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MetroPCS (NYSE: PCS ) took an earnings hit in the first quarter, no doubt about it, with profits dropping precipitously over last year's numbers by 63%. The first quarter is supposed to provide the best numbers for the pre-paid month-to-month mobile carriers, so this result is even more disturbing. But hold on -- what's this? Service revenues actually jumped by 10%. Hmmm.
The answer to that seeming slip twixt profits and revenues lies in the carrier's long-term goal of moving its subscribers onto its 4G LTE network. In fact, MetroPCS has been successful at doing just that -- 16% of them have upgraded to LTE-capable smartphones, almost doubling the company's LTE subscribers.
But with that success came its profit margin woes. Getting those subscribers to upgrade to LTE phones meant the company had to do what the long-term contract carriers have been forced to do: subsidize some or all of the costs of those pricey smartphones. MetroPCS's cost per gross addition was up considerably over the same period last year, almost 50% higher to $235.
And that was the culprit, said MetroPCS Chairman and CEO Roger Lindquist in the company's press release: "[T]he significant number of upgrades at a higher promotional handset cost during the quarter resulted in higher costs and as a result both adjusted EBITDA and adjusted EBITDA margins were pressured significantly."
Lower costs, higher profits
The growth in the company's LTE subscribers "occurred in spite of the average price of handsets approach[ing] $300," according to Lindquist in the company's earnings conference call. "We believe acceleration of 4G LTE adoption in the U.S. will rapidly drive lower smartphone cost[s]."
Thomas Keys, MetroPCS COO, said during the call, "We anticipate [the] first wave of affordable 4G LTE smartphones to be introduced prior to the back-to-school season. ... Samsung, LG, Huawei, ZTE, and other manufacturers are developing low-cost handset solutions that will hopefully retail in the sub $150 range."
But until those cheaper LTE phones arrive, Lindquist said, MetroPCS will "focus on operating margins and free cash flow over subscriber growth."
To achieve that, said company CFO J. Braxton Carter, also on the conference call, said the company has "substantially curtailed the handset promotions that were out in the marketplace during the first quarter." That promotion, Carter said, will be replaced with a $25 talk and text plan, something that does not have data or Web access.
But is pay-as-you-go going away?
Speaking of subscriber growth, the company now has 9.5 million customers but saw a slowdown in the rate at which it attracted new ones. Net additions were only 131,000 in the quarter, compared with 190,000 added in the previous quarter, and down 82% over the same quarter last year. MetroPCS's rival month-to-month mobile carrier, Leap Wireless (Nasdaq: LEAP ) , also saw a sudden shrinking of its customer growth in the quarter, down 22% over a year ago. Is this an industry trend?
The answer to that may be attributed to the major carriers' strong push for the downmarket customer. Sprint Nextel (NYSE: S ) and T-Mobile have offered free phones to some people meeting certain low-income thresholds. Sprint even had a secret plan to buy up MetroPCS, one nixed by Sprint's board of directors two months ago.
A good bit of news for MetroPCS is that its 3.1% overall churn rate was down from 3.7% last quarter, and it matched its record low of a year ago. Its LTE churn rate was only 2%. Leap was not so fortunate. Its churn rate rose to 3.3% from last year's 3.1%. Leap also expects its second-quarter churn rate to climb to 4.2%.
At least one analyst is pessimistic about the fate of pay-as-you-go carriers. Craig Moffett of Bernstein Research wrote in a research note: "Leap's results were nothing to write home about; their results were OK. But the results at [Metro]PCS are so poor as to cast a pall over the whole pre-paid subsector."
That's not a pretty picture, but I would like to remind readers that Moffett doesn't pull his punches. It wasn't too long ago that he scared the willies out of Sprint investors when he said that carrier could very well end up bankrupt.
But I digress.
Putting aside the prepaid-carrier industry's worries about having the big boys take over the pay-as-you-go industry, for MetroPCS's grand plan to work, those affordable LTE phones have to get here by the end of 2012. Those phone-making elves had better get cracking. There are only eight more shopping months until Christmas.
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