AT&T's Cingular Success Story

The wireless unit's record earnings seem to vindicate its parent's competitive strategy. The iPhone deal should help propel the telecom even further

AT&T's (T) Cingular Wireless unit reported the best earnings in its history on Jan. 24, demonstrating that the telecom giant's aggressive acquisition strategy is working. Once regarded as a clumsy runner-up to rival Verizon Wireless (VZ), former Cingular Wireless owners BellSouth and SBC decided to assert themselves in 2004 with a $41 billion acquisition of the old AT&T Wireless. SBC went on to buy the separate AT&T landline business for $16 billion and BellSouth for $86 billion in separate deals (see, 12/29/06, "AT&T-BellSouth: Together at Last"). It changed its name to AT&T as well.

Cingular performed successfully across the board. It reported annual revenue of $37.5 billion, up 9% for the year 2006, and quarterly revenue of $9.8 billion, up 10% for the period. The company added a record 2.4 million subscribers during the quarter, reaching 61 million. Operating margins rose about one-third of a percentage point, to 34.4%. And the percentage of customers who switched to a rival company dropped to 1.8%, down from a problematic 2.1% in the fourth quarter of 2005.

Successful Merger Strategy

Cingular Chief Executive Stan Sigman told investors that the results reflect the success of the $41 billion AT&T Wireless deal (see, 5/1/06, "Wireless: Still Too Crowded?"). "Our merger acquisition is working," he said during a conference call. "At the end of 2004, we began a quest for industry leadership. We did exactly what we said we would. We can look back with pride. We had a great plan and great execution."

Investors are enthusiastic. Analysts from Merrill Lynch (MER), Banc of America Securities (BAS), and other banks have a "buy" rating on AT&T, thanks in great part to Cingular. AT&T stock rose 3.79% on Jan. 24, up $1.34, to $36.70. Banc of America analyst David Barden expects it to hit $39.

On Jan. 24 Sigman offered more reasons for optimism. He said that he expects earnings growth to remain in the low double digits in 2007 and that profit margins will keep rising, to 40% and more by 2008. Synergies from the AT&T Wireless deal aren't fully realized, he said. He declined to provide details, explaining AT&T would provide an update on all of its deals when it reports earnings on Jan. 25.

Serious Competition

The key to future growth is that growing data revenue—that is, revenues from e-mail, text messaging, Web browsing, and entertainment—is finally offsetting declines in older voice businesses. Sigman said that new development was historic. It shows that billions of dollars worth of capital investments are paying off. Data revenue is up 69%.

That's no small feat. Rivals such as Sprint Nextel (S) are running into hard times despite a growing market (see, 10/11/06, "Is Time Running Out for Sprint's Forsee?").

The most serious competition has come from Verizon Wireless, long the largest player in the country. Verizon lost that title to Cingular in 2004 when Cingular bought AT&T Wireless. But in the last two years, Verizon has added more subscribers than Cingular, threatening to overtake the leader. Verizon added 1.9 million customers during the third quarter of 2006, compared to Cingular's 1.6 million. It's not clear whether Cingular's performance in the fourth quarter will be enough to widen the distance between it and its major rival: Verizon hasn't reported its fourth-quarter results yet.

Scoring the iPhone

Cingular has successfully used its scale and scope to drive down costs. That's also helped it strike exclusive deals for cutting-edge mobile phones. Cingular scored a coup on Jan. 9, when Apple (AAPL) CEO Steve Jobs introduced the much-anticipated iPhone, a combination mobile phone and iPod, and said Apple would offer the device in the U.S. exclusively through Cingular (see, 1/10/07, "The Future of Apple").

Apple said Cingular's willingness to step aside and give Apple complete control over product development was an important factor in its decision to give Cingular the exclusive contract. In the past, telecom executives have been notorious control freaks, demanding ownership of every aspect of their customer offerings.

Cingular has innovated in the area of mobile entertainment, too. Its new Cingular Music service allows users access to music subscription services such as that offered by Yahoo! (YHOO). Rivals, including Verizon, have created their own music services.

During the next year, Cingular will begin experimenting with mobile advertising. In the next few months, it will begin offering 411 callers searching for a local business such as a dry cleaner or restaurant a text message with ads from establishments located nearby. Subscribers will receive the ads only if they want to view them, Cingular executives told in an interview. Cingular also plans to integrate ads into mobile search, those executives said. Mobile advertising revenue isn't figured into more earnings forecasts for the company.

Plenty of challenges remain. Verizon remains the industry leader by some measures. It's smaller, but it has higher margins and a lower rate of customer defection. But Cingular says it has plans to achieve leadership in those areas, too. Given its recent success, those claims need to be taken seriously.

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