North American Wireless Industry Study: Releases Industry Study

Chris Diceman, CFA, Rory Buchalter, CFA / 416-593-5577 ext.2242, ext.2268 / cdiceman@dbrs.com

 

DBRS is releasing the North American Wireless Industry Study: “The C’s of Change.” The Study cites concerns that the wireless industry is becoming more challenging with the increasing business and financial risk due to slowing subscriber growth.  As a result only those carriers with substantial customer bases and the support of a telco-affiliated parent will likely maintain their current credit ratings.  However, those lacking size or parental support will likely see further pressure on their balance sheet, with corresponding reductions in their credit ratings.

 

A key issue that the study identifies is that it appears subscriber penetration levels in North America may not reach the levels seen in Europe.  This may not have been a realistic expectation in the first place, as the growth that was originally forecasted now appears to be based on adding subscribers with lower marginal value.  On the other hand, the European penetration levels were based on fundamental differences in the business model and different market conditions. 

 

While the North American wireless industry continues to grow, overall subscriber and operating cash flow growth is easing, raising concerns about (1) near term liquidity, (2) capital markets support, and (3) growing market share in the major markets where they operate.  As a result, there is a heightened concern about the ability to increase cash flow and reduce debt levels.

 

In response, the wireless operators in North America are focusing on ARPU, subscriber, and EBITDA growth.  However, free cash flow net of the items below remains the key criteria.  With future growth now uncertain, the industry’s ability to generate sustainable free cash flow will now depend on how it manages “The C’s of Change.”

 

(1)     Capex: The cost of growth, especially capital expenditures, must be examined.  Capex budgets for the current year have not been scaled back to reflect what appears to be a diminished growth profile.  In addition, there has been too much duplicative capex in the U.S. with six carriers building national footprints with only minimal co-builds.  Although wireless operators project that future growth will be linked to data- related services, this same argument was used in the long-haul carriers industry that is currently in turmoil.

(2)     Churn rates: Customer churn is an issue that wireless operators in North America have not addressed adequately.  With rates generally ranging from 2%-3% per month (annual subscriber turnover of between 24%-36%), it would suggest that customer service levels are somewhat lacking for most operators.  As wireless services are now essentially a commodity, the industry needs to adopt measures for better customer retention to create differentiating factors based on customer service and reliability.

(3)     Cost of customer acquisition: North America has substantially higher costs of customer acquisition relative to Europe attributable to handset subsidies and related marketing costs.  Assuming that most high- value business customers already have wireless service, the value of the incremental subscriber being acquired is somewhat questionable.  Lower-cost direct distribution channels and reduced handset subsidies for lower ARPU subscribers will have to be emphasized going forward to reduce costs.

(4)     Consolidation: There are many parallels between the evolution of the North American wireless industry and the long-haul carrier industry. The roll-out of advanced technology networks ahead of known customer demand has increased financial risk, as large capex programs have been predominantly debt financed.  However, unlike the long-haul carrier industry, most wireless carriers have substantial customer bases and do generate positive operating cash flow.  These factors support industry consolidation.

 

 

Dominion Bond Rating Service Limited (DBRS) has published a study that provides additional analytical detail.  To see this study, please click on http://www.dbrs.com/web/sentry?COMP=2900&DocId=110940.  If you do not have access to this study, please contact us at info@dbrs.com.