The US mobile operators are facing a critical turning point – one which many MNOs in developed markets will also face in the coming two years. Their traditional business models are collapsing, with the end of handset subsidies and device lock-ins, and the saturation of the postpaid smartphone base. Handset makers will increasingly sell directly to consumers (see separate item below), which also means the operators will lose their control of the software platform and user experience.
At the same time, they are facing a second wave of intense network build-out, densifying their LTE networks in order to maintain a strong quality of experience (now the number one reason to choose, or leave, a network, according to Verizon, rather than price). It is urgent that they find new ways to monetize all that investment, and a shake-out of those which fail to make the transition looms ahead.
This was clear in the quarterly results of the two largest operators. AT&T acknowledged weak net additions of postpaid subscribers, but highlighted key strengths in connected cars and the quality of the network. These are the elements which will ensure an operator’s survival – a network capable of keeping subscribers happy, and therefore at least stabilizing the user base, and of supporting new devices and services such as cars; and more revenues coming from the internet of things or from content.
In Verizon’s case, the acquisition of AOL may, if well executed, put it in pole position to offer differentiated content across mobile and fixed networks, and it also has extensive IoT initiatives – while AT&T is ahead in cars and has achieved high profile for its smart living options, Verizon is taking a more business-to-business approach, working closely with auto makers and utilities to enable their new IoT services. Verizon said the IoT and telematics were responsible for $165m in revenue in Q215 and $320m in the year to date.
But of course, these new revenue streams are currently a tiny part of the MNOs’ total income, and very immature. In the short term, it is still important to boost the high value postpaid base – currently, this is mainly happening via tablets rather than smartphones – and even to increase prepaid business, which though lower margin, is useful for cashflow, customer attraction (some prepaid users, especially young ones, later upgrade to postpaid) and market share.
New tariffs, and equipment leasing plans, which are replacing subsidized handsets, are very important to the competitive position of the top four US mobile carriers. Bundled plans which allocate a monthly data allowance to a collection of devices have been strong growth drivers. In Q2, AT&T’s Mobile Share data accounts were up more than 38% year-on-year in number, reaching 20.1m with an average of three devices per account.
The operators are also seeing rising revenues from wireless equipment, though this may be a short term factor as they start to move away from devices, and consumers become more accustomed to buying handsets direct (see below). AT&T has said it will eventually stop selling subsidized smartphones with two-year contracts. Almost 37% of its postpaid users are now on its Next leasing plan, ahead of Verizon, which said 16% were using its Edge EIP program. AT&T added that 64% of its postpaid smartphone subscribers are on no-subsidy Mobile Share Value plans.
The changes to the carrier’s business go far deeper than shifts in tariffs and device ownership. AT&T’s Q2 results also clearly show the rapidly changing complexion of a US MNO’s business, looking beyond smartphones, which have been the key growth driver since the iPhone launch in 2007.
For instance, AT&T Mobility added fewer postpaid customers in the second quarter than Wall Street had expected, at 410,000 – and the figure was sharply down on the year-ago quarter’s 1.026m. But overall, it added 2.141m net new connections – a healthy figure, but one with a very different make-up from the operator’s traditional pattern. There were 331,000 prepaid additions and 1.4m connected devices, including 1m connected cars. On the postpaid side, there was a net loss of smartphone customers, offset by 600,000 postpaid tablets and computing devices.
Meanwhile, Verizon’s postpaid phone net additions totaled 321,000 in the quarter, while tablets added 852,000 connections. In contrast with AT&T, it lost 126,000 net prepaid device customers.
AT&T CFO John Stephens said on the earnings call that the MNO had done better with its Cricket prepaid brand, acquired with Leap Wireless, saying that “Cricket is really kicking into gear”, gaining as many subscribers in Q2 as it lost in the year-ago period. Although AT&T and Verizon have traditionally stayed largely aloof from the price wars of the prepaid segment, AT&T is changing its strategy, reaching out into pay-as-you-go but focusing on the higher value end of that market, or on family plans with a combination of postpaid and prepaid. Stephens said Cricket ARPU was “similar or sometimes better than other carriers’ postpaid ARPU”.
He highlighted what he regards as the carrier’s key mobile assets – a premium prepaid experience, a lead in connected cars, a high quality LTE network, and its Next plans. These are very different from the areas he would have showcased a few years ago, and all of them require a dense network with strong capacity and coverage, making densification a matter of urgency.
Both new and old business models require the LTE network to have ever-higher levels of capacity to support rising data usage and new connected devices – but also increasingly good coverage, for high reliability applications in the internet of things (IoT); as well as good QoS, at a time when users are becoming more demanding, and more likely to churn on the basis of their quality of experience. Verizon CFO Fran Shammo said on the Verizon Q2 earnings call: “The number one reason a customer leaves you is because of quality of the network, price is number two.”
The main carriers are taking different approaches to densification, but they are all embarking on this phase of their roll-outs, having come close to completing the first wave of coverage-oriented, macro layer deployment. Now they will turn their attention to higher frequency spectrum, which is more oriented towards capacity than the 700 MHz bands in which Verizon and AT&T initially rolled out LTE. It will be interesting to see whether the increasing focus on capacity means next year’s 600 MHz auction may attract less frantic bidding that last year’s AWS-3 sale.
Verizon may not even bid for 600 MHz licences, with its executives indicating on the recent earnings call that it was mainly interested in mid-band and high frequency airwaves. They even hinted that buying some of Sprint’s plentiful store of 2.5 GHz spectrum could be an option for future expansion.
Verizon’s current densification program revolves mainly around carrier aggregation, 4×4 MIMO and small cells, including DAS (distributed antenna system). “Our network densification plans, which include small cells, DAS nodes and in-building solutions, are on schedule,” Shammo said on the earnings call. “In New York City we are well into our deployment and continue to scale and develop a healthy pipeline. Downtown Chicago is another large urban market with small cell densification plans well underway.”
Mike Haberman, VP of network support at Verizon Wireless, told the recent Wells Fargo telecom symposium that the MNO is actively deploying carrier aggregation technology in its 20×20 MHz channels in order to support wider channels in future, and boost peak download speeds. According to Wells Fargo analyst Jennifer Fritzsche, 4×4 MIMO is also strategically important to achieve a diversity gain that could increase uplink speeds. She added that Verizon now has 20×20 MHz channels in its AWS-1 spectrum in most of its major markets, offering higher speed services under the XLTE brand.
Also relying heavily on MIMO is Sprint, which rolled out its first 8×8 sites in Chicago recently, together with multilayer MIMO and multi-channel carrier aggregation. Sprint has always had the most ambitious densification strategy on paper, but has repeatedly failed to hit expected deadlines, even since Softbank – such an ambitious MNO in network architecture terms back home in Japan – took control. Sprint has been struggling, of course, with years of customer defections and the need to create a coherent network out of unusual spectrum bands (including the 2.5 GHz TDD airwaves) and several legacy systems, such as iDEN.
The first phase, to create a flexible, multi-protocol, multiband infrastructure – also capable of hosting third party networks, an important future way to expand revenues – was labelled Network Vision and was the brainchild of former network chief Steve Elfman and CTO Stephen Bye. The departure of both executives this year has led to speculation that Network Vision has failed to deliver all its objectives, perhaps because of over-ambitious timescales or technology choices, or because the Softbank parents have different priorities.
BTIG analyst Walter Piecyk wrote in a blog post: “Sprint may need to devise a plan to clean up any mess in the macrocell site network left by [Elfman] and his Ericsson-driven Network Vision project, which failed to deliver on the competitive LTE speeds that he and Sprint’s management team promised.”
That project has laid a framework for the future, but it has not achieved the necessary feat of catching up with Verizon and AT&T in terms of LTE coverage and speeds, which was an essential goal for Sprint, for several reasons – to reverse its shift towards prepaid markets and price-cutting and finally restore growth to its postpaid base after years of decline; and expand its already strong MVNO and wholesale businesses as well as support moves to the IoT. It needed to make the best of its WiMAX adventure – a brave attempt to steal a march on the big two in 4G, but which turned out to be a technology dead end – by repurposing the plentiful 2.5 GHz spectrum for TD-LTE and harnessing that capacity for the main network. This it has been doing in selected markets with its triband Spark service, but shareholders and customers are asking for more dramatic progress.
The vehicle to deliver this is a new Next Generation Network project, designed to build on Network Vision but also to introduce new architectures far more rapidly. The small cell layer, which has been neglected, will be a priority, as will carrier aggregation, and the densification of the macro layer with MIMO.
Last month, Sprint executives were reported to have received sign-off from Softbank for the new approach, and more details of NGN are expected during the operator’s Q2 earnings call next week. Various sources suggest that the program will include the roll-out of about 70,000 small cells, plus several thousand additional macrocells and the use of the 2.5 GHz spectrum for backhaul as well as access.
Wells Fargo’s Fritzsche believes Sprint has struck a deal with tower and small cell integrator Mobilitie to deploy around 20,000 of the small cells. Airspan (which has a 2.5 GHz access/backhaul small cell product), Nokia and Samsung are said to be the main metrocell suppliers. The original Network Vision was led by Ericsson and Alcatel-Lucent, with a smaller role for Samsung, but Nokia was later brought in for Spark, and has been particularly important in providing the 8×8 MIMO radios. The newer iterations of Sprint’s strategy seem to squeeze out Ericsson, to some extent at least.
The large number of cells, and the expected use of out-band wireless backhaul (a portion of 2.5 GHz spectrum dedicated to this function), may drive Sprint into its usual trap of over-complicating its roll-outs. New Street’s Jonathan Chaplin said: “I’m sure it’s going to cost them a lot more and take them a lot longer to get it right than I think they are suggesting at the moment”, and also speculates that Sprint may need far more than 70,000 small cells, as well as a more aggressive modernization program than Network Vision entailed. That project upgraded 38,000 cell sites, but Chaplin added: “The plan would be a lot more plausible to me on the surface if it involved getting to 50,000 macrocells for the core EV-DO/LTE network, and on top of that was going to build a dense small cell network. They really need to be building those macro sites now and they’re not.”
And other analysts think the densification will only prove a temporary band-aid, and what Sprint really needs is to invest in more mid-band spectrum to improve coverage, not just targeted capacity (for which 2.5 GHz is a good asset). Analysts at Jefferies said the NGN plan could pressure Sprint’s free cashflow at a time when “we see the new network densification plan as a stopgap measure to structural issues that will likely only be fixed by a meaningful investment in low- or mid-band spectrum.” They calculate this could cost an additional $1bn to $1bn a year on top of capex of $4bn to $5bn a year, for the next three years.
Sprint CFO Joe Euteneuer said on the company’s last earnings call in May that he expects capex for this fiscal year (to March 2016) to be about $5bn, but insisted the carrier would drive a harder bargain with its suppliers. “The initial reads of the RFPs is that we’re able to get a lot more done for a lot less along with being able to get favorable financing terms ultimately when we decide on what direction we’re going in regards to the final capital program.”
The operators, including Sprint, are starting to think about future architectures, particularly virtualized Cloud-RAN. Although the US carriers have been less enthusiastic than their Asian peers about the two key architectures for the next wave of mobile build-out – small cell HetNets and C-RAN – they are starting to move in these directions. Verizon’s Haberman pointed to early C-RAN activities, telling the symposium that Verizon was starting to connect some cell towers to dark fiber for fronthaul (the super-fast link between a remote radio head and a virtualized baseband in the cloud, to enable C-RAN), as well as backhaul.
Over at AT&T, there are new challenges as a consequence of the finalization of its deal to acquire DirecTV. The carrier has many calls on its cash and its capex budget, and while its new purchase will open up new opportunities to provide service bundles and content, it will also intensify its investment dilemmas. Arriving at the right balance of spending between fiber, LTE and content, among other priorities, will decide the company’s market position and profitability in the coming few years.
It seems that AT&T is on the verge of beginning to lose customers for its U-Verse broadband/TV services, and needs a way of retaining these – enter fiber, which the carrier is mandated to offer to up to 12.5m homes over the next four years, as a regulatory condition for approval of the DirecTV deal. That was always going to be AT&T’s answer, but now it can do it with a far better video line-up and larger subscriber base, thanks to its new acquisition, and blame the capex spend on the terms laid down by the FCC and Department of Justice. Other conditions include discounts for low income customers and net neutrality provisions.
But that’s not where the operator’s capex needs will end now it also owns the US’s largest satellite TV provider. AT&T has a lovely new LTE network, in far better condition than its poor reputation for cellular suggests. It has achieved this by over-spending on cellular capex for three years and it says it will now take a rest, effectively moving its spending to fixed line.
But can it really do that? It will have to continue with some densification, via WiFi offload, small cells and DAS, to accommodate video travelling across the LTE network. It has hinted that it will find it far easier to compete with Verizon’s new over-the-top system if it offers video over LTE, likely saturating its brand new network far more rapidly than it had previously believed. The ratcheting up of video competition between the two giants will put even greater than anticipated burdens on their mobile networks – New Street Research calculates that Verizon will saturate its own cellular network within two years once it launches its OTT service, due in 60 days.
So AT&T will be locked into multiple cash and capex calls on multiple fronts – beefing up US cellular to take more video; expanding cellular networks and making acquisitions in Latin America; keeping customer acquisition on track at a saturated US DirecTV, and bringing faster broadband to 12.5m US homes. And why just 12.5m? It needs to reach more than twice that number to hold cable at bay or it will remain an under-invested fixed broadband network.
AT&T also agreed with the FCC to offer 1Gbps service to any eligible school or library requesting E-rate services, inside company’s fiber footprint. This will, in a way, be part and parcel of its fiber build-out. And the same build-out will change AT&T’s backhaul position for cellular.
It will be a significant challenge for AT&T to make a transition from where it is today, to where it needs to be – competitive on both broadband and multiscreen mobile video, while keeping at bay calls from investors to slow capex, and also keeping its new international operation in Mexico performing under tough competitive conditions. If it also has to fight in the original content market and build out into technologies beyond LTE, then its optimal balance of spending priorities becomes even less clear.
As for T-Mobile, it has been forcing the pace of the network upgrades of the other three by piling on the commercial pressure. Its series of ‘Uncarrier’ launches have accelerated the end of the device subsidy and pressurized all the major operators to adopt new business models and creative tariffs – and to ensure their LTE coverage and QoE stays ahead of the fourth MNO’s.
However, after a slow start and a difficult migration process (moving 3G out of the AWS band, an odd one in ecosystem terms for HSPA, and then deploying LTE there instead), TMO is making real progress of its own. On its Q2 earnings call, it said it has completed the refarming of CDMA spectrum, acquired with flat rate carrier MetroPCS, and has finished the customer migration too, ahead of schedule. Its LTE network now covers 290m POPs and that figure should rise to 300m by year end, according to CTO Neville Ray.
The MNO also has ‘Wideband LTE’, in 15×15 MHz channels, deployed in 212 markets, and is targeting 250 by the end of this year. In spectrum terms, TMO is taking a different approach from that of the big two. It has started in AWS, after moving its 3G network into PCS spectrum, and is now moving into the 700 MHz coverage band, having acquired those frequencies from AT&T when their planned merger fell apart. 700 MHz LTE is now active in 141 markets, covering about half of its total POPs at 100m.
“My goal is to have a least 50% of our customer base with low-band compatible handsets this year,” Ray said on the call, although CMO Mike Seivert later added that having all its handsets support all its frequencies would be a big opportunity to launch new services and guarantee strong QoS for all kinds of usage. This will be significantly enhanced if the next iPhone supports the 700 MHz Band 12 in which TMO operates. CEO John Legere said: “Do we expect band 12 support? The answer is yes, we certainly would expect that, and we look forward to hearing about it in the future.”
T-Mobile spent $1.2bn in the quarter, up from $982m in the first quarter and $940m in Q214, on its LTE network, but the investments in quality, as well as the Uncarrier deals, are boosting subscriber numbers and starting to change TMO’s recent image as a low cost, low end operator. It reported its ninth consecutive quarter of over 1m net additions, with 2.1m new customers in total, 1m of them postpaid.
All this investment in network infrastructure may, however, only hold back the tide of mobile data and content temporarily. A research note from analysts at New Street Research said that, if data growth continues at its current pace, Verizon will run out of capacity in the next 2-3 years, even if it refarms all its 2G and 3G spectrum. “Densification may delay the crunch by a year or two, but sooner or later the company will need more spectrum,” they wrote. New resource-efficient architectures, additional spectrum (including unlicensed, with WiFi or LTE-U), virtualization – all these may help avert a crisis for a while. But longer term, there will be rising pressure to introduce services which generate new revenues but use limited capacity (as is true of many M2M applications); or to bite the bullet and adopt sharing on a major scale, or even a wholesale model, so that a larger number of service providers of many kinds can be supported by giant, fully flexible wireless pipes.