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Why LTE isn't moving the (earnings) needle—yet

New wireless technology promises better service for consumers, but investors are still in wait-and-see mode.

Investors are being cautious in the wake of Rogers’ big LTE rollout (Photo: Darryl Dyck/CP)

On July 7 Rogers launched its LTE (Long-Term Evolution) wireless service, which is billed as delivering a significant increase in speed. While it’s early days—the service is available only in the Ottawa area—investors have so far taken scant notice.

Rogers stock (TSX: RCI.B) initially saw a modest 2% bump before erasing the gain and more after Q2 revenue related to its wireless voice business slipped. Nonetheless, RBC Capital Markets analyst Jonathan Allen says LTE’s introduction should help the company in a few areas.

“No. 1 is that over time there will be more LTE devices and smartphones that come out. And that’s something a lot of the new entrants [e.g. Wind, Public, etc.] will struggle to keep up with. If some of the new entrants can’t acquire new spectrum licenses or don’t have the cash to invest in the networks then it will help Rogers distance itself from the discount competitors.”

In fact, short-term advantage is all Rogers may be able to wring out of what its executives said in a July 26 Q2 conference call will be about a $500 million capital expenditure from 2011-2012. There are three reasons for this. First, Bell and Telus have announced their LTE networks will be live by the end of the year. (Rogers says it will have four markets, including Toronto, covered by then and 25 more by the end of 2012.)

Second, only two consumer phones (one from HTC and another from Samsung, but not the best-selling iPhone) will support LTE by the end of the year, relegating it to use initially by the Rogers Rocket Stick. It will take time for more phones to become LTE capable and by then competitors will have launched their services. As a result, churn rates—the number of people discontinuing service or leaving one company’s service for a competitor’s—on wireless, which are trending up slightly at the moment (+0.21% year-to-date), could start to rise more quickly (+0.24% for the quarter, so yes) and impose higher retention costs on Rogers as it fights for customers.

Third, while Rogers of course touts the network technology’s speed gains—current max 75MBps down vs. 21 MBps down on existing HSPA (3G) networks for a Rocket Stick—HSPA can still be improved, lessening the appeal to consumers of the new technology. Coming network upgrades will take HSPA to 84 MBps, according to Allen, while the maximum theoretical speed for LTE is 150 MBps.

But it will allow Rogers to claim the mantle of fastest network without any of the, ahem, flak it took the last time it tried that. Says Allen, “It gives them some marketing advantage. I don’t see a near-term benefit to their subscriber trends or even some of their data and ARPU [average revenue per user] trends.”

This may explain in part why Rogers didn’t talk up LTE as much as might have been expected during its Q2 call. LTE’s real impact won’t be seen until the network is available more widely and especially in the big Toronto market. Overall, wireless revenues were up 1% for the quarter but profits on same were down 7%, attributed to costs associated with new smartphone sales as well as the previously mentioned decline in voice ARPU.

What LTE can do as the installed base grows is bring those numbers closer to balance by attracting customers to higher value “buckets” (those monthly plans you and I sign up for when we pick a service level). First-mover advantage should also pull customers away from competitors—or give existing Rogers customers another reason not to leave.

On the Q2 call, Rob Bruce, president of communications, noted, “We launched LTE [data] pricing recognizing [that] customers are going to need larger buckets. And as buckets get larger the price per gig moves down … We don’t see any evidence of customers cutting back in terms of their spending on data usage across all devices.”

An additional concern is the near-term impact on earnings of capital expenditures and marketing costs associated with LTE. However, Bruce characterized the capex as necessary and sustainable, in line with costs for rolling out the HSPA network, which has obviously been quite profitable. It’s worth noting that despite market turmoil and a relatively weak economy, Rogers’ cash and debt positions remain favourable. (Free cash flow on a per share basis is up 2% year-over-year and stands at a strong $559 million for the quarter, despite a very high debt ratio of about 78%.)

RBC’s Allen says that while capex and marketing costs look dilutive to earnings, “It’ll have a minimal impact on ARPU. It’ll have a slight negative in the sense that if you’re only adding mostly data stick customers, those customers are classified as post-paid for Rogers and so therefore they’d only be generating say $50 dollars a month compared to the average which might be $70.”

But as the saying goes, you have to spend money to make money, and given that the market is forever demanding increased speeds, by being first Rogers has wisely invested in the future. And the investors? They’ll come around.

(Note: Canadian Business Online is owned and operated by Rogers Media Inc.)