The Southwest Airlines of Mobile Calling?

MetroPCS and Leap Wireless are outperforming other U.S. wireless carriers; by merging, they'd really start disrupting the industry

by Olga Kharif

A $340 wireless bill with unexpected charges was the last straw for Linda Targett. "We are tired of the unknowns and the surprise bills," says the 33-year-old office manager in Naples, Fla. "These extra fees, it's just getting ridiculous." Come June 4, she plans to drop her AT&T (T) wireless calling plan for MetroPCS, which offers unlimited calling for as little as $30 a month—and no extra fees.

Straight-ahead calling plans like that, plus interest from users like Targett, have turned MetroPCS (PCS) into the fastest-growing wireless service provider in the U.S. MetroPCS initially sold shares in April, and during its first quarter as a publicly traded company, it added 454,000 customers for a total of 3.4 million. That's 85% more new customers from a year earlier. Sales at MetroPCS are rising faster than for many other providers, its margins are among the fattest, and in the past month, the company's stock has rallied 30%, to $36.11.

MetroPCS and its smaller rival, Leap Wireless (LEAP), which offers comparable call packages through its Cricket brand, are having a ripple effect across the $100 billion mobile-phone service industry. "We expect Metro to have a similar impact on wireless as Southwest (LUV) had on the airline industry," UBS (UBS) analyst John Hodulik wrote in a recent note. Others agree that Leap could follow in the footsteps of the once tiny airline that's now a major airline industry player.

Growing Subscriber Base

Indeed, the companies are growing apace. With MetroPCS's unlimited calling plan selling for $30 a month, vs. more than $100 for most major carriers, "it's perfectly conceivable that they will be taking 50% of [new customers] in the U.S. market in the next one-and-a-half years," says Andrei Jezierski, partner with venture consultancy i2 Partners. MetroPCS may have about 10 million subscribers by 2011, almost three times its current base, says Michael Mahoney, managing director at EGM Capital, who owns MetroPCS stock.

But the Southwest comparison may not hold up for long. The number of U.S. wireless subscribers up for grabs will fall sharply from 21 million last year to 5 million in 2009, according to consultancy Strategy Analytics. So even if the companies lead the industry in net additions, growth will slow.

A Sensible Merger

To compete with the giants, MetroPCS and Leap will need scale, deeper pockets—and possibly each other. Analysts speculate that a merger between the two companies, or a combination with a larger carrier such as Alltel (AT), will be necessary to ensure the long-term viability of MetroPCS and Leap.

Both companies benefit from an ability to keep costs in check. Unlike larger carriers, Leap and MetroPCS recruit most customers through dealers rather than their own stores. Nor do they subsidize handsets, capping the average cost per new customer at about $100, roughly one-third that of bigger players. Yet the bigger operators still have the firepower to drive smaller guys out. In April, Boost Mobile, a division of Sprint Nextel (S), began testing demand for a service that includes unlimited calling for $45 to $55 a month in markets in California and Texas where MetroPCS is thriving.

But what's the likelihood of a deal between Leap and MetroPCS? Leap declined to comment, and MetroPCS didn't respond to inquiries. And there's no evidence they're considering it. Indeed, the deal would appear unlikely, considering the flurry of patent-infringement lawsuits exchanged between the two companies last year.