TWST: What is your coverage in the wireless space?

Mr. Breen: It's pretty broad. In the traditional wireless space, I cover AT&T (T), Verizon (VZ), Leap (LEAP), MetroPCS (PCS), Sprint (S), Boingo (WIFI). Internationally, I cover America Movil (AMX) in Latin America and Nextel International (NIHD) in Latin America. The other half of my coverage are the data center and internet infrastructure names, Rackspace (RAX) and Equinix (EQIX). A lot of the growth in the data center is coming from mobile traffic.

TWST: What are the investment trends in wireless right now? What are the big themes you are watching?

Mr. Breen: I think right now, meaning over the last few weeks and heading into the new year, there are a couple important things going on. One, this is the time of the year when the prepaid providers Leap and Metro generally have better quarters, because seasonally they have a strong fourth quarter and first quarter. People are trying to monitor whether that seasonality is going to come to fruition this year as it has in most years. I think the bigger picture with the AT&T/T-Mobile (DTE.DE) merger being withdrawn is what the competitive dynamic will look like over the next two quarters.

This fourth quarter of 2011 is the first quarter where Verizon and AT&T and Sprint have all had the new iPhone at the same time. Verizon noted at one of the industry conferences this week that they activated a little over 4 million of iPhones this quarter. So it will be interesting to see when all three of those companies report their fourth-quarter numbers how many iPhones they actually activated, and then on those that they activated, which were new subscribers versus existing subs just upgrading. That's why it makes an interesting quarter. Previously, while Verizon's had the iPhones last February, which AT&T had had six months prior, so there was not an actual equal footing between all the carriers. Now with all three of the big carriers - Sprint, Verizon and AT&T - all having the same iPhone 4S, it puts everyone on par together. That means we are going to really get a good sense of the competitive landscape and what it looks like now.

TWST: Is the idea to look at whether customers switch to a different carrier now that they can have their preferred phone at any carrier?

Mr. Breen: Yes. I think there are definitely customers who would have switched to Verizon last February from AT&T if the iPhone had been a new one at that time, if they were offering the 4S iPhone rather than the older model. They probably just got the iPhone the previous summer, they have waited, and now maybe they are going to switch this quarter. I believe that Verizon will probably be in the net beneficiary area on some of the changes. Yes, I think AT&T will stay sort of in line with this normal trend, and then Sprint is likely to see a lot of their activations coming from their existing customers who just wanted a new phone. But we're getting close to the point where all the carriers have the same sets of handsets, so how do you differentiate between carriers? And we are finding that it is actually become very difficult.

TWST: What do you expect in terms of differentiation?

Mr. Breen: That's going to be the challenge. I think that depending on the market area will depend on which carrier's network is the best. On a national basis, despite some of the television commercials and the rhetoric, it's hard to say who has the best national network. There's definitely areas where AT&T works better than Verizon, and Sprint works better than both in some other areas. The majority of wireless customers in the U.S. don't travel a lot. You may travel from your hometown to a vacation spot or something like that, but most of the U.S. doesn't travel to 25 or 30 different cities in the U.S. every year. When you look across the carriers, I think it is generally pretty consistent. That will change a little bit as Verizon and AT&T and Sprint launch LTE. Theoretically they are going to have faster speeds in some markets. But as we have seen from some of the headlines, those launches haven't been completely smooth, despite the fact that there's a lot of advertising for 4G phones, there really aren't any true 4G phones yet because coverage is just ramping up.

TWST: Is 4G and the 4G phone going to be the "next big thing"?

Mr. Breen: I think so. I think that what you found, and it's why the carriers are a little bit in a hard spot, is that historically, from a technological standpoint, the carriers have been able to dictate how technology is used by the consumer because they control the gateway to that technology. With the advent of the iPhone and the Google (GOOG) Android platform, really the handset providers are the ones stirring the pot with consumers and saying, "OK, here's this new device, we're going to give you this; here's what you could do with it if the carriers improve their network quality." It phases a portion of the carrier's full capex into the network and to upgrade speeds at the same time that they are forced to subsidize more expensive smartphones. So from a cash flow perspective, it's a little bit of a squeeze.

TWST: Looking at the challenges for a moment, is the biggest challenge for the carriers dealing with bandwidth and demand?

Mr. Breen: I think it is. If you look at some of the general statistics around Internet traffic and wireless traffic, the move from 3G to 3.5G to 4G may increase the speeds and it may increase the availability of bandwidth four times from where it is today. But the reality is that, if fully utilized the way they should be, whether it's an iPad or a smartphone or some other tablet, the amount of bandwidth demand is probably 20 times. That demand is part of the reason why the carriers have looked around for ways to add capacity - it's probably the reason why AT&T wanted to buy T-Mobile. They recognize that there is going to be a shortage of spectrum again if we keep going at these growth rates. I think that's part of it on the spectrum side, and then just on the wireless side, you're seeing a lot of fiber getting built out. We continue to see good growth rates in fiber infrastructure. The carriers themselves need fiber deeper into the field to service these wireless tablets.

TWST: Will we see large capital expenditures in 2012?

Mr. Breen: I think that most of the commentary from the large carriers is that capex would be flat, maybe down slightly. I think you're going to see some shift though internally at Verizon and AT&T from their wireline business to their wireless businesses, mainly on the heels of the LTE buildout. Those two carriers combined are the bulk of the U.S. wireless capex.

TWST: Looking at where we are and what's happening with the more-even landscape among the carriers, who do you like? Who are your top picks and why?

Mr. Breen: Within the U.S., we actually only have one "outperform" right now: It's on MetroPCS. I upgraded that in the beginning December. Part of that is the seasonality that's happening with that name now as they put up seasonably stronger fourth and first quarter results, as they have historically done. I also think from a valuation standpoint, it trades at a pretty good discount to Leap. They are very similar companies, and so we believe the valuation discount is unjustified. On top of that, there still is some growth within that prepaid segment. They have EBITDA growth in the low teens, whereas on the high-end of the market growth is pretty slow at this point because there are not a lot of incremental new customers coming in at the high-end of the wireless market.

From AT&T and Verizon's stocks' perspective, those companies tend to trade around the dividends. They generate a lot of free cash flow even after they pay their existing dividend, which is why even though the breakup fee for AT&T is a large number - from a cash perspective, $3 billion - it's only a fraction of the actual free cash flow they generate after dividends. Those companies tend to trade around those dividends. When things appear to be fundamentally strong, the dividend may come down to 5.5%, and when fundamentals seem weak, they go up to 6.5% or 7%. AT&T and Verizon are acting more and more like utilities. It's interesting, I think people would rather pay their wireless bill than they would their electric bill at some point because of their need for wireless.

TWST: What about internationally?

Mr. Breen: International is still in its earlier days, and it's a different type of customer dynamic. Within the U.S., 75%, 85% of the subscribers are postpaid subscribers. You are paying for the service after you use it. With most of the carriers outside of the U.S., with the exception of Canada, the majority of the subscriber bases are prepaid. That has done a couple of things. One, maybe a part is because it is a demographic. Your average citizen in Brazil or Mexico basically can't afford to pay $300 for a smartphone. We're definitely seeing a little bit of a shift this year where I think you are going to see smartphone pricing come down into that $100 or sub-$100 range where the phones become Internet access devices and they are almost a substitute for computer Internet access in a lot of countries. I think that's going to lead to probably better financial performance for some of these international carriers, especially in Latin America, just because it is not quite as far behind the U.S. in some areas. But I think that's something we are going to keep an eye on over the course of the next 18 months - are these customers, be it your typical subscriber in Mexico or Brazil that's paying $12 or $13 per month for their service, are they willing to pay $15 or $16 per month to get pretty rudimentary Internet access on their phone? We think if the device is cheap enough and it's accessible enough, they will be.

TWST: Do you have stronger picks in the international market than in the U.S. market right now?

Mr. Breen: In Latin America, I have an "outperform" on Nextel International, NIHD, which is all business focused. I think they are well positioned to take advantage of this upgrade to data, as a lot of 3G networks get rolled out in Latin America. AMX is one, I have a "market perform" on it now, but I think that they are another company that could be a beneficiary of this trend, maturing markets moving more toward data ARPU, away from voice ARPU.

TWST: Are any of the international carriers looking to enter the U.S. space at this time?

Mr. Breen: I think it's probably unlikely to see a large international carrier coming into the U.S. right now, part of the reason is that the U.S. market is very competitive. The name that would come off the top of your head would be like a Deutsche Telekom which owns T-Mobile, or a company like Vodafone (VOD) which owns 45% of Verizon Wireless, or a Telefonica (TEF), but I think that if you look at their ownership base, they don't have a lot of interest in moving into a market like the U.S. where it seems like we're reaching the point of maturity and potentially increased competition on the price side. The question is, if we look out three or four years, are we going to start to see sort of megaconglomerates? As these markets really mature and they do end up looking a lot more like utilities, it is possible that an America Movil or AT&T could get together and form one large North American carrier. That wouldn't be too dissimilar from a company like Telefonica owning assets in Latin America and in Europe, or Vodafone owning assets all around the world. There is that possibility.

TWST: Is the wireless space a good place for the average investor to look at?

Mr. Breen: I think it's difficult. I think that AT&T and Verizon can be good income stocks for an investor just because of the relative stability. The actual stocks don't move a lot and you have a 6% or 6.5% dividend. But they tend to be more of an income investment. From a growth perspective, there's not a lot within the U.S. that's continuing to grow. I think you're seeing companies like Leap and Metro that do have the higher growth within the U.S. wireless space are also very volatile from a stock perspective. So it's hard when you are looking at stock that is that volatile. Today is a good example of that. Both companies are down 7% or 8% today, and they were up a similar percentage just two days ago. So there tends to be a lot of volatility. Investors that are looking at these names have to have a pretty clear understanding of some of the risks involved and also of the volatility involved with owning them.

TWST: Is there anything you would like to add?

Mr. Breen: One of the companies that I cover which just came public at the beginning of last year is Boingo Wireless. It is Wi-Fi, small cap, but it's interesting from the perspective that Verizon and AT&T have both talked about Wi-Fi. Wi-Fi offloading is a way for them to alleviate some of the traffic on their existing wireless networks. Boingo provides a solution for that. AT&T had bought a similar company a couple of years ago called Wayport that did Wi-Fi in hotels and airports. And so I think there's going to be companies - if the spectrum shortage in the U.S. continues and there's concern from the carriers about their ability to get access to spectrum for the government - I think there's going to be renewed focus on alternatives to offload their traffic. And I think Wi-Fi is going to be one of those alternatives.

TWST: Thank you. (LMR)

Note: Opinions and recommendations are as of 01/05/12.

James D. Breen, CFA

Analyst

William Blair & Company, L.L.C.

222 W. Adams St.

Chicago, IL 60606

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