The consolidation among the wireless carriers seems set to continue as the Alltel/Western Wireless looks set to follow Cingular/AT&T Wireless and Sprint/Nextel
http://quote.bloomberg.com/apps/news?pid=10000006&sid=aW5KCLctb1uQ&refer=home
Most observers claim the driving force is the need for scale to survive. I disagree. The wireless industry is going through a tectonic shift which will lead to a mix of rational and irrational behaviour. Let's take a look at some of the economics of the industry.
The best way to understand the economics of a wireless carrier is to differentiate between their two main activities. First, they have fixed costs of building out a network (spectrum, cell towers, operation support systems, etc) which are largely independent of the volume of subscribers. Second, they have the costs of turning that fixed asset into a cash generative asset through attracting and retaining customers. As industries mature, history teaches us that the focus switches from the former to the latter as technology becomes less important and marketing/distribution becomes the primary basis for competition. Let's take a closer look at the economics of attracting customers.
The average subscribers costs ~$360 to acquire (CPGA - cost per gross add)
- $100 handset subsidy
- $180 channel cost
- $80 marketing
This average subscriber then generates ~$50 ARPU for a little over 2 years based on current churn levels. If you generously assume a 50% EBITDA contribution margin then the NPV of this customer is around $200.
Now let's look at how the recent M&A activity is valuing these subscribers:
- AT&T Wireless $41 billion for 22 million subscribers => $1900 per subscriber
- Nextel $35 billion for 15 million subscribers => $2300 per subscriber
So all this manic M&A activity is valuing these subscribers at an order of magnitude higher than the discounted value of the cashflow they will generate. Stop and think about this for a moment. This is a $100 billion industry that is shuffling deckchairs on the titanic.
So as a VC how do I respond to this economic disparity? Well I have developed two hypotheses which are not necessarily mutually exclusive.
The first hypothesis is that the market is pricing in improvements in CPGA, ARPU and churn which will close the gap. Unfortunately most of the long term trends suggest that at best wireless carriers will only be able to stabilize these drivers not improve them. The rise of pre-paid, new handsets requiring greater subsidies, wireless number portability are all driving CPGA and churn up. There is a ray of hope that data can increase ARPU but even if you assume it grows from $50 to $70 that still only doubles the NPV from $200 to $400. This economic imperative to increase is a trend that Hey Anita, one of the companies I serve as board observer, plays into with their Rapid Messaging Solution that is the voice equivalent of text messaging. Look out for them launching this service this year.
The second hypothesis is that CPGA and churn are the real drivers of economic value and that the wireless carriers are structurally unable to improve these drivers, so it will take different entities with different strengths in brand, marketing and distribution to effect change. This is where MVNOs enter the picture. An MVNO is a Mobile Virtual Network Operator who provides the same service as a wireless carrier but with two distinctions. First, they do not own any network or spectrum and thus avoid the fixed cost of entering the industry. Second, they control all the customer touch points (handset choice, branding, billing, customer care) so that the customer is ignorant of the network provider. Virgin Mobile with 4 million subscribers in the UK and 2 million subscribers the US is the most visible example of this. Our long term perspective on this market trend led Mobius to invest in Visage Mobile at the end of 2002. Visage Mobile is an MVNE (Mobile Virtual Network Enabler) providing the billing, customer care and logistical support for brands looking to launch an MVNO but on a variable rather than fixed cost basis. As a board observer, I have been privy to the twists and turns over the past two years and it is clear that the market is reaching an inflection point where people in the industry have switched from thinking "why" to "how" which puts the Visage team in a great position to capitalize.
Look out for new MVNO entrants in the second half of 2005 who will continue to change the economic landscape through smarter marketing and distribution efforts.