Take a Number: Portability
Clouds Cellphone Firms' Future

Phone users frustrated by bad cellphone service will get the chance beginning next month to switch phone companies while keeping their existing number.

But before dialing your phone company, you might want to call your broker first.

Wireless phone companies -- finally back on their feet after a bear-market pummeling -- face a newly bleak outlook as customers go deal-hopping in search of the best prices. That will drive up costs, lower prices and likely hurt earnings and stock prices.

The so-called number portability rules go into effect Nov. 24 and Wall Street analysts are jumping over each other in an effort to predict how the shift will play out, picking the likely winners and losers.

But the bigger likelihood is that all of the big wireless carriers will lose out, as the rule turns cellphone service into a commodity like long-distance service, with the same margin-crushing results for the phone companies.

"It's a very big deal and I don't think the market is recognizing it," says Dean Kartsonas, an analyst at Federated Investors, the Pittsburgh-based mutual-fund company.

The three "pure play" wireless stocks -- Nextel Communications Inc.; Sprint PCS, the wireless division of Sprint Corp., which trades separately as a tracking stock; and AT&T Wireless Services Inc. -- likely will feel the most heat.

The other three major wireless companies are controlled by one or more major phone companies: Verizon Wireless (by Verizon Communications Inc. and Vodafone Group PLC), Cingular (SBC Communications Inc. and BellSouth Corp.) and T-Mobile USA Inc. (Deutsche Telekom AG). But these companies, which have gotten much of their recent growth from wireless, could still be hit. Merrill Lynch estimates that a 25% increase in churn for Verizon Wireless will cut the parent company's earnings by 3.5% next year.

GOING MOBILE See market share for major U.S. wireless carriers and the average monthly percentage of subscribers who left their carrier in the second quarter of 2003.

The three pure-play wireless companies are up an average of 157% over the past 12 months after being thrashed during the stock-market slump.

Some of the run-up was deserved. Wireless providers have cut costs, lowered customer turnover, or churn, and added subscribers. The result has for the most part been solid free cash flow.

All that may change shortly. "They've done a very good job operationally this year. Unfortunately this portability is going to be a big negative for them," says Mr. Kartsonas, whose firm doesn't own these companies' shares but does own some of the Baby Bells that have wireless units.

The big risk is an increase in churn, as customers switch carriers as they chase lower prices. In the past, switching meant also getting a new phone number, prompting many customers to sit tight and avoid the hassle. But under new Federal Communications Commission rules, most customers soon will be able to keep their number if they go from, say, Verizon Wireless to Cingular Wireless.

In a survey by research firm Gartner Inc. of corporate executives who buy or manage cell service for their companies, 81% said they would be likely to change their carriers within the next 12 months if they could keep their phone numbers.

Right now, churn rates at cellphone companies run at about 26% annually, meaning more than one-quarter of their subscribers leave every year. To keep growing, companies must not only add new subscribers, but also replace the lost ones. The problem: Adding a new subscriber costs about $320, according to Yankee Group, a technology-consulting firm, meaning it takes about six months to turn a profit on a new customer. Several wireless carriers acknowledge that they expect churn to rise after the new rules go into effect.

Higher churn can devastate profits. CreditSights, an independent credit-analysis firm, estimates that churn will increase 15%, on average, and that will cut operating income by as much as 17% for some of the weaker carriers.

"The cost of acquisition still remains high, so I'd be surprised if we don't see some hits to the bottom line in the first six months of 2004," says Gartner analyst Phillip Redman. "They're going to have to be more competitive if they want to keep their subscribers." Indeed, spending on advertising already is up dramatically so far this year.

For those picking winners and losers, the scenarios play out this way: Businesses and consumers who want the most extensive coverage will likely flock to Verizon Wireless. That could be significant. In a survey of business users by Gartner, 70% list coverage as the factor that would most likely cause them to switch, while 27% point to price.

Consumers, the bulk of wireless customers, are driven by price. The winner here could be T-Mobile, which has traditionally had the lowest prices.

The other deciding factor could be companies' ability to avoid the commodity trap. Here, Nextel, with its walkie-talkie "direct connect" feature, sits apart from the crowd, which could help it attract new business.

But these scenarios will likely be forgotten by investors when the first wave of bad news hits the sector. And ultimately the battle will be fought over prices and costly goodies like free phones, potentially crushing profitability across the sector.

Indeed, Randy De Lorenzo, a vice president for Telwares Communications LLC, a telecom-procurement consulting firm, said that a corporate client recently received a proposal from a major wireless carrier offering to double the amount of free service, specifically citing impending wireless number portability. And Sprint PCS has been running ads since mid-July seeking to poach business customers from AT&T Wireless.

AT&T Wireless, meantime, says that its enterprise sales force is using impending portability rules in hopes of poaching customers. However, like every cellphone company, the carrier says it won't cut prices drastically to keep business. "To the extent our competitors do that, we are prepared to respond, but we will respond in a way that allows us to maintain profitability," says Jonathan Pinter, vice-president of marketing strategy at AT&T Wireless.

How competitive will the landscape become? Several countries have adopted portability, with Finland being the latest. There, churn for TeliaSonera, the largest Finnish wireless carrier, more than doubled from 10% in this year's second quarter, before the new rules, to nearly 22% in the third quarter. Rival carriers rushed out offers after the new rules, and TeliaSonera has since responded with a single-rate mobile plan. One analyst cut his cash flow estimate for the company's Finnish wireless operations by 9% and 10% in the third and fourth quarters, respectively.

Hong Kong, which has the same number of carriers as the U.S., also experienced a large churn increase. The United Kingdom, on the other hand, saw churn basically unaffected after portability rules took effect -- which some analysts attribute to long delays to swap phone numbers to the customer's new phone.

The only potential upside from portability rules for the wireless industry: landline telephone customers will be able to switch their numbers to wireless accounts, although how extensively is still up in the air.

Of course, that could just shuffle the business from one corporate name to another, since the majority of wireless customers subscribe to carriers owned by landline telephone companies.

Write to Ken Brown at ken.brown@wsj.com and Jesse Drucker at jesse.drucker@wsj.com

Updated October 8, 2003