Will the End of the Two Year Contract Affect Mobile Telecom Stocks?

James Dennin, Kapitall: The two year contract is so Bush era. How will the end of phone subsidies affect mobile telecom stocks?

T-Mobile (TMUS) shook up the mobile telecom industry last March when it announced it would no longer subsidize users’ new phones. The company reasoned consumers would rather pay lower monthly bills than save money up front on their new phone, and the move allows buyers to upgrade phones more often.

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It also lets phone companies avoid paying its users’ hardware costs in hopes of recouping the money over the course of the contract. This means service providers can boost their gross margins and free up cash for other purposes.

Competition pros and cons

T-Mobile and Sprint (S), who are the also-rans in mobile telephone service, are aggressively attempting to even the playing field by poaching users from Verizon (VZ) and AT&T Mobile (T). The two dominant players created their economies of scale in the early days of mobile telephony with the device subsidy strategy. Before the US reached market saturation, phone companies were happy to spend money to acquire customers, keeping them legally bound to be revenue streams for a specified period of time.

But now that most US residents who are likely to own a mobile phone have one, this strategy makes less sense. In the last year all of the major players have rolled out plans that allow trade-in phones at any time. AT&T's Next, Verizon's Edge or Sprint's Easy Pay programs allow customers to hand in their phones before the two year contract period has expired. AT&T’s Next, for instance, is styled as an insurance program to “protect” users from having to use an old, obsolete phone before they are eligible for an upgrade.

Investment ideas

Telecom stocks are often perceived to be boring, low-growth safety stocks. The percent return over the past year for AT&T is -7%, though its return on investment (ROI) is nearly 13% and its return on equity (ROE) is over 20%. The story for Verizon is the same.

Handset makers, on the contrary, have been market darlings since the mid-90s. But as the market becomes saturated, and phone companies are no longer willing to subsidize the manufacturers’ sales, expect to see their growth slow considerably and their margins shrink.

The following list includes both service providers and hardware makers selected for their market share, profitability, and exposure to upside or downside growth.

Click on the interactive chart below to see data over time. 

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Do you think the end of the two year contract will be a boon or a bane for mobile telecom stocks? Use this list as a starting point for your own analysis.

1. T-Mobile US, Inc. ( TMUS): Provides communication services. Market cap at $23.49B, most recent closing price at $32.31.
 

 

2. AT&T, Inc. ( T): Provides telecommunication services to consumers, businesses, and other service providers worldwide. Market cap at $171.02B, most recent closing price at $32.47.
 

 

3. Sprint Nextel Corp. ( S): Offers wireless and wireline communications products. Market cap at $33.13B, most recent closing price at $8.40.
 

 

4. Verizon Communications Inc. ( VZ): Provides communication services. Market cap at $132.54B, most recent closing price at $46.23.
 

 

5. Motorola Solutions, Inc. ( MSI): Provides business and mission critical communication products and services for enterprise and government customers worldwide. Market cap at $16.75B, most recent closing price at $64.96.
 

 

6. Apple Inc. ( AAPL): Designs, manufactures, and markets PCs, mobile devices, and portable digital music players, and sells related software, services, and third-party digital applications. Market cap at $472.72B, most recent closing price at $527.55.
 

 

7. BlackBerry Limited ( BBRY): Designs, manufactures, and markets wireless solutions worldwide. Market cap at $5.15B, most recent closing price at $9.83.
 

 

8. Google Inc. ( GOOG): Google is the world's most popular search engine. Market cap at $405.99B, most recent closing price at $1212.51.

 

 

( List compiled by Will Kenton, a Kapitall Editor. Financial information sourced from Zack's Investment Research.)

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