Video compensates for broadband declines at AT&T and Verizon

Teresa Mastrangelo - Principal Analyst

Consumer spending weak! Jobless claims surge! Payrolls shrink for the first time in four and a half years!

Those are just the headlines from the Feb. 1 issue of USA Today. At this stage, it is hard to escape news about a weakening economy in the United States. However, judging by the earnings calls from both AT&T and Verizon – the nation’s largest communications companies – everything is great. In fact, both companies reported their largest net gains in wireless subscribers and both companies reaffirmed their expectations for continued strong growth throughout 2008.

So why are they so confident when all the signs point in a different direction? From a consumer wireline perspective, it all comes down to video services and revenue generating units (RGUs). Although telephone companies traditionally do not report subscriber data as revenue generating units, perhaps they should, as it truly is a better indicator of actual performance.

For the fourth quarter of 2007, both AT&T and Verizon reported quarter-over-quarter declines in broadband net additions. Verizon was down 7 percent, while AT&T was down 21 percent. Compared to the fourth quarter of 2006, Verizon was down 35 percent, while AT&T was down 30 percent -- yet neither company appeared to be concerned by these declines. The reason for that is simple. Both of these companies have growing video subscriptions, which are actually adding more revenue per user than broadband alone.

During 4Q07, AT&T nearly doubled the number of U-verse video subscribers, while Verizon recently touted the fact that it now has more than 1 million FiOS TV subscribers. In the case of Verizon, 92 percent of FiOS subscribers took the video option during 4Q07, indicating how critical video is to the success of FiOS.

So if we look at the same data as revenue generating units, we observe that AT&T was down 11 percent from both a quarter-over-quarter and full year perspective, while Verizon was essentially flat for both periods. Despite this, both companies experienced an increase in residential ARPU.

The video component not only makes the bundle more competitive against cable, but it offers the ability for significant revenue upside as customers add premium channels and features and/or purchase premium content from on-demand. Additionally, both companies have stated that video is proving to be more important to customer retention than broadband or voice.

Despite all of these positives, I remain skeptical. With DSL subscriber net additions dropping like a rock at Verizon, it would not be unexpected to begin to see an overall decline in DSL subscribers as early as next quarter. Is Verizon so confident that FiOS RGUs will grow fast enough to overcome this decline? Will AT&T be able to roll-out U-verse fast enough to compensate for its falling broadband net additions, particularly in the BellSouth territory?

I hope so, because otherwise we might be hearing a very different type of earnings call later this year.

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