Momma told AT&T Wireless (AWE) there'd be customers like this.

You know the type. The tight jeans, the smoker's hack, those piercing eyes that undress a company's profits from afar. Living in a van down by the river, working part time to support a reckless lifestyle involving malt liquor and throwaway mobile-phone plans.

The prepaying customer, wireless pariah. Well now, momma's ready to invite him to Sunday dinner.

AT&T Wireless wants to change the bad reputation of the prepaid customer. After first-quarter results that showed its churn and average revenue-per-user numbers heading in the wrong direction, the nation's largest wireless carrier was pilloried by investors. Prepaid customers wreck AT&T Wireless' metrics: Churn goes up as they drop off their plans, and they spend less per month than other customers, hurting EBITDA on both counts because the company earns less.

Last week, at its first independent analyst conference in Redmond, Wash., AT&T Wireless spent the morning session defending the character and makeup of its prepaid subscribers. They're not scoundrels; they're the subscribers of the future. Wireless carriers have tapped most of the easy customers willing to pay big bucks for calling on the go. AT&T Wireless shouldn't be penalized for prepaid subscribers, not if it can make money off them. Introduce yourself to a new concept: profitability from prepaid.

"I wouldn't characterize it as an evil," says Kent Reynolds of A.G. Edwards. "It's a necessary next step." A.G. Edwards has not done banking recently for AT&T Wireless.

Papa Don't Preach

Mobile-telephone carriers whisper about prepaid customer statistics as if they were unwanted pregnancies. The thinking is that only a desperate company would spend perfectly good money to get a customer who loves its phone service for three months but then bolts without a trace, leaving the carrier to deal with the discrepancy between the marketing and distribution dollars it cost to acquire the customer and the lesser amount that person spent to buy a 90-day plan.

AT&T Wireless' churn rose to 3% in the first quarter of 2001 after a heavy Christmas-related campaign that boosted its prepaid figures, a number it reduced to 2.9% in the second quarter. Nonetheless, that represented a 0.2% increase over the same quarter in 2000. The company's average revenue per user fell 10.8% year over year, from $71.50 in the second quarter of 2000 to $63.80. In that post-holiday first quarter, ARPU fell to $62.20, a 5.9% sequential decline. A higher population of prepaid subscribers -- AT&T Wireless at the analyst conference estimated it currently stands in the high-single digits, but not quite 9% -- hurt the numbers.

TheStreet Recommends

Marketing Senior Vice President Kim Whitehead explained at the conference that perhaps it wasn't prepaid customers, but the way carriers have treated them that is the problem. "This is not just the credit-challenged customer," she argued. Instead, AT&T Wireless is trying to understand what makes a customer prepaid, and it believes a lot of it has to do with being young or not wanting to commit to a more pricey traditional wireless plan off the bat. This doesn't exclude them from switching to a postpaid product later -- if AT&T Wireless makes that easy to do and reminds them of that fact -- and it doesn't keep them from becoming valuable customers.

The Street was encouraged by Whitehead's suggestion that AT&T Wireless would offer prepaid plans that include SMS (data-messaging) services because evidence from Europe shows its younger mobile-phone users are eating up SMS messaging. Carriers could look at prepaid as a seeding stage for new services.

Tougher Sell

It's also important to note that the U.S. market is nearing 41% penetration, according to J.P. Morgan estimates. Europe's numbers are in the 60% range, and prepaid has weighed heavily on subscriber gains there. Bear Stearns analyst Todd Rethemeier expects carrier subscriber growth to slow as penetration reaches the 43% to 47% range, causing him to predict a "down year" in 2002 with 22.5 million customers added, compared with estimates for 24 million new subscribers in 2001. (J.P. Morgan has done banking for AT&T Wireless, but Bear Stearns hasn't.)

Carriers can't be as picky about the next wave of customers they add. Whitehead tailored a message AT&T Wireless delivered on its earnings call to the prepaid segment, explaining that the company would have to manage the users for margin, not necessarily ARPU. Instead of being dusted by

Sprint PCS

(PCS)

, which had a big improvement in churn, sequential and year-over-year improvement in ARPU and monster EBITDA gains, AT&T Wireless might be setting the pace.

If carriers can manage churn by renewing prepaid customers, and at the same time lower the dollars they spend courting them, the segment might show it's respectable after all.