Bloomberg News

Deutsche Telekom Gets U.S. Relief as Rivals Cut Subsidies

August 08, 2012

Deutsche Telekom Gets U.S. Relief as Rivals Curb Phone Subsidies

A man walks by a T-Mobile USA Inc. store in New York. Photographer: Stephen Yang/Bloomberg

T-Mobile USA has suffered a continuing exodus of subscribers in the past year as it slashed handset subsidies to boost profitability. Now, moves by Verizon Wireless and AT&T Ltd. to do the same are giving the Deutsche Telekom AG (DTE) unit reprieve.

The two market leaders, under pressure to increase profit margins (T:US), have started to scale back offers of cheap upgrades to devices such as Apple Inc.’s iPhone, bringing their approach in line with T-Mobile’s. That, along with cost reductions following a failed deal with AT&T, helped the fourth-largest U.S. carrier improve earnings in the second quarter, said a person familiar with the matter, asking not to be identified because the details are confidential.

“We seem to be entering a new phase in the U.S. market,” said Leon Cappaert, who manages 400 million euros ($497 million) at KBC Asset Management in Brussels including shares of Bonn- based Deutsche Telekom. “Margin pressure in the sector is diminishing significantly, and that may mean a positive surprise on the margins for T-Mobile.”

T-Mobile USA probably lost 346,200 contract customers last quarter, after ceding 510,000 users in the preceding three months, a Bloomberg survey of analysts shows. As Deutsche Telekom Chief Executive Officer Rene Obermann prepares to announce second-quarter earnings tomorrow, the U.S. business needs more than a respite after its $39 billion sale to AT&T failed last year because of regulatory opposition.

Starbucks Veteran

The division faces the challenges of finding a permanent chief, increasing its clout with local partnerships and building a faster wireless network to catch up with competitors.

T-Mobile USA has been run by former Starbucks Corp. (SBUX:US) executive Jim Alling on an interim basis since Philipp Humm left as CEO in June to join Vodafone Group Plc. (VOD)

Earnings before interest, taxes, depreciation, amortization and some items probably rose 7.5 percent to 959 million euros at the U.S. unit last quarter from a year earlier, according to the average of analysts’ estimates compiled by Bloomberg. T-Mobile USA probably also benefited from the slowing customer losses and a stronger dollar.

Shares of Deutsche Telekom climbed 6 percent this year through yesterday, while the Bloomberg Europe Telecommunication Services Index, which has 23 members, was down 0.8 percent. The stock slipped 0.5 percent to 9.35 euros as of 4:33 p.m. in Frankfurt.

$30 Upgrade

AT&T fell 0.9 percent to $37.12 in New York. Verizon Communications Inc. (VZ:US), which owns 55 percent of Verizon Wireless, dropped 0.8 percent to $44.12.

Deutsche Telekom may say its adjusted second-quarter Ebitda slid 2.4 percent to 4.58 billion euros, analysts predict. That would bring it more than half way to meeting its full-year target of 18 billion euros in Ebitda.

Philipp Kornstaedt, a Deutsche Telekom spokesman, declined to comment on earnings before tomorrow’s release.

Seeking to lessen handset costs, AT&T this year doubled the upgrade fee for existing customers who want a new phone to $36 and lengthened the time users need to wait before they can receive subsidies. Verizon in April imposed a $30 levy on all customers buying new smartphones, while Sprint Nextel Corp. (S:US) charges $18 fee plus an additional $10 monthly smartphone charge.

T-Mobile USA’s costs from handset subsidies fell 42 percent in the first quarter to $310 million after the company rolled out a lower-subsidy tariff structure.

U.S. Options

Offering smartphones takes a toll on profit margins because carriers typically sell them at a loss to get customers to sign two-year contracts. Users of devices such as the Apple Inc. (AAPL:US) iPhone are lucrative in the long run because they spend money more each month to surf the Web, send e-mail and watch videos.

Deutsche Telekom has explored options to combine the U.S. unit with local rivals, including MetroPCS Communications Inc. (PCS:US), people familiar with the situation have said. It’s seeking to bolster its wireless coverage by adding frequencies from Verizon. It’s also closing in on a sale of its tower assets to help finance network expansion, people familiar with the matter have said.

To compete with the iPhone offered by all larger rivals, T- Mobile USA has embraced manufacturers that offer handsets running Google Inc. (GOOG:US)’s Android operating system. It has championed Samsung Electronics Co. (005930), describing itself as the largest U.S. provider of Samsung Galaxy S class devices.

Call Centers

The subsidy curbs and a lull in iPhone sales for rivals probably also helped slow an outflow of contract customers, who tend to spend more on call and data services than prepaid users. Even as customer defections slowed, the projected second-quarter user losses would mean T-Mobile USA has lost 9.5 percent of its contract customer base over the last two years.

To offset the resulting lower sales, the company shuttered seven out of 24 call centers and announced cutting a total 2,800 jobs. The erosion of its client base may put pressure on T- Mobile USA not only to seek additional ways to reduce expenses, but also to compromise on its low-cost strategy.

Benjamin Black, co-founder of software maker Boundary Inc. and a T-Mobile USA customer for ten years, said the monthly cost for his 5-gigabyte data plan increased to $35 from $30 over the recent months. Still, he said he keeps T-Mobile USA in addition to his AT&T contract because its “reasonably cheap phones” are convenient for his international travels.

While T-Mobile USA is now benefiting from rivals mimicking its lower-subsidy strategy, its success going forward also is at its competitors’ mercy. Apple is preparing to introduce the next version of its top-selling iPhone on Sept. 12, two people with knowledge of the company’s plans said last month. Operators deciding to go back to higher subsidies in a bid to win market share would again increase pressure on the carrier, KBC’s Cappaert said.

“T-Mobile is probably in the worst position among all U.S. players even if the overall market is getting better,” he said. “Are subsidy cuts sustainable? It only works if everybody agrees to it.”

To contact the reporters on this story: Cornelius Rahn in Frankfurt at crahn2@bloomberg.net; Kathleen Chaykowski in New York at kchaykowski@bloomberg.net

To contact the editor responsible for this story: Kenneth Wong at kwong11@bloomberg.net


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