WIRELESS CARRIERS HOLD OWN DURING ROUGH FIRST QUARTER

Heavy focus on curbing costs pays off despite falling growth rates

The wireless carrier sector, reeling from disappointing fourth-quarter 2001 numbers, got some welcome relief last week as most operators delivered healthy subscriber growth and strong cash flow in the first quarter.

Though expectations were lowered, industry watchers are taking first-quarter results as a sign that the industry is holding up well in the midst of the telecom slowdown and intense wireless pricing.

“The big story is that [cash flow] did better than expected, and that shows us there is operating leverage in the wireless business,” said Todd Rethemeier, senior wireless analyst with Bear Stearns & Co.

AT&T Wireless, Sprint PCS, Nextel Communications and VoiceStream Wireless all delivered strong cash flow and subscribers that were better than what Wall Street had predicted. Verizon Wireless, the nation's largest operator, reported a shortfall in customers, but analysts were still pleased with cash flow, the key metric in determining the financial health of a wireless operator. Cingular Wireless also posted lower net subscriber additions as it continued to convert its customer base from its analog system to digital service (see figure).

“Everyone is focusing on cutting costs — network costs for a minute of airtime, costs to acquire customers and reducing churn,” said Adam Guy, senior analyst for The Strategis Group.

Carriers also are being forced to look internally for cash. “All efforts are going toward generating more revenue per subscriber and reducing costs,” said Timothy O'Neil, wireless analyst with SoundView Financial Group.

This news is a refreshing change after investors punished wireless stocks in the first few months of 2002. The fourth quarter is typically the segment's most important because of the Christmas selling season. However, net subscriber additions remained relatively flat for most carriers, and wireless carrier-related stocks have fallen about 33% since the beginning of the year.

“While the market was quite pessimistic about the short-term outlook of the wireless industry, Sprint PCS not only met but exceeded expectations in several areas,” Arthur Krause, executive vice president and chief financial officer of Sprint, said during the company's conference call last week.

Sprint PCS, however, is not about to change the downward estimates it made at the beginning of the year regarding industry growth, choosing to remain cautiously optimistic. AT&T Wireless said it expects lower subscriber additions in the second quarter as the momentum from its new Mlife campaign and pricing promotions slow down.

“We will grow the year's EBITDA faster than revenue,” AT&T Wireless Chairman and CEO John Zeglis predicted during a conference call with analysts last week. However, Zeglis cautioned that intense pricing pressure would continue pushing average revenue per user (ARPU) lower.

“The industry's price down makes ARPU our No. 1 challenge,” said Zeglis. “At the same time, we are not going to make ourselves uncompetitive in the market place, even though we dislike lower prices and their effect on ARPU.”

Indeed, wireless operators have become more aggressive in pricing and marketing, and consumers have become more intelligent in the way they use wireless service in a slowing economy. During the first quarter, Verizon Wireless, Cingular and Alltel introduced more aggressive nationwide plans, bundling more minutes in affordable pricing plans. Last week, AT&T Wireless effectively raised rates on local and regional calling plans but expanded its selection of nationwide calling plans.

Customers, cognizant of their spending, are using wireless more during off-peak periods and not using more than their allotted minutes, a phenomenon carriers have long counted on to boost revenues.

And industry analysts are seeing another positive trend. Wireless minutes are displacing wireline minutes at a rapid rate, with the largest impact on the wireline long-distance market.

“[Wireless] carriers are taking more of a share from landline than landline wants to admit to,” said Patrick Comack, telecom analyst with Guzman & Co.

Sprint reported that its consumer long-distance voice volumes were down 10%, attributing the majority of the impact to wireless substitution. Merrill Lynch estimates AT&T's consumer long-distance revenue will fall 25% year over year in 2002, with more than half of the decline attributable to wireless replacement.