LEAP: Jefferies Cuts to Sell; Competition Rising, Spectrum Undesired
Shares of Leap Wireless ( LEAP ) are down 39 cents, or 6%, at $5.94 after Jefferies & Co.'s Thomas Thomas Seitz cut his rating on the shares this morning to Underperform from Hold, and cut his price target to $5 from $6, writing that weak business trends last year will persist this yearend that its spectrum holdings are not likely to attract any interest till the second half of this year, if ever. "Competitive intensity is increasing," writes Seitz, as Leap and pre-paid provider MetroPCS ( PCS ) face more aggressive pricing of post-paid providers Verizon Communications ( VZ ), Sprint-Nextel ( S ), AT&T ( T ), and T-Mobile USA : Since 2010, the pre-paid providers added 11 million subscribers in aggregate, and now count ~71 million subscribers (or ~25% of total wireless subscribers, up from 22% in 2010). In contrast, the post-paid market has added less than 4 million subscribers during the period, and has 218 million subscribers in aggregate. During 2012, however, the pre-paid momentum has slowed down. Granted, there has been a modest improvement in the economic activity – unemployment has trended lower, housing has picking up, as has autos, and consumer sentiment generally seems to have turned for the better. In our view, however, the seismic shift in competitive intensity is a much bigger factor impacting pre-paid growth. The Big-Four post-paid carriers – Verizon, AT&T, Sprint, and T-Mobile USA – are increasingly offering competitively priced pre- and post-paid plans as well as cheaper smartphones (even the iconic Apple iPhone is now available for free) to defend their turf. Additionally, in 2013, the pre-paid carriers are expected to scrub a significant number of Lifeline program subscribers (Leap had over 425k Cricket Lifeline customers at 3Q-end), which could further pressure growth. Moreover, performance has been poor at Leap, in Seitz's opinion, and he thinks it's not getting better anytime soon: Across the six key operating metrics that Leap reports – gross adds, churn, net adds, ARPU, cost per gross add (CPGA), and cash cost of service (CCU) – the only metric which was better YoY is ARPU which is primarily due to higher smartphone/Muve Music adoption. Gross and net adds were lower YoY, churn was higher, as were CGPA and CCU. Although Service revenues have been higher YoY in 2012, they have been either in line with Street estimates or modestly below […] Given the recent consolidation moves and anticipated capital injections into Sprint and T-Mobile USA, we expect the competitive intensity to increase substantially in 2013. Second, ARPU growth (which has been the only positive operating trend in 2012 year-to-date, please see Exhibit 6) could slow down in 2013 as smartphone penetration plateaus. Throughout 2012, smartphone and Muve Music customers have remained about 50% of Leap’s subscriber base even as sales of these devices have been in the 55%-60% vicinity. In 2011, penetration increased steadily – from 10% at 2010 year-end to 17% at 1Q11, 27% in 2Q11, and 30% in 3Q11. If we assume that the current smartphone sales rate – as % of total handset sales – represents the steady state adoption level, we estimate modest 5%-10%-points of incremental growth […] As such, in our view, Leap’s limited headroom on improving smartphone adoption could limit ARPU expansion in the future.