Shrinkage is Good

Consolidation is coming. While investors in wireless stocks have been taking it on the chin this year, carriers and financiers who attended Kagan World Media's Wireless Connectivity Summit last month said they are waiting for the next round of M&A action to re-ignite confidence in the sector.

While wireless is still arguably a growth business — subscriber growth was nearly 20% last year despite the weak economy, with a similar expansion expected in 2002 — the upgrades planned by most carriers for next-generation services will be expensive.

Combine the uncertainty surrounding demand for 2.5G/3G services with the perennial churn problem, and it's no wonder buyers are in short supply.

The need for consolidation is supported by numerous arguments and proponents. For one thing, valuations are more attractive than they have been in years. The recent sell-off in wireless stocks has pushed trading multiples (of EBITDA) into the single digits — levels not seen since the liquidity crisis of 1998. For diversified companies like the Bells or Indies that don't have strained balance sheets, never has the menu been so appetizing.

Additionally, carriers are refocusing on quality subscriber growth and retention rather than the high top-line sub growth revered in recent years. So rather than investing millions in marketing and promotions to show strong growth in customers — which may not have been profitable in the first place — carriers this year are investing in network quality and churn reduction efforts.

Every 20-basis-point reduction in monthly churn creates an additional $14 billion in industry value. So while much is made of the cost of next-gen upgrades and the bevy of data services not yet being clamored for, the upgrades provide returns in terms of customer satisfaction far sooner than m-commerce and location-based services. The latter become a longer-term bonus.

Meanwhile, the status of additional spectrum auctions remains uncertain, but the FCC has already ruled on the removal of spectrum cap limits. Spectrum-constrained operators are better off merging with each other than waiting for the NextWave situation to resolve or for new auctions to take place.

In fact, the handwriting is already on the wall in terms of carrier cooperation: Cingular/VoiceStream/AT&T and Alltel/Verizon demonstrate that care is being taken with capital deployments, asset usage and service offerings. Such ventures surely portend closer alignment down the road.

To ensure industry profitability and efficiency, the number of national carriers needs to fall from six today to three or four in the long run. The current administration should be kind to merging firms in any antitrust rulings, and once the first major combination is announced, several more could follow within a short time.

Smaller public carriers will then see where they fit in the long-term design, and investors will get the valuation benchmark they badly need to regain interest in the sector.

Richelle Elberg is a Senior Wireless Analyst for Kagan World Media (www.kagan.com).