TMUS - The U.S. Wireless Market Looks Broken: Avoid Verizon (And AT&T And T-Mobile)

2023-06-09 10:02:13 ET

Summary

• Cable's entrance to the wireless space is a big threat to US wireless.
• Verizon’s new pricing strategy will lead to further price competition.
• Expect no growth in subscription numbers at Verizon, or AT&T and T-Mobile.
• Expect further price decreases in the US wireless market in the coming years.
• As a result, all three, or four, US wireless carriers are very risky stock investments in my view.

Verizon ( VZ ) is one of the biggest wireless telecom company in the US and currently shares the market with AT&T ( T ) and T-Mobile US ( TMUS ). A fourth operator, DISH ( DISH ), will enter the market soon with its own network. Next to these companies there are many so called MVNO’s that offer wireless phone services in the US without owning a network. These operators rent a network from any of the above mentioned companies. We can expect Comcast ( CMCSA ) and Charter ( CHTR ) to become very large MVNO operators. Together with Dish these companies may spoil the wireless phone market for the next several years.

This article focuses on Verizon and aims to answer the question whether Verizon is a good stock investment. Nevertheless, many of the conclusions we draw for Verizon will also apply to AT&T and T-Mobile. We will start by looking at the growth of the total US wireless market. Then we zoom in on Verizon’s cooperation with Comcast and Charter, two very fast growing MVNO operators on Verizon’s network. Thereafter we analyze Verizon’s recently launched new pricing strategy. That strategy may not be as harmless as initially thought.

Wireless market growth

When asked, during the recent SVB MoffetNathanson conference , Verizon and T-Mobile expect the wireless phone market to grow by between six to eight million connections per annum in the next couple of years. Part of that comes from population growth, some from increase in usage, many people even have two mobile phones, and some from the shift from prepaid to postpaid, which these wireless companies count as growth.

The question arises which of the three carriers is in the best position to capture that growth. If you believe the stock market that candidate should be T-Mobile since the company is far higher valued than the other two.

Another obvious candidate is Dish which is a fourth operator that is about to launch its own network. We can expect Dish to start pitching for clients later this year. Since you don’t build a nationwide network in the US for only a few million phones we can expect Dish to start an aggressive marketing campaign that very likely will capture many millions of subscribers each year the coming years.

If that is not bad enough, since respectively 2017 and ’18 the cable companies Comcast and Charter have very successfully entered the wireless phone market. These companies currently have almost twelve million subscriptions and the number of new subscriptions is only increasing each quarter. If Q1, 2023 is indicative for the rest of the year they may add over four million subscribers this year alone.

Adding it all up, it is very likely that none of the three carriers will have substantial subscription growth, if any, for the next couple of years – Dish, Comcast and Charter will spoil the party.

Comcast and Charter’s mobile business

Given the sheer size of the mobile businesses of the two cable companies it is worth it to have a separate look at their business model and how it will affect the big three carriers. Both offer their services via Verizon on the basis of a wholesale contract that was signed in 2011. It is not clear, to me, how that contract exactly works but at least I understand that the contract has no maturity and that Verizon cannot walk away from the contract.

Let’s start with getting an impression of how that business has grown over time. Comcast started offering mobile from May 2017 and Charter launched its services in September ‘18.

The below chart gives the growth since 2018 until Q1 2023. The last three quarters in 2023 are an extrapolation based on the growth in Q1.

The chart clearly shows the recent acceleration of the growth. The two companies may be at 15 million mobile phones by the end of this year.

The reason behind that acceleration is very likely the price decreases that were a result of the new pricing plans, here and here . Charter’s Spectrum One product for instance was introduced in the autumn of ’22 and offers a mobile line for only $30, with a second line for free in the first year. These offers are clearly a form of transparent price competition at lower costs than the current offers from Verizon.

Fixed-mobile convergence

The cooperation between the cable companies and Verizon is basically about the tried and tested converged approach where the client enters into a combined fixed and mobile contract from one provider. The two most important benefits for the telco company are lower churn rates and less usage of the mobile network. Lower churn helps the telecom company as it leads to lower depreciation costs of customer acquisition expenses as these costs can be recouped over a longer period. Lower mobile usage is the result of off-loading of mobile traffic via the fixed network either at home or anywhere else where a WiFi connection from the cable company is available. The reason why off-loading is beneficial comes from the fact that wireless data traffic (capacity) is far more expensive than traffic via cable.

Ask yourself where the previous chart will top out? Note that the two cable companies have about 250 million people living in their footprint. Can you expect them to attract 10% or maybe even 20% of the market? That would be 25-50 million mobile lines in a not too distant future. From whom will they take that market share? Think about the consequences for the three/ four operators!

Who benefits, cable or wireless?

The above chart shows that the success of the two cable companies in the wireless space is too big to ignore. Now we should ask ourselves who makes the money on this success. Is it the cable companies or is it Verizon that rents out its network? The problem in answering this question is that all three companies involved tend to be very reluctant in providing information.

From Charter we know (p. 50) that it disclosed mobile service margin of 18% over q3, 2022. That number is excluding customer acquisition costs. That leaves 82% on the table for its own direct costs and a certain amount for Verizon. Verizon has, as far as I know, never disclosed any clear numbers on how profitable this MVNO relationship is. Diving deep into the 2021 and ’22 10k’s may give some indication where it is stated that the ‘non-retail service revenue’ went up with $717 million over these two years (resp. $464m and $253m). If you link that to the growth in the number of MVNO mobile lines, an increase of 5.3 million lines, you can calculate incremental revenue per line of ca. $140 dollar per annum. I must admit this is wild speculation based on many assumptions, so don’t read too much into it - we simply don’t have the information.

What we do know however is that the cable companies are offering lower prices and have substantial success in attracting customers.

Verizon’s new pricing strategy

Maybe as a result of the price actions of the cable companies Verizon recently launched a new pricing offer of its phone product. In the words of S. Sampath, CEO for Verizon Consumer Group:

We went back to our fundamental roots and says, what irritates customers the most, and then we found three things. They want flexibility, they want control, and they want more value. And we said, you know what, we are going to give them a 100% of all three of them. And we came up with myPlan. So myPlan essentially does is you go in and first you decide what two network options you have. We have two network options. You know what? Of course, one is called welcome, one is called Plus; two network options. …

A long story short, Verizon introduced a very transparent pricing strategy with two options. Now ask yourself this, why didn’t Verizon have a simple pricing strategy before? And why are all the offers of all the other telecom providers always so complex with caveats, step ups and so on?

The reason behind that spaghetti of offers, even within one company, comes from a basic economic lesson about competition in a market with only a few players, a so called oligopolistic market. The three carriers are competing in such an oligopolistic market that can be described as:

Oligopolistic Competition

a competitive situation in which there are only a few sellers (of products that can be differentiated but not to any great extent); each seller has a high percentage of the market and cannot afford to ignore the actions of the others.

And here we learn how competitors in such a market tend to behave:

An oligopoly in economics refers to a market structure comprising multiple big companies that dominate a particular sector through restrictive trade practices, such as collusion and market sharing. Oligopolists seek to maximize market profits while minimizing market competition through non-price competition and product differentiation .

So, our textbooks teach us that in order to ‘maximize profits’ the market participants should avoid ‘price competition’.

Now let’s look back to the price actions of the two cable companies and more recently Verizon. That is exactly the opposite of what our textbook teaches us how market participants should behave to ‘maximize profits’. What we see developing is aggressive price competition in an oligopolistic market, and our textbooks can already predict how this ends. This price competition will likely lead to a race to the bottom.

Over the last twenty years we have seen wireless companies all over the world lowering prices. In Europe in many markets the wireless carriers have reacted by teaming up with cable providers to become more efficient. That efficiency was then given away to the consumer in the form of lower prices. Look at the stock prices of Vodafone ( VOD ) or Liberty Global ( LBTYK ) to see how that impacted the value of both companies.

The recent price actions in the US wireless market look like an acceleration of this. The first victim may be DISH that may not be able to compete. I believe the high credit spreads in the bond markets imply that DISH has a high likelihood not to survive. I also think the low stock prices of Verizon and AT&T are just a confirmation that the companies are not in a healthy market. There is also no reason to believe that T-Mobile will be spared, despite its far higher valuation. (T-Mobile’s high valuation looks more like a reaction on its very aggressive stock buy-back program of over 35% of its shares – inflated prices).

The problems in the US wireless market are even exacerbated as the market participants Comcast and Charter are to a large extent creating the turmoil but are only to a very limited extent affected by it. Only if Verizon makes very healthy profits on these MVNO’s then it may be insulated by the current competitive environment. Verizon does not give us openness on this and I can only guess why. That is, I am not too optimistic.

Will Fixed-wireless be the savior for the wireless companies

After the above, rather gloomy, analysis you may argue that there is nevertheless hope, as the wireless carriers now offer fixed-wireless. Fixed-wireless is basically home internet offered via wireless and not via a traditional cable. Both T-Mobile and Verizon started offering a fixed-wireless broadband service in large parts of the US. Both companies grow fast in this space and added several millions of subscribers over the past few years.

The question arises whether this growth can continue and whether this product will be a large growth engine for the coming years. Peter Osvaldik, the CFO of T-Mobile basically answers the question during an interview with Craig Moffett, an analyst:

Craig Moffett

Your fixed wireless business, would you describe that as it is part of a convergent strategy for T-Mobile? Or is it part of a capacity utilization strategy where I can pick up some extra money, but I'm not fundamentally pivoting the company towards selling a bundle of fixed and mobile together?

Peter Osvaldik

So for us, fixed wireless was really an ability to monetize the massive excess capacity we're creating with this network…

Moffett

How likely is it that fixed wireless becomes a driver of incremental capital spending? And how do you think about the ROI for that investment?

Osvaldik

Well, it's something that we're investigating. It's not necessarily that it will happen. …

Well, it's something that we're investigating. It's not necessarily that it will happen. …

I will spare you the far longer answers. A long story short, fixed-wireless is too expensive to offer to everyone in the US and it will remain a limited proposition.

So, to answer the above question, fixed-wireless should only have a limited impact on the broadband market in the US and will probably not save Verizon. The current hype seems what it is, a hype, and fixed-wireless will not become a major profit driver for T-Mobile or Verizon in my opinion. For the same economic reason AT&T even hardly offers fixed-wireless.

Summary

The US wireless carriers have some difficult years ahead. The arrival of Dish and the substantial success of Comcast’s and Charter’s wireless businesses will make it very difficult for Verizon, T-Mobile and AT&T to grow its customer base.

Verizon is following a converged strategy of fiber and wireless via its cooperation with the cable companies, and to a more limited extent via its own fiber footprint. Verizon may benefit from its MVNO contract with these two cable companies but we have too little information to get that confirmed.

There are clear indications of a renewed round of price competition in the US wireless market. Comcast and Charter lowered their prices last year and Verizon followed very recently with a too transparent pricing strategy. Economic textbooks teach us that this may not end well for all market participants.

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