LTE may not save Leap or MetroPCS

editor's corner

Leap Wireless International (NASDAQ:LEAP) and MetroPCS (NYSE:PCS) discussed their latest LTE strategies as they revealed their first-quarter 2012 earnings last month. While both are bullish on the benefits they expect to receive from rolling out LTE, the logical response to their plans might best be summed thusly: So?

While both prepaid carriers work diligently on plans to deliver LTE-based broadband wireless services and compatible devices on par with their larger competitors, the fact is their efforts may be for naught. Both regional operators are struggling to keep pace with their national rivals, and the investments they are making in LTE will not help them differentiate significantly. At best, LTE will enable Leap and MetroPCS to play a game of keep-up with deeper-pocketed operators, while MVNOs and carrier sub-brands aggressively attempt to undercut both carriers' prepaid price plans.  

MetroPCS secured its spot in the record books as the first U.S. operator to introduce commercial LTE service, and it also marketed the world's first dual-mode 4G LTE/CDMA handset. At the end of the first quarter, MetroPCS had rolled out LTE to 80 percent of its total footprint covering roughly 9,500 cell sites, and the company expects to have full coverage by the third quarter.

Leap intends to cover 25 million POPs with LTE in 2012 and should cover two-thirds of its current network footprint with LTE in the next two to three years. It also signed a five-year wholesale LTE agreement with Clearwire (NASDAQ:CLWR) to provide capacity for off-load services to supplement its own LTE network. "We are pleased with the performance of our initial LTE launch in Tucson and the progress we're making toward deploying LTE in additional markets," said Bill Ingram, executive vice president of strategy and acting CFO.

Leap said its total capex will be between $600 million and $650 million in 2012, while MetroPCS reaffirmed its 2012 guidance for capex of $900 million to $1 billion.

While all of this future-looking network development work has been occurring, both Leap and MetroPCS reported shocking slowdowns in customer additions during 2012's first quarter, as consumers sought cheaper options or went with the big operators instead. Leap's net customer additions slid 22 percent year on year, and MetroPCS' net adds plummeted 82 percent. Further, Leap lost $98.4 million in the quarter, while MetroPCS' net income slid 63 percent to $21 million. The oft-grim Craig Moffett of Bernstein Research said in a research note that MetroPCS Q1 results "are so poor as to cast a pall over the whole pre-paid subsector."

The good news is that both operators are seeing their customer bases migrate from basic and feature phones to smartphones, which generally entail pricier plans that include data services. However, smartphones require higher equipment subsidies, which come right out of the operators' bottom lines and occur up front when sales are made.

Both Leap and MetroPCS were stung by steady sales of smartphones from the Straight Talk brand of TracFone, which is owned by Mexico's America Movil. Though TracFone also suffered weaker subscriber growth in the first quarter, BTIG analyst Walter Piecyk said, "Straight Talk benefits from America Movil's purchasing power, which surpasses Verizon (NYSE:VZ), and therefore does not suffer with the same level of subsidies."

With smartphone subsidies strangling its profit margin, MetroPCS is hoping lower-priced LTE smartphones hurry up and arrive so it can more affordably shift users to its spectrally efficient LTE network. The operator would like to have low-cost handsets that cost less than $150 vs. the $300 devices that are now populating the LTE market.

According to a Seeking Alpha transcript of MetroPCS' first-quarter earnings call, Roger Linquist, the operator's chairman and CEO, said MetroPCS will "focus on operating margins and free cash flow over subscriber growth until we can mainstream our LTE For All initiatives with affordable handsets later this year." That's why the operator curtailed handset promotions and since mid April has been pushing a promotional $25 plan offering unlimited voice and texting but no data, a strategy one might call "scraping the bottom of the barrel."

Deutsche Bank recently downgraded MetroPCS from buy to hold, saying it expects MetroPCS to suffer net subscriber losses during the next two quarters "due to a pause in marketing ahead of the planned LTE re-launch in 4Q, and intensifying competition."

At least average revenue per user (ARPU) for both operators increased year-over-year, with Leap attracting $3 more during the 2012's first quarter, which it attributed to a higher penetration of 3G smart devices. Yet the operator said its sequential ARPU growth is expected to slow in coming quarters as smart device penetration matures.

MetroPCS' ARPU was $40.56 for the first quarter, a year-on-year increase of of $0.14 that the operator attributed to continued demand for its Wireless for All and LTE service plans, but it was offset by higher family-plan penetration.

MetroPCS is not shy about the big plans it has for LTE in the years ahead. It intends to launch VoLTE in the second half of this year and is envisioning other services that will exploit its LTE investment. "Whereas considerable softness existed in the CDMA data service segment of our business, our 4G LTE subscribers nearly doubled in the first quarter," said Linquist in the Seeking Alpha transcript. "High-speed data at low latency is a key driver for user satisfaction, but so is the expanded menu of rich communication services, or RCS, that will serve to differentiate our premium 4G LTE services from our competitors' 3G data services."

Nonetheless, it doesn't appear these prepaid operators' heavy investments in LTE can be justified anytime soon, given their problematic metrics and the increasing competition for their prepaid customers. At best, LTE for Leap and MetroPCS is basically a long-term play. Will they have enough time to enjoy a return on their investments? The clock is ticking.--Tammy