Will T-Mobile Really Take Over the Wireless Industry?

T-Mobile is offering to pay up to $350 in early termination fees for customers switching away from AT&T, Verizon, and Sprint. Should competitors be worried?

Jan 13, 2014 at 7:00AM

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T-Mobile US (NASDAQ:TMUS) has really shaken up the wireless industry in the last year with its "Un-carrier" strategy and aggressive marketing. Now, the company is looking to build its momentum with big promotions to lure postpaid customers away from rivals AT&T (NYSE:T), Verizon (NYSE:VZ), and Sprint (NYSE:S).

Indeed, T-Mobile CEO John Legere recently declared, "We are either going to take over this whole industry, or these bastards [i.e. other telecom firms] are going to change." However, while T-Mobile is flashing the cash today in order to boost its growth, this tactic will not work in the long term. Buying growth is simply too expensive, and T-Mobile's rivals have much better access to capital in the event of a price war.

The T-Mobile threat
By doing away with device subsidies last year, T-Mobile has been able to offer potential customers lower monthly rates and no contracts, along with a variety of other perks. This strategy has helped T-Mobile quickly reverse a trend of subscriber losses. T-Mobile grew its branded postpaid subscriber base and total customer base by about 10% each in 2013.

The potential threat to other carriers got even greater last week, when T-Mobile announced that it would reimburse new customers for up to $350 in early termination fees from AT&T, Verizon, and Sprint. Additionally, under this new promotion, T-Mobile is offering an instant credit of up to $300 for trading in an old smartphone from one of those carriers.

This attacks one of the most important barriers preventing people from switching wireless providers. With the advent of family plans and 2-year contracts, many families are locked into their carriers because different family members' contracts end at different times. So while one person may be free to switch now, another family member may have a year left on-contract. Typically, the result is that the first family member upgrades his or her smartphone, thus locking in the whole family even longer!

A paper tiger
T-Mobile's new promotion raises the specter of a price war among the big four wireless carriers. To be fair, AT&T and Sprint had already rolled out new incentives of their own in the week before T-Mobile announced its plan. However, T-Mobile's promotion is significantly more aggressive, which could provoke even bigger responses from competitors.

However, I do not expect T-Mobile's current promotion to last very long, and I don't think it will do too much damage to wireless carrier margins. In all likelihood, it's just a test to see how people would react if early termination fees were no longer an obstacle to switching.

The key issue is that the incentives T-Mobile is offering are too generous to be sustainable. The company is currently shelling out up to $350 for anybody who switches -- and that assumes that T-Mobile will eventually break even on the smartphone trade-ins. At that level, customer acquisition costs can really add up.

AT&T and Verizon combined account for around 180 million retail connections. At $350/person, winning just 5% of these subscribers would cost over $3 billion! By contrast, T-Mobile's most recent guidance calls for adjusted EBITDA (a measure of earnings power) of $5.2 billion-$5.4 billion for all of 2013. Add in T-Mobile's better-than-$4 billion in annual CapEx, and you have a recipe for bleeding cash.

Moreover, AT&T and Verizon -- and even Sprint, due to its partial merger with SoftBank -- have much more financial heft than T-Mobile. All three competitors have the wherewithal to offer their own counter-incentives (either to retain customers or to win subscribers back from T-Mobile) and thereby make it prohibitively costly for T-Mobile to buy subscriber growth.

Foolish bottom line
T-Mobile has really shaken up the U.S. mobile industry in the last year, and it looks set to continue on its disruptive path in 2014. T-Mobile's recent incentives for subscribers switching from AT&T, Verizon, and Sprint are great for consumers, but they may not last long.

The problem is that if the new incentive scheme really became popular enough to pose a significant threat to the industry leaders, it would be prohibitively costly for T-Mobile. T-Mobile can't afford to shell out billions of dollars in subscriber acquisition costs when it also needs to invest heavily in its network to keep up with competitors. As a result, today's apparent price war in the wireless industry is more likely to fizzle than explode.

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Fool contributor Adam Levine-Weinberg has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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