Kenneth Leon, the analyst who follows this group for S&P, is neutral on its overall investment outlook, but he believes that in the next 6 to 12 months, growing EBITDA (earnings before interest, taxes, depreciation, and amortization) -- and even some positive as-reported earnings per share -- may support higher valuations, driven by some key factors. (Wireless service providers have typically reported losses on an as-reported basis -- which includes interest, tax, and depreciation and amortization charges -- reflecting the enormous costs to build out service networks and acquire customers at a rapid pace.)
First, the pricing environment is more stable, with major wireless carriers focused on growth that's profitable. This has become evident as key industry members have realized higher average revenue per user and lower monthly customer turnover.
Second, the industry is achieving higher EBITDA margins with improved customer-acquisition strategies and lower bad-debt expense. Finally, Leon notes that many industry players are keeping their capital spending in check by getting higher capacity out of their existing networks with enhanced software and better processes, which has led to significant improvement in free cash flow.
BUNDLE POWER. Recent results still show differences in relative performance. T-Mobile, a unit of Deutsche Telekom (DT
), and Verizon Wireless had the largest net subscriber additions during the first quarter of 2003. Nextel (NXTL
) had record EBITDA margins in the quarter, while AT&T Wireless (AWE
) and Sprint PCS (PCS
) showed improvement, but they still appear to be industry laggards with below-average net subscriber additions and EBITDA margins.
Verizon Wireless holds a competitive advantage over its rivals, according to Leon: Its bundled-service offering includes local-phone, Internet access, long-distance, and wireless services across a large nationwide area. Cingular, a joint venture of BellSouth (BLS
) and SBC Communications (SBC
), is expected to acquire radio-frequency spectrum from Nextwave, a private company, in order to fulfill its goal of a nationwide network.
Late in 2003, an expected FCC decision on local-number portability -- allowing users to keep the same wireless phone number when they switch carriers -- may increase competition, customer churn, and market-share changes. Carriers are trying to view the event as a catalyst to improve, rather than cede, market position.
BRIGHTER FUTURE. Sprint PCS and Verizon Wireless are expected to launch their versions of "push-to-talk", the walkie-talkie type service popularized by Nextel (NXTL
), in late 2003, which may put pressure on Nextel's unique offering (see BW, 6/23/03, "Nextel: Defending a Juicy Niche"). It remains to be seen if the new entrants can catch up to Nextel's technological lead in push-to-talk.
Longer term, S&P is optimistic about the industry managing change more intelligently. The past downturn has allowed wireless-service providers to become more efficient and knowledgeable in their marketing plans, according to Leon. Consolidation has shifted the focus away from the high cost of new-subscriber acquisition to greater concentration on customer retention and revenue enhancement.
Among the wireless stocks Leon follows, his top pick is Nextel, which he rates 5 STARS, or strong buy. He believes it's executing its business model better than its competitors and is attractively valued compared to its peers.
Industry Momentum List Update
For regular readers of the Sector Watch column, here's this week's list of the 11 industries in the S&P Super 1500 with Relative Strength Rankings of "5" (price performances in the past 12 months that were among the top 10% of the industries in the S&P 1500) as of June 13, 2003.
S&P STARS* Rank
Casinos & Gaming/Consumer Discretionary
Computer Storage & Peripherals/Info. Tech.
Storage Technology (STK
Consumer Electronics/Consumer Discretionary
Harman International (HAR
Genuine Parts (GPC
KB Home (KBH
Internet Software & Services/Info. Tech.
Office Electronics/Info. Tech.
Everest Re (RE
Philadelphia Suburban (PSC
Wireless Telecom Svcs./Telecom Svcs.
* S&P's stock appreciation ranking system for the coming 6- to 12-month period: 5 STARS (strong buy), 4 STARS (accumulate), 3 STARS (hold), 2 STARS (avoid), 1 STAR (sell). Stovall is chief investment strategist for Standard & Poor's