The Southwest Airlines of Mobile Calling?
A $340 wireless bill with unexpected charges was the last straw for Linda Targett. "We are tired of the unknowns and the surprise bills," says the 33-year-old office manager in Naples, Fla. "These extra fees, it's just getting ridiculous." Come June 4, she plans to drop her AT&T (T) wireless calling plan for MetroPCS, which offers unlimited calling for as little as $30 a month—and no extra fees.
Straight-ahead calling plans like that, plus interest from users like Targett, have turned MetroPCS (PCS) into the fastest-growing wireless service provider in the U.S. MetroPCS initially sold shares in April, and during its first quarter as a publicly traded company, it added 454,000 customers for a total of 3.4 million. That's 85% more new customers from a year earlier. Sales at MetroPCS are rising faster than for many other providers, its margins are among the fattest, and in the past month, the company's stock has rallied 30%, to $36.11.
MetroPCS and its smaller rival, Leap Wireless (LEAP), which offers comparable call packages through its Cricket brand, are having a ripple effect across the $100 billion mobile-phone service industry. "We expect Metro to have a similar impact on wireless as Southwest (LUV) had on the airline industry," UBS (UBS) analyst John Hodulik wrote in a recent note. Others agree that Leap could follow in the footsteps of the once tiny airline that's now a major airline industry player.
Growing Subscriber Base
Indeed, the companies are growing apace. With MetroPCS's unlimited calling plan selling for $30 a month, vs. more than $100 for most major carriers, "it's perfectly conceivable that they will be taking 50% of [new customers] in the U.S. market in the next one-and-a-half years," says Andrei Jezierski, partner with venture consultancy i2 Partners. MetroPCS may have about 10 million subscribers by 2011, almost three times its current base, says Michael Mahoney, managing director at EGM Capital, who owns MetroPCS stock.
But the Southwest comparison may not hold up for long. The number of U.S. wireless subscribers up for grabs will fall sharply from 21 million last year to 5 million in 2009, according to consultancy Strategy Analytics. So even if the companies lead the industry in net additions, growth will slow.
A Sensible Merger
To compete with the giants, MetroPCS and Leap will need scale, deeper pockets—and possibly each other. Analysts speculate that a merger between the two companies, or a combination with a larger carrier such as Alltel (AT), will be necessary to ensure the long-term viability of MetroPCS and Leap.
Both companies benefit from an ability to keep costs in check. Unlike larger carriers, Leap and MetroPCS recruit most customers through dealers rather than their own stores. Nor do they subsidize handsets, capping the average cost per new customer at about $100, roughly one-third that of bigger players. Yet the bigger operators still have the firepower to drive smaller guys out. In April, Boost Mobile, a division of Sprint Nextel (S), began testing demand for a service that includes unlimited calling for $45 to $55 a month in markets in California and Texas where MetroPCS is thriving.
But what's the likelihood of a deal between Leap and MetroPCS? Leap declined to comment, and MetroPCS didn't respond to inquiries. And there's no evidence they're considering it. Indeed, the deal would appear unlikely, considering the flurry of patent-infringement lawsuits exchanged between the two companies last year.
And yet, many observers say it's a good idea. Today, each company manages to grab about 10% to 15% of the subscribers in markets they enter. Combined, they could get that percentage up to as much as 25%, figures Mahoney. "It makes a whole lot of sense for the two companies to combine," says David Kerr, a vice-president at Strategy Analytics.
Leap and MetroPCS approach the market in similar ways. Both offer unlimited, low-priced service plans and target younger, lower-income users, many from ethnic groups. Both companies use the same network technology, Code Division Multiple Access, making integration relatively painless. And a combination would help the companies reduce the cost of expanding their networks.
What's more, a merger would eliminate a potential competitor. Currently, there's little overlap between their areas of focus. Leap, which began its service in 1999 and in 2004 emerged from Chapter 11 bankruptcy protection, has traditionally targeted small to midsize markets such as Eugene, Ore. MetroPCS, in operation since 2002, focuses on top metro areas, such as Miami, Atlanta, and San Francisco. But they're likely to start treading on each other's turf as soon as next year, says Michael Nelson, an analyst with Stanford Group.
Other companies may be interested in taking out one or the other as well. EGM Capital's Mahoney reckons Vodafone (VOD), part-owner with Verizon (VZ) of Verizon Wireless, may wish to purchase a company it can control fully. Upstart Clearwire (CLWR), headed by wireless pioneer Craig McCaw, might want to purchase MetroPCS or Leap, Kerr says. Clearwire's mobile WiMAX service, which allows for wireless broadband access on the go, is still a ways off. A Leap or MetroPCS could help Clearwire expand its customer base now, fast.
Another possible purchaser: Alltel, recently bought out by private equity firms TPG Capital and GS Capital Partners for $27.5 billion. With its 12 million wireless customers and longtime relationships with handset and equipment vendors, Alltel would provide more scale. The company, whose ads have lately been featuring five high schoolers at a café or in a van discussing wireless services, seems to be targeting similar customer demographics, too.
For now, though, MetroPCS and Leap will continue bagging users like Targett and ruffling the feathers of the bigger players where they can—enjoying the disruption while it lasts.