DoCoMo's Holding Strong

When I look at the competitive pressures and business challenges NTT DoCoMo (NYSE: DCM) faces, I can't help but think this is what Sprint Nextel (NYSE: S), Verizon (NYSE: VZ), AT&T (NYSE: T), and Alltel (NYSE: AT) have to look forward to. What the U.S. providers have going in their favor is that cellular phone penetration rates are slightly lower in the U.S. than in Japan and the population in the U.S. continues to grow, while Japan's is flat. But overall, there are a few large players in each market, and the largest growth opportunities come from selling additional services to existing customers.

Wednesday, DoCoMo reported its third-quarter financial results, and it's safe to say the company continues to tread water while it rolls out a number of services it hopes will increase sales in profits in the future. Through the first nine months of the year, the company's revenues increased 0.4% to 3,597 billion yen ($29.7 billion), while net income decreased 21.8% to 403.7 billion yen ($3.3 billion). Most of the decline in net income is actually due to asset sales in the prior year that are one-time items. Looking at the company from an operating income or EBITDA perspective shows the results were flat, or like revenues down less than 1% compared to last year. Meanwhile, the company continues to have a strong balance sheet and fund the expansion of its high-speed network throughout Japan.

The biggest negative in the report is the increase in the company's churn rate to 0.93% in the most recent quarter, after hovering around 0.60% for the first half the year. From DoCoMo's perspective, the dirty thief is number portability, which was rolled out in late 2006 and allows customers to switch carriers and keep their existing phone number. Despite the increase in the churn rate, DoCoMo now has 52.2 million subscribers, compared to 50.3 million at this time last year. That's a growth rate below its competitor au (owned by KDDI), but ahead of Softbank, which purchased its mobile phone business from Vodafone (NYSE: VOD) in the past year. For now, this is acceptable, but Vodafone is embarking on a price war, which could cause problems for everyone in the industry.

DoCoMo's ability not just to survive but to thrive in this environment is dependent on its ability to roll out new features that customers are willing to pay a slight premium for. One of these features is the company's osaifu-keitai (portable wallet) functionality, which allows a mobile phone to function as a cash card (stored money), credit card, train pass, plane ticket, or other item. Starting from next to nothing a year ago, 20 million subscribers now have phones with this functionality, and 1.5 million have applied for and activated the credit card functionality. The company also has 100,000 readers in place in Japan that allow customers to use the portable wallet functionality of their phones, and it expects to have 150,000 in place by the end of March. It's important for the company to continue building out the network effects here because the financial success for DoCoMo is not in the phone sales, but in the transactions.

DoCoMo doesn't have an easy road in front of it, and the company's shares reflect a scenario where the business never grows free cash flow again or grows it only by about 1% a year. While this could be the case, I happen to believe the transactional model the company is attempting to build should allow for slightly higher growth. Within the next few years, we'll know one way or another.

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Alltel and Vodafone are Motley Fool Income Investor recommendations. AT&T is a former Stock Advisor recommendation.

At the time of publication NathanParmelee owned shares in NTT DoCoMo but had no financial interest in any of the companies mentioned. He was ranked 40th out of 21,218 CAPS investors. The Motley Fool has an ironclad disclosure policy.