During the last quarter, AT&T (NYSE:T) lost another 180,000 postpaid phone subscribers. That brings its tally up to 1.9 million over the past seven quarters. On the bright side, the loss is down from last year's second quarter, when it lost 276,000. Competition in the wireless space is fierce, and Verizon (NYSE:VZ) is successfully cornering the premium market in which it and AT&T play.
AT&T says that it's making up for those subscriber losses with its Cricket brand prepaid customers. Indeed, it's added more prepaid phone subscribers than its postpaid subscriber losses in each of the past five quarters.
But postpaid subscribers are generally considered more valuable than prepaid. They tend to churn out less, and stick to higher-priced phones and service plans such as high-margin family plans. Still, AT&T says it's mostly losing lower-value postpaid subscribers, and it's not worried.
During AT&T's second-quarter earnings call, CFO John Stephens told analysts that the math works out in the company's favor if it replaces postpaid subscribers with prepaid subscribers one for one.
"The postpaid subs we're losing are a lot of feature phones. They are averaging about somewhere around $35," he said on the call. "On the prepaid side, we're probably closer to a $41, $42, depending upon the specifics, average ARPU."
He added that prepaid customers have lower customer acquisition and maintenance costs compared to postpaid subscribers. That's evident in the company's margins, he said.
Indeed, EBITDA margin improved 30 basis points year over year, and adjusted operating margin increased by the same amount. But if you look specifically at AT&T's service margin, you see that EBITDA service margin is flat year over year, and adjusted EBITDA service margin is down 170 basis points.
Part of that decline in service revenue may be due to the growth of equipment installment plans, which AT&T says half of its smartphone base is on, while another 25% of the base brought their own device or have paid off their device. As a result, postpaid phone service ARPU fell 2.4% year over year last quarter.
Stephens' claims that postpaid feature-phone subscribers generate less revenue at lower margins than the average prepaid customer sound fair. AT&T has added around 1 million smartphone subscribers while losing almost 3 million feature-phone subscribers over the past four quarters from churn or from converting them to smartphone customers.
Yet something doesn't add up.
AT&T's mobility segment saw revenue fall 2.1% year over year last quarter, suggesting that the surplus of prepaid subscribers is not making up for losses from postpaid customers. While overall margins are improving, that's more likely because it's paying for fewer device subsidies by signing up more customers to its equipment installment plans and fewer people are upgrading devices. AT&T is also benefiting from lower churn from postpaid subscribers, posting its second-lowest quarter in history at 0.97%.
Comparatively, Verizon, which has added postpaid subscribers while shedding prepaid subscribers, saw its operating revenue for its wireless segment fall just 1.5% as customers hold on to their devices longer, and its EBITDA margin increased 300 basis points year over year in the first quarter. It also posted a similar churn rate to AT&T of 0.96%.
What's more, just 68% of Verizon's smartphone activations were on unsubsidized plans, compared with 90% for AT&T. Phone subsidies generally cut into margins, which makes AT&T's lower margin expansion particularly noteworthy.
Verizon and AT&T both cater to a similar high-value customer base with better networks than the other two major U.S. wireless carriers. AT&T's larger declines in revenue without the same increase in margins indicates that Stephens' math is a little fuzzy. If most of its postpaid subscriber losses really were low-margin low-revenue customers, its results would look more similar to Verizon's, with more robust increases in margins.
Investors can't expect AT&T's margins to continue to improve if it continues to lose postpaid subscribers and add prepaid customers. For one, AT&T has only about 6.5 million feature-phone subscribers left. If it continues to convert or lose them at its current rate, they'll be gone in about two years. More importantly, AT&T has some big fixed costs to maintain and grow its wireless network. If revenue continues to decline, those fixed costs will start to eat into the company's margins.