Behind In LTE Coverage AT&T Spends Big To Gain New Customers

Having trailed the industry leader Verizon (NYSE:VZ) in adding wireless subscribers in recent quarters by a big margin, AT&T (NYSE:T) is stepping up its efforts to bridge the gap. The second largest wireless carrier in the U.S. announced Thursday that it will add a higher than expected 500,000 wireless subscribers during Q2 2013 on several successful promotions that it ran during the quarter. This net adds guidance is a good 70% higher than the previous quarter and over 50% more than the number of subscribers it added in the year-ago quarter. The high cost of promotions and subsidies on smartphones sold will however cause margins to shrink. AT&T expects Q2 EBITDA margins to be comparable to last quarter, implying a y-o-y decline of around 180 basis points.

However, the margin compression should not be much of a concern since the carrier has in return for the subsidies locked its subscribers into two-year postpaid contracts. The near-term margin hit will therefore be more than compensated for by the regular service fees that the subscriber is obligated to pay AT&T over the term of the contractual period. A saturated wireless market however means that AT&T’s subscriber gains this quarter are coming at the expense of its rival carriers. It will be interesting to know if Verizon or one of the smaller carriers is facing the brunt of AT&T’s aggressive marketing campaign this quarter. If AT&T is being successful in weaning subscribers away from Verizon, it may even decide to continue its margin-compressing promotions for a few more quarters.

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AT&T Making Up For LTE Lag

The U.S. wireless market has become increasingly saturated recently with wireless connections having exceeded the population in mid-2011. This has made the acquisition of new subscribers, especially those that pay for the higher-margin data plans, highly tough for the wireless carriers. AT&T’s dismal postpaid net adds in recent quarters is to an extent reflective of this industry-wide phenomenon, but Verizon’s comparatively much better performance shows that LTE coverage is the differentiating factor here. While Verizon added close to 680,000 postpaid subscribers last quarter, AT&T did less than 300,000 during the same period. Last year as well, Verizon added over 5 million postpaid subscribers, more than three and a half times of AT&T.

Being the first carrier in the U.S. to start 4G LTE deployment, Verizon has raced ahead of rivals with LTE coverage in about 497 markets currently – almost 95% of its 3G footprint. With its initial LTE deployment phase nearly done, the carrier is gearing for a second round of LTE deployment that will see it use its recently acquired AWS airwaves from the cable companies. In comparison, AT&T expects to complete its initial LTE deployment only by the end of 2014 – a full year and a half after Verizon. Currently, AT&T’s LTE network is available in about 280 U.S. markets and will cover about 300 million Americans by the end of 2014.

With Verizon touting its LTE lead to gain an upper hand over AT&T in recent quarters, it will be interesting to see if AT&T’s better than expected Q2 subscriber adds have come at the bigger carrier’s expense. If so, it may cause AT&T to continue its promotions and aggressive marketing strategy in the next few quarters as well, causing margins to remain compressed in the near term. We will be watching for comments in this regard during next month’s earnings call.

LTE to help margins in the longer term

The margin compression will be less of a concern in the longer term as AT&T bridges the LTE gap in the coming quarters and its new LTE network sees increased adoption. This will reduce dependence on AT&T’s 3G networks, which are under great strain due to heavy data usage by smartphone users. Also, LTE as a network technology not only supports higher speeds but is also more efficient than the current 3G networks at handling data, thereby improving margins by reducing maintenance and handling costs.

Further, higher LTE speeds will see subscribers increasingly use data-intensive applications on their smartphones. This will drive data revenues, thereby increasing ARPU levels for AT&T over the coming years. In the near term, limited LTE coverage may be a deterrent for some, but a fallback option in the form of the carrier’s HSPA+ network, which provides higher speeds than 3G and has a wider coverage area than its LTE network, should offer an interim solution.

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