Super Game Sunday greetings from Kansas City (H&R Block Headquarters pictured) and Charlotte. The Patterson household is eagerly awaiting the 49ers/ Chiefs matchup and the return of the Vince Lombardi trophy to the City of Fountains. Regardless of the outcome, there is no doubt that the AFC Champions have generated city-wide enthusiasm not seen since hundreds of thousands packed the Union Station plaza to celebrate the Royals 2015 World Series pennant (great pic in the link that will bring back memories for fellow Kansas City fans).
This week, we will cover two fourth quarter earnings announcements (Charter and AT&T) and do our best to correlate our findings into common themes. Due to the overwhelming amount of material to cover, we will not have any TSB follow ups this week.
One final reminder for the Denver TSB faithful – I’ll be keynoting the 5th Annual Colorado Wireless Association Education Conference this Wednesday (February 5th). It’s a full day of panels, speakers, and networking. More on the conference here.
Charter Earnings – Why is Tom Rutledge Smiling?
We’ll start our earnings analysis with Friday’s earnings announcement from Charter which blew away all expectations (link to material is here) . Like our discussion of Comcast, Charter lost video and voice subscribers versus the previous quarter (105K and 152K respectively). Unlike Comcast, Charter got a jump start on a video price hike and grew sequential revenues (+$113 million) in video. The fact that Charter was able to successfully implement price increases in the fourth quarter is one reason Mr. Rutledge is smiling.
We would argue, however, that the greatest reason for optimism going into 2020 is Charter’s High Speed Internet (HSI) performance. Here’s a chart outlining their growth in subs, penetration, and revenue per Personal Subscription Unit (PSU) over the last several quarters:
There’s a lot of information in this analysis, but here’s the punch line: Charter is growing volumes of their HSI product and growing yields. They are doing this as a result of capital spent prior to 2020 (DOCSIS 3.1 investment – roughly $450 million) and this product does not have the retransmission renegotiation cost burden that video carries (60-65% of every video PSU dollar earned goes directly to programmers). Outside of Bloomberg/ Trump/ Steyer/ DNC/ RNC election-driven advertising growth in 2020 (which also cracks a smile), High Speed Internet growth is highly profitable and desired.
Not only was Charter able to grow video revenues, but they also hiked prices on High Speed Internet (new and base), a bold move when you consider their territory includes fiber-rich areas such as New York City (Verizon FiOS), Los Angeles (AT&T U-verse), Atlanta (U-verse), and Dallas/ Ft Worth (also U-Verse with a bit of Frontier FiOS). As the chart shows, Average revenue per PSU/ mo. rose from $55.29 in 4Q 2018 to $58.51 in 4Q 2019 (+5.8%) and ending subscribers also grew 1.3 million.
So what turns Mr. Rutledge’s grin into a full toothy smile? That nearly 25 million subscribers in 2020 will be paying $3.22 more per month for their Internet and that underlying costs to manage this base are falling on an absolute basis. 24.908 million * $3.22/ month = $80 million per month or ~$960 million in annualized (nearly) free cash flow happiness for 2020. This is before additional household growth (which continues into 2020) and DOCSIS 3.1 upgrades. Mr. Rutledge has more growth options than Andy Reid’s offensive playbook.
This price-up (to use a Verizon term) covers a lot of debt repayment and investment (re: Charter had a 4.45x leverage ratio entering 2020 or 4.31x excluding mobile losses). It also covers a lot of mobile investment. As the revised chart shows, Charter added 288K net subscribers to their base, crossing the 1 million threshold and garnering 7% more subscribers in their first six quarters of operation than Comcast. Together, the two cable MVNOs had ~550K net additions (note that substantially all of these are coming from smartphones and should be compared to wireless carrier phone net additions figures as a result).
While wireless revenue grew 23% sequentially, Charter CFO Chris Winfrey was quick to point out that the majority of that revenue came from handsets ($138 out of $236 million or about 58%). Charter sold a lot of devices in the quarter as a percentage of gross additions (this was helped in part by the retail store investments described in their earnings release).
This also indicates that Charter had $98 million in quarterly service revenues (management did not give the exact mix between unlimited and by-the-Gig but seemed satisfied that the mix was “healthy”). Using an average customer base of 938K wireless subscribers in the quarter, this translates into a ~$35 ARPU for their current base. If we assume that 47% is unlimited ($45 ARPU) and 53% is by-the-Gig, this equates to ~$26 ARPU for by-the Gig. As we have stated, and as Charter’s comments largely supported, the by-the-Gig gross profit is supporting what is a gross margin breakeven proposition at best for Unlimited. In his comments about profitability, Winfrey stated that “in 2021, our mobile service revenue will exceed all regular operating costs, excluding acquisitions and growth related mobile costs.”
One of the ways to improve profitability is to extend the offload footprint. This could take the form of greater public Wi-Fi Hotspot deployment/ alliances, or to find additional offload partners like AT&T. In this regard, and to no one’s surprise, Charter indicated that they would be a likely participant in the CBRS Priority Access Licenses (PAL) in June (CBRS is a 3.5 GHz spectrum band further explained in this TSB here and in the TSB Deeper post here). PALs will be auctioned on a county basis (smaller than MSAs or BTAs – see 2018 RCR wireless article explaining the difference here). Charter described this decision as separate from the ongoing capital allocation process – “a separate business case” that needs to stand on its own ROI.
One of the interesting stories to unfold is how (or even if) all of cable embraces CBRS and significantly builds out capacity in their markets. Given Apple’s and Google’s votes of confidence in the spectrum band (and potentially adjacent bands as we talked about in last week’s TSB), the offload opportunity could be significant, causing Charter and Comcast’s relationship to resemble a C Spire or US Cellular relationship with Verizon, and less like a traditional MVNO. More on this topic in upcoming briefs.
Bottom line: Price hikes are sticking, margins are growing, operational efficiency is improving, and debt loads are decreasing in an advertising-intensive election year. Cable has won the broadband battle for now against AT&T and Verizon in most rural locations (it’s hard to actually categorize any ILEC as an incumbent on a go forward basis), and, while video is transitioning to streaming, Charter has growth in business and mobile to offset. While they still have a lot of debt ($78.4 billion and shrinking), there’s growing cash flow to keep investors and management smiling.
AT&T Earnings – What’s the Growth Plan (besides HBO Max)?
AT&T had a quarter where each major business line except for mobile service posted lower operating revenues versus 4Q 2018 (full results can be found here). Here’s the fourth quarter and full year picture for the Communications Segment:
And here’s the WarnerMedia segment:
The dynamics of each group are very different, but we contrast the tepid performance assessment seen from AT&T with the upbeat assessment by Comcast last week (where cable revenues rose 2.6% including 8.8% in business revenues and EBITDA rose 5.4%, and NBC Universal revenue only declined by 2.8% and EBITDA by 4.7% with Olympic tailwinds in 2020). While there are some differences between the programming and production assets each company owns, the Comcast portfolio once again beat (and in the case of cable vs. wireline, trounced) their closest broadly diversified competitor.
Rather than do a full dissection of AT&T this week (we will save that for after the CenturyLink earnings release), our attention will be focused on mobility earnings. AT&T Mobility grew 2019 revenues thanks to higher prepaid (Cricket) customers and marginally higher postpaid ARPUs (0.4% or $0.24/ user/ month – contrast that with Charter’s HSI growth) per postpaid phone user (see nearby chart). The overall postpaid base decreased 861K versus 2018 driven by feature phone and data plan decreases. Lower subscriber bases place pressure on AT&T to raise revenue per user on the remaining base (HBO Max), sell more prepaid, and the like. Churn rose for both postpaid as a category and for the important phone subset to their highest levels in recent memory.
While the fourth quarter is seasonally weak, AT&T’s prepaid net additions continue to decrease at a very steady clip. Part of that competition comes from T-Mobile’s continued suburban and rural expansion (nearly 100K subscriber gap between T-Mobile and AT&T in 4Q net additions), as well as by-the-Gig options from cable.
On the postpaid side, it’s interesting to note that AT&T grew their total base of smartphone users by 302K (and phone overall by 229K). In their Business Solutions proforma, wireless solutions revenue grew by $141 million versus 4Q 2018 but only $15 million versus 3Q 2019. Even at $15 million, however (at $55 ARPU), approximately 91K of the 229K comes from business (40%). This highlights two key issues: 1) Business wireless service growth slowed significantly in the fourth quarter versus the previous three, and 2) Even with the slower growth, Business (and likely FirstNet as a proportion of this) played a major role in overall net additions.
Bottom line: AT&T’s real consumer phone growth, factoring in prepaid losses, was closer to 120K which was weaker than 2Q and (likely) 3Q. When weighed against Comcast+Charter growth (4-5x stronger) and T-Mobile’s growth (likely 8x stronger when factoring out business net additions), AT&T is losing ground. To grow mobility service revenues more than 2% (which will likely be required to meet the overall 1-2% growth level), AT&T will need to create a more competitive consumer value proposition.
Based on the earnings call, this is exactly what AT&T executives envision with the addition of HBO Max to select wireless plans. As reference, to get HBO Max for free, customers need to either be existing HBO Now customers or be on the AT&T Unlimited Elite plan (see plan features here). In addition to HBO, this plan includes 100 GB of High Speed Data per line, 30GB of which can be Hotspot, prior to prioritization.
For every 100,000 wireless who upgrade (assuming the ARPU impact is ~$11/ month), AT&T’s full quarter revenues will rise $3.3 million. To grow mobility service revenues 1% from their current levels ($13.93 billion in 4Q), revenues need to grow $139 million. To have HBO Max account for all of this increase, they will need to have 4 million upgrades immediately to show service revenue growth (4 million upgraded lines * $11 increased ARPU per line * 3 months = $132 million in increased quarterly revenue). That seems a reasonable initial adoption rate, but 3-4 million per quarter throughout 2020 is another issue.
Then there’s the thought mentioned on the conference call that 5G speeds would drive conversions from metered to unlimited plans. Here are AT&T COO John Stankey’s comments from the call:
“We also expect a higher adoption of our unlimited plans. We’re at a little more than 50% penetration today, but we expect the 5G device upgrade cycle will bring into our stores lots of customers not on unlimited plans today. Increasing the adoption of our best unlimited plans is obviously an ARPU growth opportunity for us. And when you add into the mix the customers on select unlimited plans will get HBO Max for free, it’s a great opportunity to also improve our overall churn, which we’ve seen happen from giving HBO to current unlimited customers. A reduction of 1 basis point of wireless churn across the base is worth about $100 million to us annually. To sum it up, we’re expecting growth of more than 2% in mobility service revenues this year.”
Underlying this statement are two fundamental questions: 1) After being conditioned during capacity scarcity over the past three years that standard definition video resolution is OK for normal use, will customers be convinced by advertising and in-store representatives that it’s finally time to upgrade simply because they purchased a new and improved device? and 2) This clearly assumes that 1080p remains a premium product and not the new standard, especially for 5G, for baseline plans. If the T-Mobile/ Sprint merger is approved, what are the chances that T-Mobile will keep HD at their current price points versus launching a new Uncarrier initiative called “HD for All?” Or, if the merger is not approved, what are the chances that Sprint will use HD baselining as a differentiator in those markets where it has chosen to deploy 5G? The inertia is too great to price a valuable product feature (same GB cap) at lower rates if capacity exists. And, either way (and especially if the merger is approved), capacity will be available for this feature in late 2020/ early 2021.
We will need to pick up the Verizon and Sprint earnings analysis (as well as wireline analysis overall) next week. Until then, if you have friends who would like to be on the email distribution, please have them send an email to email@example.com and we will include them on the list.
Have a great week – and (with extra emphasis this Sunday) GO CHIEFS!