1 Thing AT&T Doesn't Want You to Know About Its Wireless Business

AT&T (NYSE: T) reported its first quarter of positive postpaid phone customer additions since 2014 when it released its fourth-quarter earnings. Postpaid phone customers are often considered the most valuable to wireless carriers, as they produce higher average revenue per line and don't churn as much as prepaid customers.

AT&T pointed to its efforts to provide more value to its wireless customers by bundling in HBO and offering a discount on DIRECTV for customers subscribing to its unlimited wireless data plans. But T-Mobile 's (NASDAQ: TMUS) management "kindly" points out that AT&T may be relaxing its standards for acquiring postpaid customers, which led to a big boost in the number for the fourth quarter.

A rendering of AT&T's headquarters.

Image source: AT&T.

A massive drop in prepaid subscriber additions

At a recent investor conference, T-Mobile CFO Braxton Carter broke down AT&T's strategy for boosting its postpaid subscriber numbers. "What they've done is they've embraced BYOD, or bring your own device, and have completely relaxed the credit standards associated with the recurring service revenue," he said. "So they're not having to make any investment into the handset, and they're attracting massive prepaid flow to fortify their postpaid phone numbers with really no credit evaluation associated with it."

Take that with a grain of salt -- T-Mobile is AT&T's competitor -- but AT&T's numbers back up Carter.

AT&T's prepaid subscriber net additions totaled just 85,000 in the fourth quarter. That's down from 227,000 in the third quarter and 406,000 in the fourth quarter last year. That 321,000-subscriber year-over-year drop in prepaid net adds doesn't quite offset the 396,000-subscriber increase in postpaid net adds, but it's awfully close.

By offering former prepaid customers the option to bring their own device, AT&T doesn't take on any risk that customers will default on the equipment installment plans it offers to well-qualified postpaid subscribers. So there's less financial risk for AT&T on the monthly bills it sends out to its new batch of postpaid customer, but there's still some risk that a customer won't pay it.

Prepaid customers, as the name implies, pay for the service before they receive it, removing financial risk for the service provider. Postpaid customers pay after receiving the service.

What's more, prepaid customers have a much different churn profile than postpaid customers do. AT&T's postpaid phone churn for the fourth quarter was 0.89%. Its overall branded churn rate was 1.75%. As AT&T brings more customers into its postpaid plans who would otherwise be in a prepaid plan with other carriers, it could see its postpaid phone churn rate climb.

Under pressure already

AT&T's wireless business is already under significant pressure. The company is seeing steadily declining service revenue, and its EBITDA margin is shrinking.

That's largely due to competitive pressure from T-Mobile, which has expanded its network and repeatedly offered more value to subscribers with its wireless data plans. Over the past five years, AT&T has been one of the biggest "donors" of subscribers to T-Mobile, as the latter's management likes to say. That puts the pressure on AT&T to offer similar value to its subscribers.

AT&T stepped up in 2017, taking advantage of its acquisition of DIRECTV and potential acquisition of Time Warner . The company released two unlimited data plans -- one priced above T-Mobile's, and one undercutting its pricing. It also packaged HBO with its high-end plan and expanded that offer to its low-end plan after T-Mobile started offering free Netflix to subscribers. And it offers a discount on any of its television services.

AT&T says the bundle was key to its success in 2017, and it's going to find more ways to add value for subscribers. And if the bundle results in more subscribers for both its wireless and video services as they did in the fourth quarter, AT&T can afford to sacrifice some profit margin for scale.

But offering steep discounts on video and free HBO for wireless subscribers, combined with more lax credit standards as Carter suspects, could trade short-term success for long-term degradation of its customer base. Subscriber numbers for wireless and video services may increase now, but cancellation and default rates may increase later.

10 stocks we like better than AT&T

When investing geniuses David and Tom Gardner have a stock tip, it can pay to listen. After all, the newsletter they have run for over a decade, Motley Fool Stock Advisor , has tripled the market.*

David and Tom just revealed what they believe are the 10 best stocks for investors to buy right now... and AT&T wasn't one of them! That's right -- they think these 10 stocks are even better buys.

Click here to learn about these picks!

*Stock Advisor returns as of March 5, 2018

Adam Levy has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Netflix. The Motley Fool recommends Time Warner and T-Mobile US. The Motley Fool has a disclosure policy .

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

More Related Articles

Sign up for Smart Investing to get the latest news, strategies and tips to help you invest smarter.