Smartphones could solve prepaid carrier problems

MetroPCS and Leap Wireless reported disappointing earnings last week. MetroPCS stock plummeted after missing analyst estimates by 20%, dragging down Leap with it.

MetroPCS has been a hot stock. It’s the fifth largest cellular network operator — only MVNO TracFone and the Big Four are larger — and has the fastest growing network. It’s been aggressively advertising in its local markets, and through a roaming agreement with Leap claims to provide (voice) coverage for 90% of the US population.

Its Q2 results were not all bad — with 19% YoY increase in subscribers, and an “adjusted” EBITDA up 11% over Q1.

With the bad news, the stock has lost its high-flying multiple. Since the Aug. 2 bad news, it’s dropped almost 50% below where it traded since May.

Some were quick to announce MetroPCS’s impending doom. In Fortune Scott Woolley wrote:

The question now is, can the company's stock claw its way back? Yesterday's tumble reflects increasingly visible cracks in the budget provider's armor.

Certainly costs per subscriber are rising faster than ARPU.

At least MetroPCS is showing a profit. The shares of Leap (operator of the Cricket network) fell 32% after its quarterly loss more than doubled compared to a year ago. The stock had already fallen 20% due to fears raised by the MetroPCS disappointment.

Why are the two discount prepaid carriers facing such problems now? One factor mentioned is that they are facing increased competition from #3 carrier Sprint. Certainly its Virgin and Boost brands are aggressively competing with unlimited service plans in the $40-60 range that directly target the two prepaid carriers. (Interestingly, all three are CDMA carriers, and of course Leap is a Qualcomm spinoff).

I see a different problem. Thanks to the iPhone success, almost every man, woman and child wants a smartphone, which in the US today means either the real thing or the Android substitute.

While the iPhone remains exclusive to the Big Two, Virgin has a good range of (slightly delayed) Sprint Android phones which has enabled it to grow rapidly. From my own brief experience as a MetroPCS customer last week, its Android offerings do not yet measure up.

It’s clear that MetroPCS knows that Android is crucial to its near-term success. Both CEO Roger Linquist and COO Thomas Keys talked extensively about Android phones during its earnings call last week. So if this is only a temporary problem — with “good enough” phones coming down the road — then subscriber growth and earnings may turn around.

Meanwhile, for more than a year Leap has needed the scale that its larger and faster-growing rival could provide by acquiring it. With its smaller subscriber base and incompatible data strategy, it will have even a harder time getting the latest Android phones.

Both MetroPCS and Leap are beneficiaries and victims of commoditization: they are using price to compete, but need acceptable quality commodity (i.e. Android) smartphones to be attractive to prospective subscribers. The decision of the Big Two to end unlimited data plans creates an opening for both if they have the right products.

The collapse of the MetroPCS stock makes it less likely that the long-fought merger will happen. For antitrust reasons, I think it unlikely that Verizon would be allowed to buy either carrier, and so far Sprint has been too sickly to consider further acquisitions.

I believe the next 18 months are crucial for both companies: if their offerings are considered comparable to the (non-iPhone) offerings of the Big Four, then their subscriber and ARPU growth will continue. Otherwise, they may become cheap enough for even Sprint to afford them.

A tale of two commodities: Android and discount CDMA carriers

It’s no secret that Qualcomm has played a major role in getting Android off the ground — going back to the public launch of Android in 2007 — and has been rewarded handsomely for its aggressive bet.

The goal of Android is to make smartphones a commodity, and in the US it’s been quite successful. By supporting Android, carriers hoped that it would spur adoption of wireless data plans, even at the risk of making them a commodity.

Thus it was surprising to discover this weekend that two of the US cellular carriers most responsible for commoditizing voice service — Leap (Cricket) and MetroPCS — have very different Android strategies. The two are so similar in strategies (including their use of CDMA) that there have been repeated calls for them to merge despite Leap’s repeated rejection of the MetroPCS advances.

Like other San Diego companies with ties to Qualcomm, Leap has been aggressive in supporting and promoting Android. In March it became the first discount carrier to announce an Android handset, the Kyocera Zio. Its website is promoting its second Android handset from Huawei, and it even has billboards around San Diego announcing $55 for its Android smartphone unlimited voice/text/data plan.

Meanwhile, MetroPCS launched its first Android phone last Wednesday, from LG. However, you wouldn’t know it from visiting the website unless you tried hard to find the (one) Android phone among its offerings.

Still, MetroPCS is a little more aggressive on the pricing: $50/month (vs. $55 + fees for Cricket and $80 + fees for Sprint). MetroPCS has often started price wars in the cellphone industry, so this may put pressure on the other carriers to cut their prices. Also, as one of the top five global carriers, LG has a better brand than Kyocera or Huawei (even if it doesn’t quite match Samsung or Motorola in the US).

Interestingly, when I was researching this blog posting, MetroPCS asked me to take a survey about future purchases, which focused on smartphones but also asked about tablets and WiFi hotspots (like MiFi). They even asked about the iPhone, even though the availability of a premium iPhone on a discount carrier seems a long way off.

Qualcomm's next monopoly

Qualcomm was among the first Fortune-500 backers of the Android alliance when it was announced by Google three years ago this month. Qualcomm won a design win for the first Android phone, and has aggressively invested to leverage its local ecosystem to develop and port technologies to Android.

Paul Jacobs seems to understand embedded software more than most cellphone CEOs — which is why his former COO rationalized Motorola’s platform strategy and seems to be turning the once-great US maker.

Qualcomm’s early efforts seem to be paying great dividends. A report by PRTM in Forbes found that of 57 Android-based handsets they studied, 77% used Qualcomm chipsets.

The PRTM analysts provided specific evidence of the long-predicted commoditization of handset makers by the Google OS. There are lots of handsets running the same software, making it nearly impossible for any handset maker to use software to achieve differentiation (as Apple has).

However, they go further in predicting Qualcomm-Google monopoly rents:

[M]ost of the handsets–77% of the sample–are based on Qualcomm chip sets. Seasoned observers may find this ominous. Over the years, Microsoft and Intel have captured far more value than the makers of the PCs. Will “Quadroid” become the new Wintel?

This is not just Android: Qualcomm has enjoyed increasing market share in smartphones.This part of a broader shift of revenues and profits from patent licensing to an increasing dependence on chip sales.

However, unlike Microsoft or Intel, Qualcomm has always faced competition in its chip business (if not patent licensing). If Apple can get into the smartphone/tablet CPU business, then Qualcomm will have other firms offering ARM cores — not to mention yet another effort by its arch-rival Intel to enter the mobile business.

So the recent trend is positive for Qualcomm’s chip business — and even if it loses some share points, revenues will grow along with Android’s explosive unit share growth. At the same time, its enviable margins will invite further entry, whether by chip makers or handset makers.

Qualcomm progeny are Android partners

Qualcomm has very close ties to the Open Handset Alliance and its Android operating system. Thus, it’s not surprising that its Leap Wireless spinoff is winning the first Android handset for a discount carrier.

Leap’s discount brand, Cricket, is believed to be the first carrier for the new Kyocera Zio. Along with Metro PCS, Cricket has been promoting price competition in the handset business through its flat-rate pricing.

Leap was created as a 1998 spinoff of Qualcomm’s cellphone licenses. In the final irony, Kyocera got into the CDMA handset business when it bought Qualcomm’s handset business in 2000.

Symbolic Snapdragon success

The new Google Nexus One incorporates a 1 GHz QSD 8250 “Snapdragon” processor, part of a series of design wins that includes the Google G1.

I think there are two aspects to this announcement.

First, Snapdragon has been recently promoted as the heart of the Qualcomm-promoted “smartbook” and its push beyond the cellphone, and indeed Lenovo announced a Snapdragon-powered smartbook on Tuesday.

In other words, the Snapdragon is a new, market-creating processor but its most important sale in 2010 could be in QCT’s traditional core market, high-end cellphones.

Second, the announcement validates Qualcomm’s strategic commitment to Android, and perhaps suggests that its Android bet may displace its bets on various other operating systems.

San Diego's Android connection

Last week I was able to attend an Android event held in Sorrento Mesa. Despite the inextricable link between Android and its Google parent, San Diego has a strong representation in the Android ecosystem.

At the event — as at any gathering of SD telecom companies — the 600 lb. gorilla was Qualcomm. The big Q was one of the five founding members of the Open Handset Alliance.

Of the four presenters, two were local companies among the 34 OHA founders: Qualcomm and PacketVideo. Three other non-local founders were also represented: host Wind River (based near Oakland but acquired a San Diego operation) and attendees from LG and Sprint.

The panel was

• Jason Bremner, Senior Director, Product Management, Qualcomm QCT (responsible for Multimedia, Winmobile, and all activities surrounding Android at QCT).
• Dr. Cheuk Chan, Senior Vice President, CORE Client Products, PacketVideo (Dr. Chan's team is responsible for PV's OpenCore, which is the multimedia framework for Android)
• David Tokunaga, Director of Technology Marketing, Nokia
• Egil Gronstad, VP Technology Planning, Leap Wireless

Bremner talked how Qualcomm’s traditional two application platforms — Brew and Java — now include BlackBerry, Windows Mobile, Android and Linux. In the future it will also be supporting Brew MP, Flash and Symbian.

Qualcomm is providing chipsets for a wide range of Android devices. The first Android phone, the G1, was launched with Q’s MSM 7201A (which will also be used with the HTC Magic). Bremner said Qualcomm had the “industry’s broadest chipset support for Android,” with three levels:

• QSD 8650: with 1 GHz MID, 720p HD video (suitable for Android-based netbooks)
• MSM 7600: The replacement for the 7201A, a WVGA video chip suitable for smartphones.
• MSM 7627: designed for sub $150 smartphones with VGA video

Chan talked about how formation of the Open Handset Alliance dates to 2006 — the year after Google acquired Android and a year before the public announcement of the Open Handset Alliance.

Tokunaga talked about general principles of open platforms in the context of the Nokia-owned Symbian open source platform. My ears perked up when he talked about “open enough” platforms — open enough to attract third party enhancements but closed enough to be controlled by a firm. (The reason my ears perked up is that “How open is open enough?” was the title of my 2003 paper on open source firms strategies).

Finally, Gronstad talked about this from Cricket’s standpoint. (Egil gave us a long intro on Leap, and several of us noted that the company and its Cricket brand are well known locally.) He talked about their plans to have its CDMA network open to all devices, both those it sells and those it does not. Someday (perhaps not soon) there will be a Cricket smartphone — just as there is already a Metro PCS smartphone (a two-year-old Qualcomm-enabled BlackBerry 8830 once exclusive to Verizon).

Qualcomm working with vendors for more than 20 Android-enable devices. However, a third party developer noted that handset vendors are holding off on releasing new phones because the performance and user experience is not there. Bremner said that “On the G1, we compromised on featureset and performance” to get the device to market, but now the top priority at the Q is to optimize Android performance with the MSM chipsets.

Overall, this partly answers one of my long-term questions. With CDMA going away as a separate air interface, what will be the Qualcomm-specific ecosystem or the benefit of wireless companies to locate in San Diego? There clearly is an increasing role for QCOM chipsets in shipping phones on the CDMA side, and also for Q’s expertise on platform support, thus giving local application developers a leg up over most of the rest of the country.

Motorola Android phone?

Business Week reports that Motorola is showing its prototype Android-based phone to carriers, but it’s not due until at least April. The project is staffed in the Bay Area by employees of Good Technology, the push e-mail company acquired by Moto in January 2007.

GigaOM notes that incoming Moto handset CEO Sanjay Jha has good ties to Google from his time as COO of Qualcomm. (Qualcomm chips are in the first gPhone from ATC).

While the timing would support Motorola’s planned jettisoning spinoff of its handset division, Forbes speculates that due to the financial crisis, Motorola may have to push back the date.

Hat tip: Kevin Maney in Conde Nast Portfolio.

Paul loves his gPhone

Qualcomm was one of the major cosponsors of Google’s Open Handset Alliance when it was announced last November. Qualcomm had not previously joined other mobile phone Linux efforts, such as LiMo (driven by Vodafone) and LiPS (once driven by France’s Orange).

This week, CEO Paul Jacobs was all smiles with the announcement of the T-Mobile G1, with Google’s Android OS and a Qualcomm MSM7201A processor. Of course, Taiwanese maker HTC has been a longtime and loyal buyer of Qualcomm chips. HTC exactly fits Qualcomm’s business model, which allows new (and presumably less capable) entrants to compete with large vertically integrated incumbents.

Google leverages the same market entry process. HTC doesn’t have the ability to design its own smartphone architecture to compete with the iPhone or Blackberry or various Nokia smartphones. Instead, it has produced probably the widest range of Windows Mobile devices. With the long-rumored G1, HTC is demonstrating its commitment to an open innovation sourcing of technology rather than to Microsoft per se.

Both firms thus have an interest in empowering new entrants, thus increasing handset competition and reducing the power of incumbents. Otherwise, their business objectives are quite divergent.

Google wants its software component to be a commodity so it can make money on another part of the ecosystem, i.e. ad-supported web applications. Qualcomm (like Microsoft) has spent billions on component R&D so it can make money selling those components.

And, in fact, Google has made sure that Qualcomm will not have an exclusive role in supplying Android hardware components. Google wants to commoditize the entire mobile Internet stack, except of course for its near-monopoly on key web applications. So Android adoption is a clear win for Google but has risks for Qualcomm.

One interesting opportunity, not yet tapped, is when will there be a CDMA phone enabled by Android. RIM is selling its Blackberry to all carriers, but otherwise the most exciting smartphones are GSM only: iPhone with AT&T, the G1 (so far) with T-Mobile, and Nokia (perhaps someday) selling to both.

The OHA was launched last November with the two weakest US carriers — T-mobile and Sprint, with the two major US carriers holding out. A month later Verizon also joined in, so three of the four Big Four (and both of the CDMA carriers) are in OHA.

Whatever the Android platform’s pizzaz relative to the iPhone, in the CDMA world it would be a dramatic step forward except for the most hardened Crackberry addict. A quick Google search suggest that all has been quiet since last December on what Verizon plans, although there’s been considerable speculation about Sprint’s needs and hopes to ship an Android phone.

As a loyal Sprint customer going back to more than a decade (and Sprint's cooperation with Cox to deploy CDMA in San Diego), there’s a huge pent-up demand for a good smartphone on their network Will it make it in time for Christmas? I guess we’ll find out soon.