Fiber Infrastructure To Continue To See Strong Growth Rates, As Demand For Wireless Bandwidth Continues, Says Analyst At William Breen
February 1, 2012 - The Wall Street Transcript has just published Wireless Communications & Telecom Report offering a timely review of the Wireless sector. This Special Report contains expert industry commentary through in-depth interviews with public company CEOs, Equity Analysts and Money Managers. Please find an excerpt below.
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James D. Breen, CFA, joined William Blair & Company, L.L.C., in 2010 as a communication services Analyst. Previously, he spent 10 years as an Analyst at Thomas Weisel Partners LLC. He has been recognized several times in recent years by The Wall Street Journal's "Best on the Street" and the Financial Times/StarMine "World's Top Analysts" listing, the former of which recently ranked him the number two stock-picker for 2010 in Internet/computer services. Mr. Breen also worked as a high yield and fixed income Analyst at BancBoston Robertson Stephens and as a Civil Engineer at Modern Continental Construction Companies, Inc. He holds a B.S. in civil engineering from Tufts University and an MBA from the Carroll School of Management at Boston College.
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?
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