The Worrisome Wireless Pricing Wars

Pricing wars and low customers additions should have investors on alert at domestic wireless providers including AT&T, Verizon Communications, and T-Mobile.

Jul 21, 2014 at 12:30PM

A couple of notable trends are making investing in the domestic wireless space a concern. The stocks trade at multiyear highs and a pricing war triggered by T-Mobile (NASDAQ:TMUS) is causing average revenue per user, or ARPU, to decline -- at least in the case of AT&T (NYSE:T). The combination usually doesn't go hand in hand , especially considering the domestic market is virtually saturated with users, causing Verizon Communications (NYSE:VZ) to struggle with customer additions since it hasn't entered the pricing wars.

Any pricing war should always alert investors to pending stock losses, but with AT&T trading sideways for nearly two years now do investors really have cause for concern?

A worrisome trend
The aggressive pricing moves by T-Mobile led BTIG analyst Walter Piecyk to warn of potential ARPU declines at AT&T. The analyst said the culprit was AT&T's elimination in February of device leasing requirements for existing subscribers to sign up for shared plans in the 10-gigabyte range. The move immediately caused a flood of customers to the shared plans that could reach 60% of total subscribers by the end of 2014. Piecyk said he expects service AT&T revenue to decline by up to 5%. Even worse, he expects the annual decline to hit 10% and cause ARPU to drop below $60 by 2015.

Verizon isn't seeing the same impact to service revenue, since it placed greater barriers on customers switching to lower data pricing plans. The analyst said he only expects 30% of smartphones acquired during Verizon's second quarter to be leased by customers, placing less pressure on ARPU.

Lack of customers
The biggest problem facing wireless carriers is that virtually all Americans now have wireless phones and the vast majority are using smartphones. That makes it difficult to grow service revenue, especially when a weaker third or fourth largest competitor is willing to lower pricing. AT&T and Verizon are faced with the options of keeping pricing stable and not adding subscribers or cutting ARPU and gaining a few subscribers.

That trend was very evident in the first quarter, as T-Mobile added over 2 million net customers while both AT&T and Verizon struggled to keep subscriber totals flat from the previous quarter. While AT&T added 625,000 net postpaid subscribers of apparently questionable quality and recently guided toward adding roughly 800,000 in the second quarter, Verizon Wireless added only 539,000 net subscribers.

Foolish takeaway
Based on the analysis from BTIG, Verizon and especially AT&T are likely hoping for an eventual merger between Sprint and T-Mobile. Any combination that creates a large third domestic wireless provider could end the push to attract customers at all costs and allow for stable pricing and strong margins among the remaining companies. Outside a merger, the only hope appears to be for a push to higher data plans in the 20-gigabyte range that would strain the networks of both Sprint and T-Mobile and provide advantages for the most advanced networks of AT&T and Verizon Wireless.

Lower revenue from existing customers is always a worrisome trend, especially in a saturated market. If a provider can't add customers, revenue is going to head in the wrong direction, and that is never good for a stock. With the sector, especially AT&T, trading at recent highs, the combination doesn't add up for stock gains going forward in the wireless business.

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Mark Holder and Stone Fox Capital clients own shares of AT&T.; 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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David Hanson owns shares of Berkshire Hathaway and American Express. The Motley Fool recommends and owns shares of Berkshire Hathaway, Google, and Coca-Cola.We Fools don't 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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