AT&T (NYSE:T) demolished analysts expectations with its second quarter earnings results. One of several highlights was the 789,000 net additions to its postpaid phone service. Analysts were expecting just 278,000 on average.
AT&T has added more than 2.8 million postpaid phone subscribers over the past four quarters. That's its best 12 months in over a decade, CEO John Stankey noted on the company's second quarter earnings call. Those numbers are comparable to T-Mobile (NASDAQ:TMUS), and far exceed the 277,000 phone net adds at Verizon (NYSE:VZ) during the same period.
But investors shouldn't expect AT&T to maintain this pace.
What's pushing AT&T's net additions higher?
One of the biggest factors leading to higher net additions for AT&T is lower subscriber churn.
The entire wireless industry has seen churn rates decline, but AT&T has seen a substantial improvement. Its postpaid wireless phone subscriber churn fell to 0.69% in the second quarter, down from 0.84% in the second quarter last year and 0.86% in the second quarter of 2019. By comparison, Verizon's second quarter churn rate increased from 2020 to 0.65%, but it's still down slightly from the 0.72% it reported in 2019. T-Mobile's churn number are obfuscated by its merger with Sprint, but they still show improvements.
But what's driving the lower churn at AT&T has been its heavy promotions. The company is offering one of the best deals on new devices in the industry. While device promotions are usually limited to new customers, AT&T is offering existing customers the same deal. AT&T has been most aggressive with device promotions while T-Mobile and Verizon have been mostly opportunistic around new device launches and opportunities to get 5G devices into customers' hands.
As a result of AT&T's promotions, the company's wireless EBITDA margin is shrinking. AT&T kept just 42.4% of revenue as EBITDA in the second quarter versus about 45% in each of the last two years. AT&T's 10% jump in operating revenue is led by equipment sales, which AT&T then reimburses customers for on a monthly basis with its promotions.
AT&T has also seen declining revenue per phone subscriber over the last couple years. Meanwhile, Verizon's revenue per postpaid account growth has outpaced the growth in connections per account over the last two years.
It turns out giving more to customers for less is a good way to grow subscribers, but not profits.
The pace is unsustainable
Growing the top line at the expense of profit margin isn't always a bad strategy. A smaller slice of a bigger pie can still mean more pie.
But AT&T's growth doesn't look sustainable. And at some point revenue growth will slow while more customers are taking device and service promotions, negatively impacting both margin and profits.
Analyst Craig Moffett at MoffettNathanson points out the industry is growing postpaid phone subscribers at five times the rate of population growth. That's being driven, he says, by promotions that give customers incentives to add lines they don't need. That pace of growth is obviously not sustainable across the industry.
But since AT&T's growth is so heavily reliant on its promotions and not the quality of its service, it's going to be even harder to sustain. It's at a disadvantage to the competition in its 5G network buildout because of its spectrum position and balance sheet, which it's working to clean up through divestments.
T-Mobile is much better positioned than AT&T to lead in 5G and take market share on the merits of its network and service. And when AT&T's subscriber and revenue growth slows, but more customers are taking its promotional offers, that means profit growth disappears as its margins shrink.