Themes in the Cable and Telecom Sector
February 9, 2011
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Telecom Services
Citadel Securities Calling: Here Cometh the
Twilight of Wireless Voice?
By Shing Yin and Judah Rifkin
Now that the Verizon iPhone has finally been released to the masses who, based
on initial reports, are demonstrating substantial demand for the device, one might
conclude that Verizon’s self-proclaimed reputation as “America’s most reliable
network” has been validated. To be fair, though, extrapolating anything from iPhone
sales at this point is probably a bit of a stretch (a fool’s errand, even), since all
CDMA iPhone buyers are already Verizon customers, at least as of this writing.
(Recall, Verizon customers got to pre-order their iPhones a week earlier than the
less-privileged masses.)
Regardless of whether the popularity of the “VeriPhone” (we’d really like to
trademark that term) can be declared as evidence of Verizon’s superior voice
network, it’s hard to deny that Verizon has differentiated itself from the other national
carriers over the past decade. The company has consistently ranked at the top of
independent surveys, especially for voice reliability (remember the “Can you hear
me now?” campaign, which perhaps not coincidentally has been revived with the
launch of Verizon’s iPhone?).
It’s probably no coincidence that Verizon’s superior network quality has been
associated with significantly more capital spending than its national peers. Each and
every year since 2007, Verizon has spent more capital on its wireless business than
each of the other three national carriers, save for being slightly outspent by AT&T in
2010 (Exhibit 1). The cumulative result has been a capital outlay of $28.6B over the
past four years, 17% more than the $24.4B spent by AT&T and more than double
the spending of both Sprint and T-Mobile (Exhibit 2). To be clear, we do not view
Verizon’s spending as a poor use of funds; to the contrary, the carrier enjoys the
highest margins in the industry—by a mile.
Vijay Jayant 646-403-8255 vijay.jayant@citadelsecurities.com
Shing Yin, CFA 212-651-7729 shing.yin@citadelsecurities.com
Judah Rifkin 212-271-8547 judah.rifkin@citadelsecurities.com
Kunal Madhukar, CFA 646-403-8246 kunal.madhukar@citadelsecurities.com
Ankit Sharma 646-403-8370 ankit.sharma@citadelsecurities.com
Mark Lanzana, CFA 212-271-8532 mark.lanzana@citadelsecurities.com
 Citadel Securities Calling: Here Cometh the Twilight of Wireless Voice? / Telecom Services

Exhibit 1: Annual Wireless Capex Spend for National Exhibit 2: Four-Year Cumulative Capex for National
Carriers Carriers (2007-2010)

Source: Company reports Source: Company reports

Note: 2010 Capex for Sprint and T-Mobile are consensus estimates Note: 2010 Capex for Sprint and T-Mobile are consensus estimates

With industry maturity comes (voice) service commoditization

A problem (or good news, depending on which carrier you ask) is that as the wireless
industry matures, voice – the primary differentiator thus far in carrier quality – is quickly
becoming less important. (Besides the brief revival of the ―can you hear me now‖ campaign
mentioned above, Verizon has largely replaced it with a ―Rule the Air‖ campaign.) We see
the arguable commoditization of voice services as the result of a host of factors, not least
among them the proliferation of smartphones. Smartphones, as the name suggests, are more
than just phones—they’re basically mini computers, some of them with more horsepower
than the desktop computers we used just a few years ago. For that reason, in many cases,
voice quality on such devices is often an afterthought (i.e., a consumer often chooses the
device first and carrier second. How else could one explain the wide success of Sprint’s
EVO?). While it might be a stretch to say that using a phone merely as a phone has become
un-cool, the data, as they say, don’t lie. According to the CTIA (the gold standard of all stats
wireless), the average number of minutes that a typical wireless customer uses per month
was at its lowest level in five years during 2009 (696 minutes, on average; see Exhibit 3).
Could the wireless voice ship, as the saying goes, ―be sinking‖?

Conversely, SMS and MMS traffic (―texting‖) has risen dramatically since 2006 (Exhibit 4).
While the mix shifts from voice traffic to data traffic have thus far virtually offset one
another from an ARPU perspective, it isn’t always about the money (well, ok, it is, but bear
with us while we try to make a broader point).

February 9, 2011 / 2
 Citadel Securities Calling: Here Cometh the Twilight of Wireless Voice? / Telecom Services

Exhibit 3: Average Voice Minutes of Use per Month per Exhibit 4: SMS and MMS Traffic
Sub, 2000-2009

769

.
180
708 714 708 696
160
Monthly Voice Minutes

SMS/MMS (Monthly, B's)

584 140

507 120

427 100
380 80
60
255
40
20
0

01

02

03

04

05

06

07

08

09
20

20

20

20

20

20

20

20

20
00

01

02

03

04

05

06

07

08

09 MMS SMS
20

20

20

20

20

20

20

20

20

20

Source: CTIA, Citadel Securities LLC analysis Source: CTIA, Citadel Securities LLC

Putting aside data network speeds for the moment (we promise to come back to this later),
there’s very little a carrier can do to differentiate itself in terms of SMS or MMS ―quality.‖
Think about it . . . When was the last time you had a gripe because your text didn’t go
through quickly enough? Indeed, so long as there’s a signal – and nowadays there’s almost
always a signal for the four national carriers – SMS and MMS messages work just fine.
Based on the CTIA data, we think it’s safe to say that the voice aspect of the cellular
experience has become incrementally less important as texting has grown in popularity.
(There’s clear evidence that many– particularly those of the teenage ilk –prefer to type short
messages rather than bothering with a phone call . . . much to the chagrin of parents and
grandparents everywhere.)

Yet wireless voice pricing has been a tough nut to crack . . .

The recent diminishing of voice usage is unfortunately only part of the problem, especially
for carriers looking for some way to differentiate themselves. Voice pricing – once a strong
cash generator for carriers – has fallen precipitously. When P and Q are both declining, well
Houston, we have a problem.

It wasn’t always like that. Wireless calling was, for a very long time, one of life’s luxuries.
Consider the pricing plan for the very first cell phone, introduced in 1947: not only did the
thing weigh 80 pounds, it also came with a monthly service cost of $337.33 (in today’s
dollars) and that didn’t even include airtime, which was around $4.50/min.

As phones became lighter and sleeker (who can forget Motorola’s StarTac?), voice pricing
came down ever so slightly, but not enough to be considered a commodity by the mid-1990s.
In September 1993, the Government Accountability Office conducted a detailed (28-page)
study titled, ―Telecommunications: Charges for Itemized Cellular Telephone Bills.‖ The
GAO’s calculation of the average monthly costs for the most economical plans in the 10
largest markets for a mere 150 minutes of monthly usage averaged $89.14 per month, or, in
inflation-adjusted dollars, $134.51. That’s a cool $0.90 per minute (Exhibit 5). Of course,
back in 1993, wireless penetration in the U.S. was a paltry 6% of the population.

February 9, 2011 / 3
 Citadel Securities Calling: Here Cometh the Twilight of Wireless Voice? / Telecom Services

Exhibit 5: 1993 Pricing for 150 Voice Minutes in Top 10 Markets

Monthly Monthly Per Min Per Min

Price Price Price Price
Market (Unadjusted) (Adjusted) (Unadjusted) (Adjusted)
New York $115.99 $175.03 $0.77 $1.17
Los Angeles 103.57 156.29 $0.69 1.04
Chicago 67.80 102.31 $0.45 0.68
Philadelphia 91.95 138.75 $0.61 0.93
Detroit 74.19 111.95 $0.49 0.75
Boston 92.20 139.13 $0.61 0.93
San Francisco 107.43 162.11 $0.72 1.08
Washington, D.C. 86.60 130.68 $0.58 0.87
Dallas 66.34 100.11 $0.44 0.67
Houston 85.28 128.69 $0.57 0.86
Average $89.14 $134.51 $0.59 $0.90

Source: Government Accountability Office

Note: Adjusted prices reflect inflation as calculated annually using the CPI

. . . But when pricing did crack, it cracked hard

As it turned out, the cell phone was too useful and too convenient a tool for people to be
without, and competition – and then price wars – rapidly took hold. Today, one can get
unlimited national calling for $40/month (inclusive of taxes and fees) courtesy of MetroPCS.
But we would argue that the real price destruction came at the hands of Sprint, when on
February 28, 2008, it introduced a national unlimited postpaid plan for $99, known as the
―Simply Everything Plan.‖ As CEO Dan Hesse put it at the time, "This is a bold,
unprecedented move1." Hesse wasn’t kidding, as his statement proved prescient. Sprint’s
competitors, naturally, soon followed suit, and as it stands today, all four national carriers
offer unlimited postpaid plans for around $70 (not to be outdone, we note that Sprint now
also includes data and texting).

With the essential collapse of wireless voice pricing, carriers have turned to data services as a
differentiated stop gap. As argued above, although SMS and MMS services are relatively
difficult to differentiate, other more complex services like tethering and web browsing are
carrier-specific in their range of quality.

While it’s beyond the scope of this report to review each carrier’s data service (though we
think Verizon probably has the lead with its LTE rollout), the proliferation of data has the
potential, in our opinion, to further commoditize carrier voice businesses, if it hasn’t already.
Just as voice has taken a meaningful shift toward IP technology in the landline world (with
the cable MSOs being the primary beneficiaries), we see an increasing array of applications
available to consumers that allow them to bypass their carrier’s own voice services. And no,
it’s not just Skype. For example, there’s a useful little app for the iPhone called Line2. For
$15 per month, users can make unlimited calls over their wireless data networks, with voice
being transmitted in IP packets. Even if carriers ―fight back‖ by offering tiered data plans (as
most already have), services like Line2 use a minimal amount of data (unlike, say, video).
We’ve tried it; Line2 isn’t breaking any data thresholds in all but the most extreme cases.

1
http://community.sprint.com/baw/thread/6885

February 9, 2011 / 4
 Citadel Securities Calling: Here Cometh the Twilight of Wireless Voice? / Telecom Services

And the danger to carriers’ voice businesses doesn’t end there. As most of us who have
travelled overseas know, international roaming charges – even to highly industrialized states
– can be prohibitively expensive. Calling home from the U.K., for example, can be upwards
of $4/minute (no doubt a profit center for the carriers). However, an innovative company
named Ubiquisys seems to have come up with an elegant solution: a USB-sized Femtocell
called the Attocell. The historical problem with Femtocells has been that most have GPS
receivers in order to ensure that they are used only in a carrier’s coverage area (makes sense,
right?), basically to prevent exactly what the Attocell allows users to do. The Attocell is
designed to be used internationally. Ubiquisys has confirmed that its device works with the
iPhone, Blackberry and other devices. Simply plug it in to a laptop USB slot, and so long as
there is a data connection, voilà, free calling home from around the globe, from a regular cell
phone (no awkward Skype headsets required). (Note: it’s unclear to us at this point whether
the Attocell will need carrier cooperation, and in the case that it does, carriers would likely
find a way to make some money. Regardless, we believe that with innovative solutions like
the Attocell, the days of $4/minute (or more) for international roaming are all but over.)

To be sure, the carriers are not standing by idly as their data networks are effectively used to
bypass their voice services. Their solution: no “naked data” allowed. What we mean by
―naked data‖ is that in the U.S. today, one cannot purchase a pre-paid or post-paid phone
without some tier of voice service included. Of course, one could conceivably purchase the
lowest voice tier and effectively arbitrage the savings by using IP calling heavily, but that
sounds like an awful lot of trouble, especially when, as discussed above, voice plans are so
cheap anyway. There remains the risk that at some point a carrier does offer naked data and
others would then follow suit (Can anyone guess which one might be the first to do it?).
Needless to say, we’d expect that the introduction of naked data would create a slippery
slope indeed. In fact, just today, AT&T announced that subscribers can enjoy unlimited
calling to any wireless carrier, so long as they subscribe to an unlimited SMS plan. Perhaps
we are witnessing the ―beginning of the end‖ of carriers charging for voice.

Circling back to the iPhone – Could (gasp!) AT&T be a better option than Verizon?
We started this piece talking about the iPhone, and we’ll close with some final points on the
smartphone that changed the world here. We believe there is ample evidence to suggest that
AT&T’s voice network is indeed inferior to Verizon’s. So for those consumers who value
call quality most, then the Verizon iPhone – though still untested on a mass scale – may very
well be the better choice.

But, as we’ve argued above, voice calling seems to be going the way of the Members Only
jacket (if there are any ―Members‖ left), while data, on the other hand, seems to be all the
rage. In that case, we think there’s little denying that AT&T’s iPhone 4 offers significantly
higher data speeds on its HSPA+ network than Verizon can on its EV-DO Rev A network
(unlike voice quality, which is subjective, the physics of data speeds are more clear cut). And
although Verizon has been faster out of the gate in its LTE network build, there’s no telling
when an LTE iPhone will be available (many industry observers have suggested that it will
be available during Apple’s next iPhone refresh around June, but that is a highly dubious
assumption, in our view. Apple releases products when they’re ready for prime time, not at
the behest of carriers). So as it stands today, if one wants an iPhone primarily for its data
capabilities (including WiFi tethering, which AT&T has confirmed it will offer, just like
Verizon will), then maybe the VeriPhone isn’t as good of a proposition as has been generally
portrayed. Oh, and if you’re one of those interesting individuals who likes to surf the web,
talk on the phone, run a marathon, and jump rope at the same time, we all know which
network will allow you to do those activities simultaneously.

At some point, we think there will almost surely be an LTE iPhone; yet by that time AT&T
might already have its LTE network built out, in which case Verizon should technically no
longer have an advantage in voice quality. The most important question for all the carriers, in
our view, is if anyone is going to pay for the privilege of using their phone as a phone. To
that question, the best we can answer is that only time will tell.

February 9, 2011 / 5
 Citadel Securities Calling: Here Cometh the Twilight of Wireless Voice? / Telecom Services

Analyst Certification: We, Vijay Jayant, Shing Yin, Judah Rifkin, Kunal Madhukar, Ankit Sharma and Mark Lanzana, hereby certify
1) that the views expressed in this research report accurately reflect our personal views about any or all of the subject securities or
issuers referred to in this research report and 2) no part of our compensation was, is or will be directly or indirectly related to the specific
recommendations or views expressed in this research report.

IMPORTANT DISCLOSURES:
For explanations of ratings, please refer to the stock ratings key located on the last page.

Sprint Nextel (S) Price : $4.35 Price Target: $5.00 Rating: Add
Citadel Securities and/or an affiliate is a market-maker in the securities of Sprint Nextel.

• Valuation Methods Used to Determine the Price Target

Our one-year target price for Sprint is derived by applying a 4.7x multiple to our 2012 EBITDA estimate, then adding the value of
Sprint’s Clearwire stake at market value. Our target multiple is lower than the average for the U.S. carriers to reflect Sprint’s lower
growth and higher uncertainty in its future results.

• Risks That May Impede Achievement of the Price Target

Downside Risks
• LTE build out: Sprint may decide to build its own LTE network leading to significantly higher capex and lower or negative cash flow.
• Price war to gain subscribers: The company could enter into a price war to increase its subscriber base. This could hurt EBITDA
margins, leading to downward pressure on the shares.
• Clearwire funding: Clearwire could require higher funding than expected, resulting in increased diversion of free cash flow from
paying down debt to investing in Clearwire.

AT&T (T) Price : $27.97 Price Target: $33.00 Rating: Add

Citadel Securities and/or an affiliate is a market-maker in the securities of AT&T.

• Valuation Methods Used to Determine the Price Target

We value AT&T by applying a 12.5x multiple – consistent with the stock’s historical P/E – to our 2012 EPS estimate, leading to a target
price of $33 per share.

• Risks That May Impede Achievement of the Price Target

Downside Risks
• Subscriber Growth: Postpaid subscriber growth could decelerate faster than expected, leading to slower EBITDA growth going
forward.
• Title II reclassification: Congress may pass a bill before leaving for the elections that would increase the risk of Title II reclassification
by the FCC.
• Dividend Tax Increase: The proposed increase in dividend tax rate could cause downward pressure on AT&T shares, which are amongst
the highest yielding shares in the S&P 500 Index.

Verizon (VZ) Price : $36.68 Price Target: $34.00 Rating: Neutral

Citadel Securities and/or an affiliate is a market-maker in the securities of Verizon.

February 9, 2011 / 6
 Citadel Securities Calling: Here Cometh the Twilight of Wireless Voice? / Telecom Services

• Valuation Methods Used to Determine the Price Target

We value Verizon by applying a 12.5x multiple – consistent with the stock’s historical P/E – to our 2012 EPS estimate, leading to a
target price of $34 per share.

• Risks That May Impede Achievement of the Price Target

Upside Risks
• Data demand: The carriers may collectively move to metered data plans and gain acceptance in the marketplace, leading to higher-
than-expected growth in data revenues and hence EBITDA.
• Cost control: The company could reduce costs at its wireline operations more than market expects, leading to higher EBITDA margins
and free cash flow.

Downside Risks
• Subscriber Growth: Postpaid subscriber growth could decelerate faster than expected, leading to slower EBITDA growth going
forward.
• Title II reclassification: Congress may pass a bill before leaving for the elections that would increase the risk of Title II reclassification
by the FCC.
• Dividend Tax Increase: The proposed increase in dividend tax rate could cause downward pressure on Verizon shares, which are
amongst the highest yielding shares in the S&P 500 Index.

February 9, 2011 / 7
 Citadel Securities Calling: Here Cometh the Twilight of Wireless Voice? / Telecom Services

Important Disclosures Continued:

The research analysts at Citadel Securities receive compensation based in part on revenues from the overall firm, which include revenues
from investment banking activities.
Citadel Securities trades regularly in the securities of the subject company of this report.

Ratings Definition
• Edge Positive: The analyst has a differentiated, proprietary view with a strong conviction that the stock could appreciate materially
based on factors not yet incorporated into the stock price or reflected in consensus.
• Add: The analysis of financials, fundamentals, sector views, company dynamics and/or potential catalysts drives the analyst's view
that the stock may appreciate.
• Neutral: The analyst’s view is not materially different from that of consensus; the stock is viewed as fairly priced within roughly
+/- 5% of current levels.
• Reduce: The analysis of financials, fundamentals, sector views, company dynamics and/or potential catalysts drives the analyst's view
that stock may decline.
• Edge Negative: The analyst has a differentiated, proprietary view with a strong conviction that the stock could decline materially
based on factors not yet incorporated into the stock price or reflected in consensus.

Ratings Distribution:

Covered companies rated “Edge Positive” or “Add” would be classified as having a buy rating. Covered companies rated “Neutral”
would be classified as having a hold/neutral rating. Covered companies rated “Reduce” or “Edge Negative” would be classified as having
a sell rating. Please see the below chart for the percentage of all covered companies for which Citadel would assign a buy, hold/neutral or
sell rating, and the percentage of covered companies within these three categories for whom Citadel Securities has provided investment
banking services within the past 12 months.

Ratings Distribution & Investment Banking Disclosure

Rating Count Ratings Distribution* Count Investment Banking**

Buy 22 35.50 2 9.09

Hold/Neutral 23 37.10 0 0.00
Sell 17 27.50 0 0.00

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February 9, 2011 / 8