Leap Wireless gets its day in the sun

q&a Leap Wireless is finally in the right place at the right time.

The company, which sells its prepaid service under the Cricket and Jump Mobile brands, has been in the wireless service market since 1998, when it was spun off from mobile chipmaker Qualcomm. It filed for Chapter 11 protection in 2003 and was restructured and emerged from bankruptcy protection a year later.

Now the company is strategically expanding its network into 14 new markets with spectrum it won in two recent Federal Communications Commission auctions. It now operates in 29 states and holds licenses in 35 of the top 50 U.S. markets, including Chicago and Philadelphia, where it recently launched service, and in Washington, D.C. and Baltimore, where it plans to launch soon.

And all of this happening as Americans are getting fed up with lengthy and expensive wireless contracts from national carriers, such as AT&T and Verizon Wireless. And as finances tighten, people are looking to reduce their monthly expenses by finding cheaper options for phone service. Prepaid service plans, which allow customers to pay in advance for service without signing a contract, provide a good alternative. Low-cost unlimited plans, from Leap and others, make it an easy choice even for wireless subscribers who talk and text a lot.

I recently chatted with Leap CEO Doug Hutcheson to get his take on the prepaid wireless market and get his thoughts on the future of the industry. Below is an edited version of our conversation.

Q: Prepaid cell phone plans are getting a lot of attention lately. Why do you think that is?
Hutcheson: The prepaid cell phone market is in its third or fourth phase of development right now in the U.S. And it's at the same phase that the European market entered about five or six years ago. Prepaid really started to take off in Europe as wireless penetration started to reach 100 percent. And of course the economic realities of today are also a factor. For a number of people, prepaid wireless is the best value.

Do you think prepaid carriers, such as Leap Wireless, are in a position to threaten the nationwide incumbents, such as AT&T or Verizon Wireless?
Hutcheson: I don't think we are a material threat to either AT&T or Verizon Wireless. They have built great, broad franchises with 80 million customers. What we are trying to do is focus on our customer base, which tends to be younger and more ethnically diverse with people at the median to below median household income level. We serve this market really well. And this is a customer base that others aren't as interested in serving or aren't able to focus on. These operators have their own prepaid products, but I think AT&T's primary focus is on selling iPhones and two-year contracts. And Verizon is focused on its 4G rollout and combining those services with its Fios fiber network.

What about T-Mobile USA and Sprint Nextel? These nationwide operators have been positioning themselves as a value choice for consumers. Is Leap Wireless' Cricket service a threat to them?
Hutcheson: Sprint seems to have recently gotten more active in the prepaid market in the last couple of quarters with its Boost brand. But we've been through this before. In 2006, Boost launched rate plans that were almost on top of our rate plans when we were launching some new markets. We managed to work our way through that, and we did just fine. Interestingly enough, in 2008 and 2009 we have been launching more markets and Boost is there again. So there is a little bit of rhythm to it. But we think it will work its way in our favor again.

And T-Mobile?
Hutcheson: T-Mobile has introduced its Flex Pay product, which is their effort in that area. They have had some success. But what we have found historically is that when we have seen increased prepaid product offerings in a given market, it increases the pie for everyone. The same thing happened in Europe about four or five years ago. The more entries you saw in the market, the more growth we saw in the overall prepaid market. We see this happen repetitively. More activity in a market sort of validates the business model. But we will have to see what happens over the next several quarters.

As people look for more value in their cell phone plans, do you think the prepaid model will kill the post-paid business model?
Hutcheson: There is no question the industry is shifting. As penetration in the U.S. market increases, where we see growth is in prepaid. I'll point to Europe again. Wireless penetration there is 120 percent to 130 percent. Growth continues in two primary areas. People are carrying multiple phones. I don't know about you, but I have my smartphone, which I use for e-mail and data, and I have my voice phone. The second area of growth is mobile broadband. I think there is a lot more growth to be had in the wireless market as we see more devices coming online. And I think other carriers are also looking to these areas for growth.

Cricket was the first to offer flat-rate monthly pricing, and others have now followed suit. But now you also offer a traditional pay-as-you-go service. Which model do you think customers prefer?
Hutcheson: We are finding people want both a prepaid monthly plan and a traditional pay-as-you-go plan, depending on their financial situation. For our core customer base, they want the straight up, pay-in-advance service. That's the largest percentage of our business. About 90 percent of these customers use their cell phone as their primary form of communication. Roughly 60 percent of them don't have a landline phone at home.

But there is a segment of our customer base that would like a pay-as-you-go plan. These are customers who may not have enough money to even pay monthly. But they still need a phone. Or these are customers who don't have a big need to be connected. They just want the phone there when they want to use it, but don't really want others reaching out to them. These might be the same customers considering Tracfone's or Virgin Mobile's services. They buy a card with minutes, use those minutes and then top it up.

Wall Street analysts say it's hard to make money from prepaid wireless service. But Leap is making money. How?
Hutcheson: It starts with cost. We relentlessly focus on cost. We don't try to be all things to all people, which is why we don't operate a national network. But we do have a national product available with our roaming partners for people who may leave our coverage area. But for someone who stays in one geographic area, we nail the cost on that better than anyone else. And this allows us to deliver a good value to our customers. In some of our most mature markets, the average revenue per user (ARPU) is around $42 to $43. And we sell twice the number of voice minutes and two to three times the number of text messages as the large national carriers, which have ARPUs that are $10 to $15 higher than ours. And our profit margins fall in the high 30 percent range. In some older markets we are closer to 40 percent. We've said we expect to run in the mid-40 percent range.

Just to give you some perspective, these margins are a little lower than Verizon, but a little higher than Sprint. But we do it on much higher usage and lower ARPU. So this means that these providers can't expect to drop prices and lower ARPU and expect to make these same margins. You have to seriously increase volume and control costs.

Virgin Mobile and Boost Mobile use Sprint Nextel's network. Whose network do you use?
Hutcheson: We build and operate our own network. We buy backhaul from others, just like any other wireless operator. But we own our own fixed plant network. With our Washington and Baltimore markets included, we have 11,000 cell sites now, which can serve up to 90 million potential subscribers, and we are moving toward 100 million potential subscribers. This means that we have the ability to serve about a third of the U.S. population.

I know you are going through a major market expansion now, but do you think you'll eventually take the Cricket network nationwide?
Hutcheson: We are about 75 percent of the way through our network expansion, which adds another 44 million potential subscribers to our network. So right now, I just want to sit down and take a breath. I don't have a lot to say about going further than that. We might consider it over time, but right now, we are going to focus on the 100 million potential subscribers.

We do have roaming agreements with 25 different partners; Metro PCS is one of them. And we offer a premium plan that offers extended coverage using these different carriers' networks for roaming.

All the big national carriers are starting to talk about their next-generation 4G networks. And I know you already have an EVDO network and are rolling out the next-generation EVDO Rev A. But does Leap have a plan for 4G?
Hutcheson: We do see a future for 4G. We don't have any specific plans right now. We have gotten some spectrum in the FCC's AWS auction. We didn't bid on spectrum on the 700 MHz auction. But we have some spectrum.

Which technology do you think you'd use? WiMax or LTE?
Hutcheson: We haven't made any announcements, but I think the industry is sorting itself out pretty clearly. And it's more likely that the LTE family will be the technology to use. WiMax doesn't look like it has much steam. But we will keep an eye on it for a little while longer before making any decisions.

Most prepaid wireless services, including yours, don't really have cool smartphones in their lineup of products. Do you think you will get any? Any chance of a Cricket iPhone?
Hutcheson: Yeah, didn't you get our release about selling the iPhone? I'm just kidding. We do pretty well selling phones with an entry price between the $30 to $50 price range and going up to about $300 for our high-end customers. But we don't sell a lot of high-end phones. And we just don't see demand for smartphones.

Do you think that is because without a subsidy these phones are too expensive, somewhere between $500 and $700?
Hutcheson: Yes, I think there is some price sensitivity. We actually found that in the first quarter our most popular phone was the Samsung Messenger, which has a QWERTY keyboard and a larger screen. It offers access to the mobile Web and was priced below $200. I think our customers have figured out that they don't need to pay the high prices for these phones or the higher service contracts for smartphones.

I've noticed a lot of people with smartphones are mostly using the phone for e-mail, which they can get with a less expensive phone and data plan. Do you think, in general, consumers with smartphones are overpaying for their service?
Hutcheson: I don't know. The industry is still evolving, but there is a chance they are overpaying. I think some people will figure this out over time. The monthly service for the iPhone appears to be a little steep.

There has been some talk in the past about operators allowing any device to connect to their networks. What do you think about that? Would you like to see Cricket customers coming to you with a phone they may have used on Sprint or Verizon Wireless?
Hutcheson: We are open to exploring this. We are not necessarily a hard advocate at this time. But I think it merits discussion, especially as we watch more of these exclusive phone deals. I don't think those exclusive deals are good for competition, and it's not really clear to me why it is good for the handset makers. But that's a separate issue. If it's a good phone, we generally think it should be available on anyone's network. Carriers should compete on the basis of their service plans, which is why people buy these services. So we are still watching the situation.

Cricket offers a $40-a-month prepaid mobile broadband service without a contract for laptop users. National carriers have been targeting their $60-a-month mobile broadband service for business travelers. Who do you see as your primary customers for this product?
Hutcheson: Roughly half of the people signed up for our mobile broadband product are existing customers. So it is not strictly a business product. It's an access product that works for everybody. Our customers also have laptops. And they are looking for mobility where they live, work, and play. In fact, the No. 1 reason our customers say they want this product is for mobility in the home. It's been really well-received from our customers, because it is easier to manage and set up than a cable modem service or DSL.

Virgin Mobile just announced a pay-as-you-go wireless broadband service. But some critics say it's too expensive. What do you think?
Hutcheson: I won't comment specifically on Virgin's service. But I will say it is great to have them competing in this market. I'm not inviting all comers to this market. I hope you don't hear me saying that. What I am trying to say is that thoughtful competition helps expand the segment. And this is a virtually untapped market in the U.S. It will evolve and mature over the next 5 to 10 years, and penetration will increase over time just as it has in Europe. So there is an opportunity here, and we don't think that we will have it all to ourselves. There is plenty of room for other people to participate in it.