Merger Murmurs Spruce Up a Woeful Wireless Season

Talk of consolidation among wireless carriers remains one of this industry's few upbeat topics as earnings season kicks off. Wireless companies continue to cast about for any sliver of good news, amid stunted growth, declining revenues and a Moody's downgrade of the entire sector last month.

Investors will be waiting impatiently today for any developments out of Deutsche Telekom(DT Quote), whose CEO, Ron Sommer, reportedly may throw in the towel to appease shareholders and the German government, which is a 43% owner of the company.

Sommer engineered the company's spending rampage over the past two years, including a $31 billion purchase of VoiceStream. The unit was reportedly in preliminary discussions with a wide range of U.S. carriers, including AT&T Wireless(AWE Quote), in an estimated $10 billion merger.

Some analysts believe that with Sommer out, the road to a deal with either AT&T Wireless or SBC Communications(SBC Quote) and BellSouth(BLS Quote)-owned Cingular would be paved.

"If there's new management with a clean slate, that could potentially make it more likely that VoiceStream is sold," said W.R. Hambrecht analyst Peter Friedland, whose firm has not performed any underwriting for the companies mentioned.

In the past, consolidation among the big six carriers in the U.S. was deemed unlikely, given the regulatory hurdles. But with the Federal Communications Commission lifting the cap on spectrum that any one carrier can acquire in any one market by January 2003, and the depressed state of the sector -- partially brought on by intense pricing pressure among the competitors -- analysts said such forces may help set the stage for a much-hoped-for round of M&A activity.

"With equities of the larger wireless operators crushed and no recovery in sight, we believe the environment has become ripe for consolidation," wrote Jefferies wireless analyst Ben Abramovitz. "We believe that regulators will likely become more lenient on approving a merger between two large operators."

Until such activity happens, however, investors will be focusing on the nitty-gritty routine of metrics-gazing.

Nextel (NXTL Quote) has largely taken any surprise out of its report Tuesday by reaffirming its 2002 guidance of $2.5 billion in earnings before taxes, interest, depreciation and amortization, and 2 million new additional subscribers.

So all of the attention will fall this week on the earnings call of Sprint PCS(PCS Quote), one of the few companies not entangled in this season's merger rumors. In the past, though, it has been linked to the only other technologically compatible player in the U.S. market, Verizon Wireless, the joint venture between Verizon(VZ Quote) and Vodafone(VOD Quote). It's wishful thinking for now.

Sprint PCS has hunkered down in the past months, preparing for the national rollout of its wireless, high-speed data network in early August. In a note to investors, J.P. Morgan analyst Thomas Lee wrote that the company is "staged to post stronger market share gains in the September quarter."

Lee credited a boost from the marketing of its new 1XRTT data network and a six-week exclusive promotional contract for the upswing in net additional subscriber growth. Moreover, Lee expects the company to begin attacking the regional market.

Until now, the company has focused on attracting subscribers to its nationwide plans, but Lee believes that it will go after regional customers with vigor in the coming months.

W.R. Hambrecht's Friedland cautioned against any initial euphoria over the launch, pointing out that while Sprint's expected promotions for the network will drive more customers through its doors, it does not necessarily guarantee the success of the networks.

"The overall promotion of the launch of [the] 1x product should get more people walking in the door," he said. "But it remains unclear if it has an impact on revenues or demand for wireless data services."

For the coming week, Sprint has eliminated most downside surprises in its second-quarter earnings report, set for Thursday, after preannouncing shortfalls in mid-June. Sprint warned investors that projections for net additional subscribers would be halved -- now expected to be about 300,000 -- instead of analysts' expectations of 600,000 to 650,000.

Net additions for the year also are expected to be about 10% to 15% below original forecasts of 3 million. EBITDA is expected to be at least $800 million for the quarter and $3 billion for the year. Capex came down by $100 million to $3.3 billion.

Analysts polled by Thomson Financial/First Call expect the company to report a loss of 7 cents per share for the quarter.

On top of those projections, investors need to pay attention to improving the average revenue per user, already among the industry's highest at around $60. J.P. Morgan is expecting the company to add an additional $1.10, which will have positive impact on EBITDA, in spite of the slower subscriber growth. Investors also should look for signs of growth to trend higher as it begins to promote its new data services.

Next Up: AWE

The nation's third-largest operator, AT&T Wireless, which reports the following week, is expected to meet expectations of about 550,000 net additional subscribers, sequentially down from the first quarter, when it added 650,000.

Although the company maintained prices, it concurrently launched aggressive customer-retention plans in the quarter by offering special incentives for customers nearing the end of their contracts, which analysts expect may impact margins and hurt ARPU.

"If they're getting some growth in subscribers, and holding ARPU, you'll see terrific cash-flow growth," said Thomas Weisel analyst Ned Zachar, explaining that it's one of the few upsides, though a critical one, to companies that, in the face of declining customer interest, also are cutting costs to lure new customers. The firm has done underwriting for AT&T Wireless.

Overall, analysts should focus on two yardsticks -- improving ARPU across the sector, and reduced churn, both of which are major potential upsides promised by wireless carriers as new customers remain scarce.