Wireless Churn Creams Laggards - TheStreet

Wireless investors got a sneak peek at the future this week, and the preview was anything but pretty for

AT&T Wireless

(AWE)

and

Sprint PCS

(PCS)

.

The big wireless service providers saw their shares plunge Thursday after they posted soft growth and noted a rise in subscriber defections. Worse yet, observers expect those trends to intensify in the next month with the phase-in of so-called number portability.

That rule, which allows wireless subscribers to keep a cherished phone number even as they switch service providers, is expected to accelerate the industry's separation into winner and loser camps. The issue isn't just subscriber growth, though that remains paramount; also key is who has to spend to lure or retain customers, and how that affects the bottom line.

The sector's laggards in price and consumer satisfaction, such as AT&T Wireless and Sprint PCS, are expected to suffer. But others could capitalize on the new arrangement, observers say.

Customers will make their decisions "based on two criteria: quality and prices," says Yankee Group's Roger Entner, who sees the field of winners and losers dividing along those lines. "The perceived quality leader is Verizon Wireless and the value leader is T-Mobile." Other industry watchers say customer loyalty should be on

Nextel's

(NXTL)

side.

Uncertain Smile

Of course, the effect of wireless number portability is uncertain, and industry surveys and analyst opinions vary over just how many cell-phone users will actually take the plunge come Nov. 24 when the rules take effect. But one thing nearly all agree on is that AT&T Wireless and Sprint will not emerge as winners.

Fanning the anxiety this week are two surveys by industry consulting firms the Yankee Group and Management Network Group. Both outfits predict churn rates -- the percentage of customers lost over a given time period -- will increase by as much as half as customers who love their numbers but hate their services switch carriers.

The dust will start to kick up in coming quarters, with monthly churn rates jumping to 3.5% over the 2.5% industry norm, says Entner. He says that when the dust settles, two outfits -- the Verizon Wireless joint venture of

Verizon

(VZ) - Get Report

and

Vodafone

(VOD) - Get Report

, and the T-Mobile unit of

Deutsche Telekom

(DT) - Get Report

-- will come in ahead of the pack as consumers opt for perceived quality and lower prices.

In a separate survey by Management Network Group, some 29% of users say they will change services because they can keep their numbers. Over the vast expanse of U.S. wireless subscribers, that could mean 42 million switches in the coming year.

Perhaps more troubling for the big business service players -- again, think AT&T Wireless -- is a recent survey by the same group that says a quarter of all companies plan to switch providers in the coming year.

Though some question the sample size of the surveys and whether they merely gauge the sentiment of users rather than their actual plans to change services, many industry observers say they expect some degree of turbulence over the next several months.

And in some cases, the fun has already begun.

Both Sprint and AT&T Wireless said this week that their churn jumped to 2.7% last quarter, a

disturbing sequential increase that

surprised investors who were looking for more stable trends. Their shares dropped 17% and 11% Thursday.

As a function of their rather middling efforts to date, AT&T and Sprint are in a bit of a sour spot, says Bear Stearns analyst Phil Cusick, in a note Thursday. "AT&T Wireless and Sprint PCS are neither high quality nor lowest priced, and seem to have trouble attracting customers," Cusick writes.

Cost Counting

For wireless investors, the concern isn't so much over which carrier grabs the most subscribers, but more over the costs associated with the higher turnover rates. Telcos will have to beef up spending on customer service, retention offers, phone giveaways and in some cases cash buyouts to win customers by paying off the penalties of their broken contracts.

Analysts like Rich Nespola of Management Network Group say the biggest risk to investors is on operating margins as these costs rise. He also cautions that the timing of the new rules may threaten the all-important holiday buying season.

The fourth quarter is traditionally the strongest sales season for cell-phone service providers. But Nespola fears that if telcos haven't prepared for the even higher volume of service switching, sales staffs will likely get tied up, which would interfere with the normal holiday rush.

Verizon was the first of the six national players to stop fighting the federal number portability rules and start talking about making the switching process easier. But some question whether that has translated to actual operational changes as well.

And though AT&T Wireless has been plagued by service quality complaints and was late to embrace number portability, at least one analyst says don't rule out the company -- it may yet show the mettle to compete in a number-portable age. Ken Hyers of In-Stat, a market research firm, says AT&T has developed a decent strategy. In fact, Wednesday, on a conference call with analysts, AT&T executives said that among their efforts to stem subscriber losses, they plan to contact high-spending customers as their contracts come to an end and try to entice them to sign them on again.

Number portability is likely to have the least effect on Nextel, say analysts. The Reston, Va., cellular service has a remarkably loyal following attributable to its defining walkie-talkie feature. Nextel has enjoyed profitable growth and the

industry's lowest churn rate at 1.4%, as of the third quarter.

To be sure, the strong sales push ahead of number portability has made the wireless sector one of the few success stories in tech this year. But even the bulls concede that that streak may be in jeopardy as the players turn their efforts toward managing the upcoming chaos.

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