AT&T adds fewer contract customers

AT&T added fewer contract customers during the first quarter, a sign that competition is heating up for new subscribers in the crowded wireless market.

The trend also calls into question where AT&T and other wireless subscribers will find growth in the future.

The company, which released the information as part of its first-quarter earnings report on Wednesday, took a significant hit due to health care reform. A change in accounting under to the new health care legislation cost AT&T nearly $1 billion, the company said. AT&T previously received a tax-free benefit from the government to subsidize health care costs for retirees, who would otherwise be on a Medicare Part D plan. Under the new legislation, AT&T is no longer be able to deduct that subsidy.

Even though AT&T noted that it set a record with new 1.9 million customers in the first quarter, the figure includes only 513,000 new contract--or postpaid--subscribers, who are considered the most valuable, because they spend more money on average every month.

That figure is down 43 percent from the previous year. Analysts had expected AT&T to add roughly 600,000 contract customers.

Randall Stephenson, AT&T's CEO, acknowledged during the company's conference call with analysts and investors that most new customers will likely sign up for prepaid service rather than contract services going forward. But he also noted that contract customers are expected to continue to spend more each month on service, offsetting any slowdown in new subscriber growth.

"Our expectation is that postpaid customer growth and net additions will come down from prior levels," he said. "But we are seeing a continuing shift in revenue growth in higher wireless data revenues and penetration of integrated devices. This is just the tip of iceberg when it comes to the opportunity for connected devices."

Stephenson said that AT&T will also make some tweaks to its prepaid business. He noted that the company has seen small positive growth in this business but that AT&T will continue to focus much of its attention on increasing the revenue from existing postpaid customers.

"We won't chase growth that is not profitable," he said. "And we won't do things that could bring negative impact to our postpaid business. That's still where our focus is."

The popular iPhone was a saving grace for the company. AT&T activated about 900,000 iPhones for new customers during the quarter. It also sold another 1.8 million iPhones to people who were already AT&T customers. Without the iPhone, AT&T's subscriber growth for contract customers would have been negative.

AT&T is currently the only operator in the U.S. selling the iPhone, but that exclusivity could expire as early as this year. There have been rumors that AT&T rival Verizon Wireless will also be getting the iPhone. Craig Moffett, an analyst with Bernstein Research, sees this as a major problem for AT&T.

"The question of what AT&T will do if and when it loses the iPhone exclusivity is hard to escape," he said in a research note.

Continued focus on contract customers
Contract customers are valuable because they tend to spend more money on wireless service and are locked into lengthy contracts, which wireless providers prefer. If these customers break their contracts, they pay early termination fees. Wireless operators have relaxed some of their early termination fees recently, but they still play a major role in deterring customers from dropping service.

Meanwhile, prepaid customers tend to spend less money per month. And because they do not have to sign a contract, they are more likely to switch to a new service if they can find a better deal. The recession, which has forced many Americans to trim expenses, has spurred more growth in the prepaid market. A new study released by the New Millennium Research Council, a Washington, D.C.-based think tank, said that for the first time ever, prepaid subscriptions grew faster than contract customers at the end of 2009.

Although AT&T is not adding as many contract customers, it is retaining more customers overall and on average it is generating more cash from its 87 million subscribers. AT&T reported that its churn rate, or the rate at which people dump it for a competitor, was 1.07 percent for contract customers and 1.3 percent overall. This is the lowest churn rate that AT&T has ever seen, the company said.

The company also saw the monthly average revenue per user (ARPU) increase 10.3 percent during the quarter, with ARPU for contract customers jumping 3.9 percent. Customers on a monthly contract are now spending on average of $61.89 a month on cell phone service. Data revenue was up 29.8 percent to $4.1 billion from the same quarter a year ago.

Overall, AT&T's revenue was flat compared with last year with $30.6 billion in sales. Analysts had expected the company to generate $30.7 billion in revenue. But the company's earnings were down substantially, which AT&T attributed to the recent changes to tax laws related to retirees and prescription-drug benefits. AT&T earned $2.48 billion, or 42 cents per share, in the first quarter of 2010. This is down about 21 percent compared with the first quarter of 2009.

As for its landline business, AT&T saw slight improvements in services sold to business customers. It continued to lose traditional phone line customers. Overall, the company's access lines declined 11.1 percent during the quarter compared with the previous year. However, Stephenson did note that the company is continuing to grow its U-verse business. The company added 231,000 new U-verse TV subscribers in the quarter for a total of 2.3 million. It also added 255,000 wireline broadband connections, which includes U-verse high-speed Internet and traditional DSL subscribers.

Updated at 8:47 a.m. PDT: Quotes and information from the conference call have been added.

Corrections at 7:02 a.m. and 7:57 a.m. PDT: The new subscriber growth data and the earnings figure are for the first quarter of 2010. Also, the data revenue figure has been fixed.