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Andrew Liyana

PCS AT A GLANCE

P/E ► 21.5 AVG EV/EBITDA ► 9.41 AVG ROA ► 5.3% AVG ROE ► 6.3% AVG Debt to Equity ► 2.27 AVG Current Ratio ► 2.21 AVG Interest Coverage Ratio ► 2.14 AVG

 

 

 

 

 

 

MetroPCS Communications (NYSE: PCS) is a wireless phone company that targets youth and minority demographics, offering service without requiring a contract or a credit check; this differs from traditional wireless carriers such as AT&T Wireless and Verizon Wireless. The company's unlimited voice plans start at $30 a month, and youth and young professionals form 55% of MetroPCS's customers.^[1] Furthermore, MetroPCS' attention on densely populated urban markets has helped it achieve the highest margins (45% EBITDA Margins) and customer growth rate (42% annual) in the wireless industry over the past three years by keeping distribution and capital expenditures per potential customer low.^[2] The company spends $124 on average per new customer added, compared to the industry average of $358.^[3]

85% of its customers use MetroPCS service as their primary phone service and 55% do not own any other phone service, reducing the risk that customers will cancel their service in an economic downturn.^[4] This mitigates the company's exposure to low-income demographic trends, which are a risk given its focus on urban communities. However, customers do not have contracts with MetroPCS, which creates pricing pressure that intensifies in a recession. The lack of contracts means MetroPCS's customers can easily switch to alternatives such as landlines, VoIP, or plans offered by MetroPCS's direct competitors, Cricket/Jump Mobile and Sprint Boost Mobile, if they view these plans as a better value.

Business Overview

Since 2005, there has been widespread consolidation in the telecommunications industry. AT&T (T) purchased Cingular Wireless at the end of 2006 and Verizon Communications (VZ) acquired MCI in 2005. Furthermore, Sprint bought Nextel in 2005 to form Sprint Nextel (S). These three companies, Verizon, AT&T, and Sprint-Nextel, now account for 72% of the entire U.S. wireless market share.^[5] With only 1.7% of the market share, MetroPCS faces challenges competing with such large players - it costs more to offer expansive networks to customers, network improvement is more expensive, and competitors can offer bundled packages.^[6] In response to competitive pressures arising from consolidation, MetroPCS Communications (PCS) offered to buy Leap Wireless in September 2007 for $5.5 billion or $75 per share. Leap rejected the terms, and MetroPCS subsequently withdrew its offer. Renegotiating is permitted as of April 2008, now that the 2008 Spectrum Auction, which restricts merger talks, has passed.^[7]

Prior to the consolidation in the telecommunications industry, MetroPCS predecessor General Wireless had filed for Chapter 11 Bankruptcy in 1998. The company spent $1.06 billion to acquire 14 FCC wireless licenses, but the value plummeted to only $166 million in 1998.^[8] After emerging from this bankruptcy in 2002, MetroPCS focused on buying coverage area in urban markets in order to keep expenses low; it kept infrastructure costs minimal by avoiding less populated areas. In order to operate within a specific area, a wireless provider needs to either purchase coverage area from the Federal Communications Commission or entered a contract to use another service's bandwidth. MetroPCS began by buying coverage area and subsequently building a network in Sacramento, Miami, Atlanta, and San Francisco.^[9] These four cities, referred to by MetroPCS as its core markets, accounted for 67% of total customers, but only 35% of net customer additions in 2007.^[10] Tampa, Detriot, Dallas/Ft. Worth, and Los Angeles, which are included in MetroPCS's expanded markets, formed the remainder.^[11] In 2006, MetroPCS spent $1.4 billion to purchase these expanded market wireless licenses from the FCC's Auction 66.^[12] Its purchases also included coverage area in New York City, Philadelphia, Seattle, San Diego, Boston, and Portland.^[13]

85% of MetroPCS's customers buy from indirect retail outlets and the remainder from company-owned retail stores.^[14] Customers can choose unlimited local call plans that start at $30 a month. For between $5 and $20, they can add services such as unlimited text messaging, voice mail services, mobile Internet browsing, and caller ID. Customers pay for next month in advance, and if payment is not recieved, then services will discontinue immediately at the end of the month that was paid for by the customer. As of December 2007, 85% of customers used plans that exceeded $40 a month.^[15] This service revenue accounted for 86%, or $1.92 billion, of MetroPCS's 2007 revenue. Sales of handsets and accessories formed the remainder.^[16]

Financial Performance and Business Metrics

MetroPCS's expansion into new markets increases sales and marketing expenses and raises capital expenditures. For instance, MetroPCS spent approximately $370 million to build out its network in Jacksonville.^[17] In order to recoup these expenses, MetroPCS has to retain its customers and seek new ones. The company can also increase revenue by selling more wireless services to each customer on average. As such, five performance measures are good indicators of MetroPCS's business health. These metrics include:

1. Average Revenue Per User (ARPU) is the monthly sales to each of MetroPCS's customers on average. Higher ARPU translates to higher revenues.
2. Cost Per Gross Customer Addition (CPGA) is how much MetroPCS spends to acquire each additional customer. A lower CPGA decreases expenses, and increases operating profitability.
3. Cash Cost Per User (CCU) is service and selling and general administrative costs, along with any equipment losses untied to acquiring customers, divided by the average number of customers. As the difference between ARPU and CCU increases, operating margins improve.
4. Churn is the turnover rate among customers that have used MetroPCS's service for more than a month. MetroPCS would like to retain customers (low churn), because the price to attract new customers (CPGA) is quite high.
5. Total Customers indicates how many people subscribe to MetroPCS's service. More customers mean more service revenue for MetroPCS.

The following table^[18] shows the figures for these five business metrics over the past three years. Also, one can see how MetroPCS compares to its competitor in the Competition Segment of this article.

MetroPCS's expansion into new markets is expensive and decreases net income in the near-term. As MetroPCS increased its expansion rate from 2005-2008, capital expenditures rose from $266.5 million to an expected $1.2 billion in 2008.^[19] In addition, MetroPCS spends more advertising in new markets. The company increased advertising spending in its expansion markets by $22.6 million in 2007.^[20] A look at income from operations in its core markets, which were established in 2002, vs. its expansion markets helps show the difference in income from operations. The following graph^[21] shows service and equipment revenue, along with income from operations, for MetroPCS's core and expansion markets.

^[22]

^[23]

In 2007, the core markets earned $529 million from operations, while the expansion markets lost $59 million.^[24] The main driver of revenue growth for MetroPCS over the past three years has been customer growth. While average revenue per customer remained flat, MetroPCS added half a million customers in 2005, a million in 2006, and another million customers in 2007.^[25]

Growth Strategy and Accumulation of Debt

As of March 31, 2008, MetroPCS markets wireless services in 8 of the top 25 most populated metropolitan areas.^[26] With its coverage area licenses purchased in FCC Auction 66, MetroPCS will be able to reach 6 more of these densely populated areas. Further, its 54 million people in current coverage areas will increase to 148 million if MetroPCS builds networks in every city where it holds licenses.^[27] The wireless provider launched services in Las Vegas and Bakersfield (California) in late March of 2008. Also, it added Jacksonville to its coverage area in May of 2008.^[28] MetroPCS hopes to roll out service in Philadelphia in the 4th quarter of 2008, Boston in the 1st quarter of 2009, and New York City in the 1st half of 2009. These three markets include a total population of 30 million people. The company will continue to use the same business strategy of no long-term contracts, unlimited fixed price calling plans, and customer retention through keeping prices low as it enters these new markets.^[29]

This current growth phase has impacted MetroPCS's debt load. While the company generated $1.15 billion in cash during its April 2007 IPO, it also has used debt to finance operations. Long-term debt increased from $905 million in 2005 to $3 billion in 2007.^[30] Interest expense rose 74% to $201 million in 2007 compared to 2006. MetroPCS's debt has a weighted average interest rate of 8.15%.^[31]

Key Trends and Forces

^[32]

^[33]

Although the wireless market has matured, MetroPCS still has room to grow

The International Data Corporation places the United States wireless penetration at 80%.^[34] Basically, 80% of Americans able to own and operate cell phones already do. With over 250 million active wireless subscriptions in the United States^[35], companies have to fight for market share or add services to existing customers, such as data, in order to drive revenue growth. Benefiting MetroPCS's growth since 2002 has been the lack of attention telecom giants Verizon Wireless, T-Mobile, and AT&T Wireless gave to the minority and youth markets. However, within the past year, these wireless providers began flat rate unlimited service offerings much like what MetroPCS offers.^[36] Despite the maturing market, MetroPCS believes most of the remaining growth will be in no contract and low-income demographics. The company points to Wall Street research (shown in the bottom right graph produced by MetroPCS) that indicates 25% of the population earning between $22,500 and $39,999 per year do not have cellular service, but only 7% of people with incomes above $90,000 do not.^[37] MetroPCS's average customer earns $38,000.^[38] Further, only 10% of Americans use no-contract wireless subscriptions, which is relatively low compared to the United Kingdom's 67%, Italy's 88%, or France's 39%.^[39]. Decreasing discretionary income, due to rising Food and Gas Prices, can cause consumers to be less confident in their ability to pay long-term contracts, and as a result, shift demand to no-contract plans like the ones offered by MetroPCS.

In response to saturation in the wireless market, wireless providers are pushing data services and consumers are buying

The data market grew 55% in 2007 to close the year at $24.5 billion in service revenue.^[40] Overall Average Revenue Per User (ARPU) declined $0.81 in 2007 for wireless providers as Voice ARPU dropped $1.50, but Data ARPU increased 7% or $0.68 for the year. This divergent trend between Voice and Data ARPU has been ongoing since the beginning of 2004.^[41] While MetroPCS offers data services such as text messaging and mobile Internet browsing, the company remains focused on delivering wireless service at low costs rather than offering high revenue generating contracts. This strategy contributes to MetroPCS earning $10 less in monthly ARPU than the industry average, but also kept its average monthly cost per user $11 lower.^[42]

Mergers and acquisitions have resulted in a few giants dominating the telecom industry

The M&A Activity has helped Verizon Wireless, Sprint Nextel (S), and AT&T Wireless claim almost three-quarters of the wireless communications industry.^[43] This consolidation puts pressure on smaller wireless providers. For instance, these large companies control wider coverage areas and have pricing power over MetroPCS when it comes to using their networks.^[44] MetroPCS tries to avoid paying competitors for use of their networks focusing on urban centers, where calls tend to be local and within its coverage area. The largest wireless providers can also use their extensive advertising budgets to target a wide range of areas. More targeted marketing in urban locations allows MetroPCS to remain competitive but does not require it to build and maintain national coverage or spend as much as competitors to attract business.

MetroPCS's failed bid for Leap Wireless and its subsequent build-out of its network

As consolidation of wireless providers left a few big players, MetroPCS made a bid for Leap Wireless in September of 2007. The deal, priced at $75.05 per Leap share, would have made the company the sixth largest wireless communications provider and given the combined company access to almost all the top 200 markets. The two companies mostly operate in different markets, so a synergy would expand presence and not simply remove competitive pressure. Furthermore, a combination of the two wireless providers will lower overhead expenses and market-level operating expenses.^[45] The deal, which would have been paid in MetroPCS shares, also called for MetroPCS to refinance almost $2 billion of debt which Leap Wireless holds.^[46] While Leap rejected the deal as its boards wanted better terms, the FCC allowed talks (if desired) to resume in April 2008.^[47]. No news stories suggest the two wireless providers have resumed talks, and further, the rival companies now are entering the same markets, which decreases the likelihood of a merger. MetroPCS launched wireless service in Las Vegas in March of 2008, and Leap followed two months later.^[48]

MetroPCS's insulation from U.S. Economic Cycles

With MetroPCS's average customer earning $38,000, rising prices at the pump and higher food costs, along with layoffs, will lower disposable income. However, 85% of MetroPCS's customers use MetroPCS service as their primary phone service, so they may find themselves decreasing spending outside of their phone bill.^[49] For example, the economic slowdown at the beginning of 2008 did not hurt MetroPCS Communications (PCS) - the company added 450,000 net subscribers in the first quarter, which surpassed analyst's expectations of 415,000.^[50]

Competition and Market Share

Competitive pressure for the roughly $168 billion wireless communication industry is quite fierce. These companies use quality, reliability, brand awareness, and value pricing to try to capture new and retain existing customers in the saturated wireless market. MetroPCS closest rivals include Cricket, Jump Mobile, and Boost Mobile. Unlike Verizon Wireless and AT&T Wireless, these brands direct advertising and payment plans towards minority and youth demographics. This segment's preference towards no-contract and prepay service plans results in consumers ability to switch quickly between wireless carriers depending mainly on value of offered services.

Wireless providers use 3 common business metrics to show success - Monthly Average Revenue Per Customer (ARPU), Net Additional Customers, and Churn rate (or turnover rate). The following table^[51] compares the companies in this industry using these metrics, in addition to showing the total number of customers, 2007 revenue numbers, and each company's market share in the wireless communication industry.

^Pre-Paid, Post-Paid Customer Data ^^Market Share Data as of Q1 of 2007

References

1. ↑ Raymond James Institutional Investor Conference 3/3/08
2. ↑ Raymond James Institutional Investor Conference 3/3/08
3. ↑ Raymond James Institutional Investor Conference 3/3/08
4. ↑ Raymond James Institutional Investor Conference 3/3/08
5. ↑ Chetan Sharma Consulting Group
6. ↑ Leap Wireless (LEAP) Form 10-K FY 2007, "Competition" Page 10-12
7. ↑ MSN Money Article
8. ↑ Answers.com
9. ↑ MetroPCS (PCS) Form 10-K FY 2007 "Service Areas" Page 4
10. ↑ MetroPCS (PCS) Form 10-K FY 2007 "Performance Measures" Page 66
11. ↑ Raymond James Institutional Investor Conference 3/3/08
12. ↑ MetroPCS (PCS) Form 10-K FY 2007 "Item 6" Page 47
13. ↑ MetroPCS (PCS) Form 10-K FY 2007 "Item 6" Page 47
14. ↑ MetroPCS (PCS) Form 10-K FY 2007 "Distribution and Marketing" Page 8
15. ↑ MetroPCS (PCS) Form 10-K FY 2007 "Company Overview" Page 47-48
16. ↑ MetroPCS (PCS) Form 10-K FY 2007 "Selected Financial Data" Page 46
17. ↑ MetroPCS (PCS) Form 10-K FY 2007 "Capital Expenditures" Page 79
18. ↑ MetroPCS (PCS) Form 10-K FY 2007 "Performance Measures" Page 66
19. ↑ MetroPCS (PCS) Form 10-K FY 2007 "Capital Expenditures" Page 79
20. ↑ MetroPCS (PCS) Form 10-K FY 2007 "Results of Operations" Page 58
21. ↑ MetroPCS (PCS) Form 10-K FY 2007 "Results of Operations" Page 57
22. ↑ MetroPCS (PCS) Form 10-K FY 2007 "Results of Operations" Page 57
23. ↑ MetroPCS (PCS) Form 10-K FY 2007 "Results of Operations" Page 57
24. ↑ MetroPCS (PCS) Form 10-K FY 2007 "Results of Operations" Page 57
25. ↑ MetroPCS (PCS) Form 10-K FY 2007 "Performance Measures" Page 66
26. ↑ Raymond James Institutional Investor Conference 3/3/08
27. ↑ Raymond James Institutional Investor Conference 3/3/08
28. ↑ MetroPCS Company Website (Press Releases)
29. ↑ Raymond James Institutional Investor Conference 3/3/08
30. ↑ MetroPCS (PCS) Form 10-K FY 2007 "Selected Financial Data" Page 46
31. ↑ MetroPCS (PCS) Form 10-K FY 2007 "Interest Expense" Page 60
32. ↑ Verizon (VZ) Wikinvest Article
33. ↑ Raymond James Institutional Investor Conference 3/3/08
34. ↑ Leap Wireless (LEAP) Form 10-K FY 2007, "Cricket Overview" Page 2-3
35. ↑ Chetan Sharma Consulting
36. ↑ Leap Wireless (LEAP) Form 10-K FY 2007, "Competition" Page 10-12
37. ↑ Raymond James Institutional Investor Conference 3/3/08
38. ↑ Raymond James Institutional Investor Conference 3/3/08
39. ↑ Raymond James Institutional Investor Conference 3/3/08
40. ↑ Chetan Sharma Consulting
41. ↑ Wireless Carriers: Voice ARPU Trends Chetan Sharma Consulting
42. ↑ Raymond James Institutional Investor Conference 3/3/08
43. ↑ Chetan Sharma Consulting Group
44. ↑ MetroPCS (PCS) Form 10-K FY 2007 "Competition" Page 9-10
45. ↑ Fierce Wireless
46. ↑ C|Net News
47. ↑ MSN Money Article
48. ↑ Telephony Online
49. ↑ Raymond James Institutional Investor Conference 3/3/08
50. ↑ Forbes Article
51. ↑ Collection of 2007 Company Financial Highlight Pages except for Market Share Data
52. ↑ Chetan Sharma Consulting