobile market. What does this mean for wholesale? Gary Kim investigates.
A relatively lengthy period of US mobile market stability appears to be coming to an end.
Verizon Communications' acquisition of the 45% in Verizon Wireless previously held by Vodafone, the SoftBank purchase of Sprint, the Sprint acquisition of Clearwire, T-Mobile USA's merger with MetroPCS to form T-Mobile US and AT&T's acquisition of Leap Wireless all threaten to unleash a new period of disruption in the US.
Both T-Mobile US and Sprint – with significant overseas financial backing from Deutsche Telekom and SoftBank, respectively – will be attempting to rearrange the market in their favour for the first time in a decade.
The fundamental dynamics to watch are simple to explain: AT&T and Verizon will try to defend their market-leading positions, while T-Mobile US and Sprint will attempt to dislodge them.
Verizon presently has a market share of about 32% and AT&T has 28%, while Sprint has about 15% and T-Mobile US 13%. In other words, AT&T and Verizon between them have about 60% market share, while the top four have about 88% between them.
Other contenders are preparing assaults of their own. US satellite video provider Dish Network owns spectrum and is seeking partners to build an LTE network, while another satellite provider, Globalstar, is also seeking permission to launch its own LTE system.
The implications of market instability for wholesale providers could conceivably take a couple of forms. Firstly at the level of what competition might mean for the wholesale MVNO business, and secondly regarding what LTE might mean for the volume and revenue associated with higher purchases of long-haul capacity and local-market backhaul.
Prepaid growth boom
On the MVNO front, it is conceivable that heightened competition could spur interest on the part of would-be new MVNOs, or expanded prepaid operations owned by some of the dominant service providers. This is because growth in the US mobile market is significantly driven by demand for lower-cost prepaid services.
Prepaid wireless revenues in the US mobile market were about $19 billion in 2012 and will reach $25 billion by 2015, according to ATLANTIC-ACM. Wireless Intelligence estimates that prepaid accounts for more than 30% of connections at AT&T, Sprint and T-Mobile US.
By 2017, accounts across the Americas will grow to 62% prepaid, Wireless Intelligence forecasts. US prepaid share is likely to remain at a fraction of that level, but AT&T's launch of the new Aio Wireless prepaid service is a reflection of the faster growth rate prepaid is expected to demonstrate. In fact, about a third of US mobile smartphone activations in the first quarter of 2013 were by prepaid services, according to NPD Group.
The implications for wholesale providers of capacity should be driven more by growth of LTE connections than by competition. The reason is simple enough: 4G users consume much more bandwidth, requiring higher cell tower bandwidth and therefore higher demand for tower backhaul, as well as higher core network bandwidth.
In fact, 4G mobile users buy bigger data allowances than 3G users, a study by Mobidia has found. Users on 4G LTE networks also consume 36% more data than users on 3G networks, Mobidia adds.
Since AT&T and Verizon operate their own backbone networks, much of the increased core network demand requiring purchasing of core network capacity will be generated by T-Mobile US (which does not own long-haul facilities) and partly by Sprint (which does own a long-haul network).
A similar dynamic will occur in the tower backhaul market. AT&T has the largest fixed-network footprint, followed by Verizon Communications. Neither T-Mobile US nor Sprint own fixed-network access assets that can be leveraged for tower backhaul.
That being the case, AT&T and Verizon will have the greatest ability to supply tower backhaul internally, while Sprint and T-Mobile US will have to buy such access more frequently.
LTE dramatically increases backhaul requirements. Where a voice-oriented 2G network might require only a few T1 links, an LTE tower might require 80 Mbps to 100 Mbps for every service provider on a single tower.
As all four of the leading mobile service providers rush to finish or extend their 4G networks, demands for Ethernet-based tower backhaul will remain a key issue, at least for a couple more years.
Heightened competition is likely to lead to new offers that stimulate end-user data consumption, especially on the part of Sprint, which now controls more spectrum than any other of the leading suppliers.
Its extensive spectrum holdings would, in principle, allow Sprint to create retail plans and services that take advantage of its greater spectrum resources.
Bandwidth demand could also be affected by new bundling, packaging and terms-of-service elements in the customer offer. T-Mobile US was the first of the four leading carriers to change the way most consumers buy devices and service – namely the purchase of a subsidised handset with a two-year service contract. But all four leading service providers now offer plans that allow users to upgrade their devices more frequently.
Some believe this will encourage the adoption of newer devices at a faster rate. Since the latest models often include new features that encourage more data consumption, even retail service plans that separate device purchase from recurring service could have the effect of boosting data consumption.
Competitive dynamics will be key. Both T-Mobile US and Sprint are launching renewed attacks on Verizon and AT&T, the market-share leaders. In fact, some believe Vodafone's decision to sell its stakes in Verizon Wireless to Verizon Communications in September 2013 was, in part, prompted by concern that heightened competition will reset retail price levels in the US mobile market at a lower level.
Make no mistake – market share in the US mobile market will be determined in the medium term almost entirely by competition between the four leading carriers, and not by further consolidation.
Department of Justice lawyers have already signalled a belief that the US mobile market is too concentrated, by opposing AT&T's bid to buy T-Mobile USA in 2011.
The Herfindahl-Hirschman Index, or HHI, is often used as a measure of market concentration. The HHI is the square of the percentage market share of each firm summed over the largest 50 firms in a market.
The Justice Department will generally investigate any merger of firms in a market where the HHI exceeds 1,000 and are very likely to challenge any merger if the HHI is greater than 1,800. With an HHI over 2,300, any deal will be heavily scrutinised and is likely to be rejected. In 96 of the top 100 US mobile markets, the HHI is over 2,500.
Also, the US mobile market is actually far more concentrated than people usually assume. Though most would concede the leadership of the four national carriers – or the 88% market share those carriers hold – one might guess that there are still meaningful network assets to be acquired.
That assumption is not true. Although, there is still 12% more market share to be gained from non-dominant regional or specialty providers, it is unlikely to drive acquisition activity by the leading four providers.
TracFone Wireless has about 6% share, but it is an MVNO with a prepaid-only revenue model and relatively low average revenue per user (ARPU). While the leading carriers have an ARPU of between $45 and $58 a month, TracFone in its first quarter of 2013 had an ARPU of just $19 a month.
Even if TracFone wanted to sell its business – and there has been no indication it is interested in doing so – it would only be selling low-ARPU customer accounts, with no network assets or spectrum licences.
As a result, there is only a percentage point or two of "facilities-based" market share to be consolidated in the US mobile market.
Another point is that the big wave of national and large regional provider mergers is over in the US domestic mobile business, for the time being. In the domestic market, that will shift the market share battle to organic growth.
Threats to revenues
Paradoxically, all of the four national carriers have recently placed big bets on the attractiveness of financial returns in the US market, just as it appears this attractiveness could be challenged by a new wave of competition.
Verizon's acquisition of the rest of Verizon Wireless from Vodafone – at a cost of $130 billion – might increase revenues by about $35.5 billion between 2014 and 2016, according to Moody's.
Deutsche Telekom's T-Mobile USA invested $1.5 billion in the MetroPCS deal, SoftBank bought Sprint for $21.6 billion, while Sprint bought Clearwire for roughly $7 billion. AT&T grabbed Leap Wireless for about $1.2 billion. Those investments show confidence in prospects for the US market.
The danger for Verizon and AT&T is partly an increase in customer churn, but potentially an even-bigger change in industry pricing levels.
Assume a new level of competition increases churn at Verizon and AT&T by 1% a month, on accounts with average revenue of $52 a month. That alone would lead to a $2 billion shift in revenue from Verizon and AT&T to Sprint and T-Mobile US – assuming that Verizon and AT&T lost share and Sprint and T-Mobile US gained that share.
But that is not the biggest potential impact. Assume a vigorous price assault leads to a drop in average revenue per user, from $52 a month to $41 a month. If AT&T and Verizon have a market share of 60% between them, that means a potential decline in revenues for the two largest carriers of about $26 billion.
As always in a market facing a price war, this is the biggest problem. There is some lost revenue when market share shifts, but the bigger danger is an overall drop in retail pricing. That is what many will be watching for – changes in generally robust US revenue and profit trends, caused by heightened competition.
Since 1993, mobile industry revenues have never experienced a single year when total revenue declined, according to the CTIA. From 2011 to 2012, for example, revenues grew by 9%. The global telecommunications industry experienced 7% worldwide growth in 2012, down 3% from 2011, according to the Telecommunications Industry Association, by way of comparison.
While growth actually accelerated in the US market (from 5.9% in 2011 to 6.2% in 2012), international markets saw a declining growth (11.3% versus 7.2% respectively), TIA reports. TIA sees this trend continuing, with the overall industry growth rate in the United States surpassing growth in international markets in 2014.
TIA predicts US growth rates of 7.1% in 2013 and 6.8% in 2014, while international markets will see rates of 7.9% and 6.5%, respectively. But these are extrapolations from current trends and do not incorporate any potential market disruption from the likes of T-Mobile US or Sprint.
SoftBank could introduce offerings radically different from those that fixed-network or wireless service providers have offered in the US market previously, analyst Jack Gold of J Gold Associates says.
Most suspect bundled content and applications could be part of that effort, as this is the strategy SoftBank uses in Japan. But a disruptive price attack was also used by SoftBank to immediately take major market share within a year or two of launch.
The potential challenge could be a combination of an Iliad Free-style pricing attack, combined with the bundled apps approach that SoftBank uses in Japan.
Then there is T-Mobile US, which has quickly reversed its subscriber decline and is adding customers again for the first time in years. The T-Mobile US customer base grew strongly for the first time in more than four years in the second quarter of 2013.
For the second quarter, T-Mobile US added 688,000 net branded postpaid customers, a significant swing from losing 557,000 in the same quarter of 2012. That year, T-Mobile US lost about 1.8 million postpaid customers, compared to Verizon Wireless adding more than five million.
Linear forecasts of what could happen in the US mobile market are likely to prove incorrect over the next few years, as ferocious competition occurs. Whether or not there are major reversals of an established market share pattern, it is highly likely that there will be serious gross revenue erosion and considerable pressure on carrier profit margins.
All of that will at least slow revenue growth in the US market. In a worst-case scenario, the market could go into reverse, leading to the first revenue declines in its history.