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Whew, US cellcos... Better find a new revenue stream, QUICK

Value crashes across American mobile companies

Analysis The wave of operator consolidation across the Americas and Europe is driven by the urgent need to cut costs and achieve economies of scale. With average revenue per user (ARPU) falling, even for supposedly premium LTE and fiber services, and with huge infrastructure upgrades still ahead, carriers need to find drastic cost efficiencies or be consigned to a spiral of rising debt and falling margins.

Even in the US, the big four operators, whose ARPUs are the envy of the rest of the world, are seeing their profits squeezed by price competition and huge capital expenditure (capex) bills, and now they are being hit by another factor, the inflated cost of spectrum. All four have seen their market values slashed in recent days, with investors scared by the bids being made in the current AWS-3 spectrum auction, as well as warnings of difficult quarters from the two market leaders and the ongoing price wars.

Such jitters will put even more pressure on carriers to adopt a dramatically different approach to building their networks, including the software-defined strategies which will eventually eat into the revenues of traditional equipment makers.

Sprint hammered despite its auction caution

All four national US cellcos have seen their stock being dumped in the past week, and have lost a total of $45bn in market value between them since mid-November, according to Wall Street Journal calculations. That loss in value is greater than the combined market capitalisation of Sprint and T-Mobile.

Sprint suffered the most, with a drop of 16 per cent in the second week of December, reflecting the persistent lack of confidence in the carrier, which has been less aggressive than T-Mobile USA in price cutting, but has failed to increase its premium base significantly either. It has also been hit by delays in its ambitious LTE rollout plan, and the transition has caused temporary network quality issues which have added to its churn woes.

The drop in Sprint’s value shows the new coolness on carrier stocks is not just about the headline factor of the huge prices bid in the AWS-3 auction, which have now topped $43bn. Sprint was the only one of the big four to stay out of that process, saying it has enough capacity to support its Network Vision multimode infrastructure and its Spark triband LTE offering for now. It will concentrate on leveraging its great asset, its huge quantity of 2.5GHz spectrum, to improve its cost:capacity position relative to its rivals, and wait until the 2016 600MHz auction to acquire more frequencies.

Staying out of the AWS-3 madness has not saved Sprint from investor anger, partly because of its ongoing issues, and partly because the current spectrum sale has set new expectations for the 600MHz incentive auction of broadcast frequencies. Since sub-1GHz bands are generally seen as "beachfront" assets, investors fear that the 2016 sale may command even higher prices than AWS-3, and at that stage, Sprint is expected to be a heavy buyer, as is TMo.

Of course, it is not as simple as that. Many market changes will have occurred by the time the delayed 2016 procedure gets under way, and many operators will be setting higher value on capacity bands by that stage, rather than coverage-focused sub-1GHz frequencies.

However, for now, fears that operators will never be able to call a halt to spectrum spending – even with the use of Wi-Fi and other options – are haunting the carrier stocks. T-Mobile lost 10 per cent in the first week of December, while Verizon lost six per cent and AT&T five per cent, partly because of the high sums they will end up paying if they are successful bidders.

But warnings about lower profits in the current quarter, issued by both Verizon and AT&T, are also a big factor, especially as these negative vibes are not about the wireline business but about wireless, which is usually the growth driver. The markets are concerned that the price wars, and the ever greater promotions and discounts operators must offer to lure and retain consumers, will drag on into next year.

The need for consolidation

Consolidation is the usual remedy for excessive price wars, as seen in other competitive markets like France. In a research note last week, Jefferies analysts Mike McCormack, Scott Goldman and Tudor Mustata wrote that they had "doubts for the sustainability of the four-player market," and that "without a more accommodative M&A environment, short term lower pricing for consumers will likely end poorly for all”.

These are the kind of opinions which send investors running, but have less impact on competition authorities. While Sprint owner Softbank argued persuasively, earlier in the year, that a merger with TMo would create a more viable third player and more profits all round – which could then be invested in services and capacity – it backed away from making a bid in the end, deterred by likely antitrust scrutiny of a deal which would reduce the number of carriers. Other offers for the fourth operator could still materialise in 2015, from Dish or even Vodafone (see separate item), but for now TMo is aggressively independent and continually upping the ante in terms of consumer offers. Even Verizon, usually aloof from such mud-fighting, has been forced to join in, hence its warning about current profit levels.

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