The Next Big Cell Phone Losers

Back in the 1980s, my first cell phone was built like a brick. It also weighed like one.

It was so clunky it looked more like a World War II walkie-talkie. Im talking about the DynaTAC 8000X. Ugly or not, the brick sold for $3,995, and it still flew off the shelves.

But I didnt care. The freedom from a desk and the increased productivity it gave me were worth it. Sure, four thousands bucks was a ton of money back then, especially since I was just starting. But I justified it by saying it was the cost of doing business.

Trouble is, being the young, foolhardy kid that I was, it didnt quite work out that way. I also used my cell phone to call pretty, young girls. I even let my friends use it to do the same.

Big mistake! I practically died when I got my first cell phone bill. I dont remember the exact amount. But I do remember it was uncomfortably close to $1,000.

After that, youd think I would have locked my brick away in a safe place so no one could use it, especially me.

But I didnt. I needed my cell phone. And to this day, I have a hard time imagining life without one. Fortunately, the bill is just a small fraction of what it was two decades ago.

My wife, my 22-year old son, and I talk as much as we want. We get 4,000 minutes per month, and we pay only $209.98 a month for all three of us. Thats not penny change. But its still just a small fraction of what I used to pay.

Falling Technology Prices Are Wonderful for Consumers.
But Not So Good for the Businesses Getting Squeezed!

The plunging price of owning and using a cell phone shouldnt surprise you one bit. Thats what generally happens when a new technology matures and is made more widely available.

The same was true years ago for calculators and digital watches. And the principal continues to apply today to MP3 players, computers, DVD players, printers, or cell phones.

Thats wonderful for consumers. But for the businesses getting squeezed with lower and lower profit margins, its not so good.

Just last week, for example, the newly-merged company combining Sprint and Nextel now the third largest wireless carrier in the U.S. delivered its Q4 results. And it dropped some very important hints about the future of the wireless industry.

The company reported that it pulled in $11.2 billion of sales and earned $197 million of profits, or 33 cents a share of profits.

From that point on, the news wasnt pretty. However, since this is the first quarterly report of the merged company, the Wall Street crowd has been a little slow in deciphering the details and recognizing the warning signs it implies to investors in wireless.

Warning sign #1: A whopping 55% drop in profits. The total profit number of $197 million may sound like a lot of money. But its actually a 55% drop from the $437 million of profits earned last year. Plus, its also a penny below Wall Streets expectations.

The company blamed the drop on $340 million of merger-related costs. But I think thats a bunch of baloney. Keep reading and Ill tell you exactly why.

Warning sign #2: Slowing subscriber growth. If youve been a reader for a while, you know what I think about this: Most people that want a cell phone already have one. So from this point forward, growth is bound to be slow.

You dont have to take that just from me. Just listen to the folks at Sprint Nextel. They say theyre going to grow their user base by high single-digit to low double-digit growth in 2006.

In other words, were probably talking about somewhere between 8% to 12% growth. In most other contexts, youd say thats not too bad. But with the company selling for twenty-eight times earnings, that kind of growth actually stinks.

Warning Sign #3: Slowing subscriber growth (Part II). Sprint Nextel ended 2005 with 47.6 million customers, which is roughly an increase of 2 million more customers in Q4.

Do the math. Two million more customers works out to a measly 4.3% growth rate. Thats pretty pathetic and hardly worth getting excited about.

Warning Sign #4: Questionable quality of new customers. Among those 2 million customers, 746,000 are the traditional postpay users like my wife, son, and I. We tend to spend much more money with that arrangement. Moreover, we lock ourselves into a one- or two-year contract.

Heres the problem: The rest of the companys new cell phone customers are the prepaid type. These are people who dont have enough money to sign up for a monthly plan, dont want to make the commitment, or both. Worse, many have such bad credit, no company in their right mind would agree to bill them in arrears.

And this is the group providing Sprint Nextel with the bulk of its already-meager growth?!

Theyre scraping from the bottom of the cell phone barrel, and heres the proof: The average monthly revenue from each subscriber dropped from $65 last year to $63 in Q4.

Warning sign #5: Layoffs tell the truth. I always get a chuckle when a company brags about how great business is … but then, when it figures few people are looking, it cuts jobs like mad.

Sprint Nextel quietly disclosed that its going to reduce its 60,000 workforce by roughly 4%, or 2,400 workers. And the workforce has already been trimmed from roughly 63,500 at the start of 2005.

The biggest warning sign of all: Sprint Nextel warned Wall Street to reduce its 2006 sales expectation from $46.8 billion to $41 billion. So were talking about $5.8 billion or 12% of its business disappearing in a puff of press-release smoke.

$5.8 billion! Thats a lot of smackers.

Bottom line: The stock is still a long, long way from recovering from the big beating it took after the glory days of the late 1990s. And its even having some trouble holding on to its recent rally.

Are there any shares of Sprint Nextel in my portfolio? Not a chance! That is also true about Verizon (NYSE:VZ), Cingulars joint venture between AT&T (NYSE:T) and BellSouth (NYSE:BLS), or T-Mobile Deutsche Telecom (NYSE:DT).

Landmines and Opportunities

Okay, now you know that the cell phone carriers are in trouble. But knowing why will help you understand not only where other landmines lie but also where the opportunities can be found.

The cell phone business is facing three problems, two of which we already discussed.

Falling prices translates into falling profits.
Widespread penetration translates into slow growth.

But its the third problem that is the biggie. Because it will help you understand where the future of the wireless industry is going …

Internet Phones

Sprint Nextel wasnt the only wireless company that delivered quiet but major news last week: Earthlink and Google quietly announced a joint bid to build a Wi-Fi network in the city of San Francisco.

Free.

Yup, Google and Earthlink would like to turn San Francisco into a place where anyone could go online from anywhere in the city, whether theyre sitting on a park bench, at a coffee house, or in the comfort of their own home.

The story:

Affordable Internet that is accessible to all San Franciscans regardless of geography or income is simply essential, said San Francisco Mayor Gavin Newsom.

We must recognize that access to information is a fundamental government service akin to libraries or public schools.

Customers shouldnt be tied to their desks, or to a single provider, to get the Internet experience they want. Both EarthLink and Google recognize this and are attempting to provide great service and choice in San Francisco.

Google has been in the business of giving away content for nothing from day one, so this isnt a big stretch at all.

I can visualize the scene now: An army of guys, working in twosomes, fanning out all over town setting up Wi-Fi base stations in the San Francisco sunset.

But San Francisco isnt even the first town to offer free Internet connectivity. The city of Chicago has hundreds of Wi-Fi hotspots in places like coffee shops, bookstores and libraries.

Meanwhile, several other cities across the USA are in the process of evaluating city-managed wireless plans that would bypass telecom companies and offer services for free or cheaper than currently available.

According to Wi-Fi tracking service Muniwireless, 186 cities including Orlando, Denver, Minneapolis, New Haven, and Portland, Oregon have already announced Wi-Fi initiatives.

Please dont miss this point.

The wireless business is not going away. In fact, it will become more ingrained in our lives than ever. But the method and cost of delivering a wireless signal is rapidly changing.

The world is switching from traditional wireless towers, which cost several hundred thousand dollars and provide coverage for 5 to 10 miles, to Wi-Fi base stations, which cost as little as one-hundredth of the money, but cover just several hundred feet.

These inexpensive base stations are the future of the wireless industry. And they are the death knell for industries that are based upon expensive cellular towers such as American Tower (NYSE:AMT), Crown Castle International (NYSE:CCI), and SBA Communications (Nasdaq:SBAC).

The wireless world is changing fast. So anybody investing in the big-name, established wireless players that did so well in the 1990s could get burned. Badly.

The new wireless winners are going to be companies that youve probably never heard of … even companies that dont yet exist. Thats how fast the industry is changing.

Where are the best opportunities?

Stay tuned because thats my topic for next week: The Next Big Wireless Winners.

Best wishes,

Tony Sagami

About MONEY AND MARKETS

MONEY AND MARKETS (MAM) is published by Weiss Research, Inc. and written by Martin D. Weiss along with Larry Edelson, Tony Sagami and other contributors. To avoid conflicts of interest, Weiss Research and its staff do not hold positions in companies recommended in MAM. Nor do we accept any compensation for such recommendations. The comments, graphs, forecasts, and indices published in MAM are based upon data whose accuracy is deemed reliable but not guaranteed. Performance returns cited are derived from our best estimates but must be considered hypothetical inasmuch as we do not track the actual prices investors pay or receive. Contributors include Marie Albin, John Burke, Beth Cain, Amber Dakar, Michael Larson, Monica Lewman-Garcia, Julie Trudeau and others.

Sign Up Free