T-Mobile and AT&T are killing the gap between prepaid and postpaid

Prepaid customers have long been almost an afterthought for most major U.S. network operators, who have opted instead to focus on postpaid users who often generate higher ARPU and lower churn. But as the growth of smartphone sales slows -- and as the gap between prepaid and postpaid ARPU narrows -- carriers are increasingly focused on the prepaid segment.

And as first-quarter earnings indicate, T-Mobile and AT&T continue to make big strides.

"We all naturally lavish a tremendous amount of time and attention on the postpaid market," MoffettNathanson analysts wrote in a research note analyzing the first-quarter performances of the four major U.S. carriers. "But as AT&T is quick to point out, the distinction between the two is becoming increasingly arbitrary."

T-Mobile and AT&T making gains

AT&T, which pursues the market aggressively through its Cricket brand, reported 500,000 prepaid net additions in the U.S. during the first quarter, and an additional 450,000 in Mexico. And T-Mobile, which employs a similar strategy through its MetroPCS offering, reported a record 807,000 net prepaid customer additions during the period.

Meanwhile, Sprint lost a net 264,000 prepaid users during the most recent quarter, down drastically from the 546,000 net additions it posted in the prior year and substantially worse than Evercore ISI's estimate of 100,000 net losses. Verizon, interestingly, appears to be the lone U.S. operator to essentially ignore prepaid, opting to view the MVNO TracFone -- which, notably, sells service on all four major networks -- as its own prepaid offering in an effort to avoid cannibalizing its postpaid business. Verizon lost 177,000 net prepaid users during the quarter, which was actually down from the 188,000 net losses it posted during the prior year.

And while increased competition appears to have driven down overall postpaid ARPU over the last three years, prepaid ARPU has made modest gains. MoffettNathanson estimates indicate T-Mobile has seen its postpaid ARPU fall from $54.07 to $46.05 since the first quarter of 2013, for instance, while prepaid ARPU has risen from $35.96 to $37.58.

Similarly, Verizon's postpaid ARPU peaked at $58.04 in the third quarter of 2014 but has since fallen to $51.87. But its prepaid ARPU rose from $22.86 to $31.68, which may signal that nation's largest carrier is better monetizing the prepaid users it isn't shedding.

T-Mobile and AT&T are seeing even higher ARPUs from their dedicated prepaid brands. T-Mobile CEO John Legere said recently that MetroPCS customers generate ARPU in the range of $38 to $39, which he described as "very steady, very good." And Cricket customers generated an ARPU of $41 during the first quarter.

And the pricing gap between prepaid and postpaid offerings is converging just as the ARPU gap is. MoffettNathanson said prepaid plans are roughly only $5 to $10 a month cheaper than entry-level postpaid plans, due largely to price compression in postpaid stemming from increased competition.

Prepaid and postpaid 'now more fungible'

The rising importance of the prepaid user stems in part from the emergence of equipment installment plans (EIPs) and the move away from two-year contracts, MoffettNathanson noted.

"The economic rationale for being a postpaid subscriber was party the subsidized handset," the analysts wrote. "If you're going to buy (and finance) your handset anyway, you might as well do it with the cheapest available price plan. Prepaid and postpaid are now more fungible. At the same time, the price distinction between the two has narrowed, in part because, well, there's just not that much difference anymore."

And as MoffettNathanson analysts note, the prepaid market is no longer driven by price alone (if it ever was) -- Sprint's Boost is the cheapest when adjusted for data plan size, and Verizon "has apparently intentionally priced itself out of contention."

With competition heating up in the prepaid market, it's worth noting that the biggest recent success stories are the dedicated prepaid brands of Cricket and MetroPCS rather than carrier-branded offerings or MVNOs. That phenomenon may be why Sprint appears to be shifting its focus away from Sprint Prepaid ahead of a relaunch of its Virgin brand later this year.

Whether Sprint can leverage a new Virgin offering regain lost ground in the segment is unclear, although Verizon's near-absence may provide an opening. Perhaps the most important question, then, is whether the nation's largest carrier will continue to cede prepaid even as growth in the postpaid phone market plateaus. For now, at least, the answer seems to be yes. --Colin | @colin_gibbs

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