New Paradigm Resources Group: Clearwire Discussion, CTA 2007

Clearwire EBITDA Positive in 10 of 25 Initial Markets…

…and other items of interest from the company’s first quarter earnings call

NPRG is initiating broadband wireless sector coverage this summer. Since Clearwire is the flagship company of the fast-growing broadband wireless industry, coverage of its first quarterly earnings call since the company’s March 8, 2007 IPO is certainly worthy of discussion. In an industry where the typical service provider is extremely local—typically serving fewer than 500 customers—Clearwire is the fast-growing behemoth with a customer base of 258,000.

Clearwire’s growth is a result of expansion of existing markets, as well as aggressive expansion into new markets. At the end of the first quarter of 2006, Clearwire’s customer count stood at 99,000. A year later, the company serves 258,000 customers—232,000 in the U.S. and 26,000 in Europe. A year ago, there were approximately 1.5 million broadband wireless subscribers in the U.S. Even assuming an aggressive 15% growth rate for the other broadband wireless providers, Clearwire now serves one-eighth of the market, and the company is growing fast.

Certainly, as Sprint prepares to utilize its 2.5 GHz spectrum in the coming years, Clearwire will face strong competition. For now, its strongest competition comes from cable modems and DSL. Clearwire’s broadband wireless competitors are the 3,000 to 5,000 mostly-tiny wireless ISPs around the United States. Additional competition from cellular companies is minimal, as the cellular carriers’ data offerings have limits—both from a capacity and service offering standpoint—that position them almost strictly as an augment to a second, primary data service. As a result, Clearwire offers a unique service with little directly comparable competition, with none expected for the next year or two.

Clearwire has fared quite well against its wireline competition. As the company noted during its earnings call, 59% of Clearwire’s customers convert from cable modem or DSL service.

Clearwire’s metrics are headed in the right direction, with average revenue per user (APRU) increasing from $32.37 to $35.80, while CPGA (cost per gross add) has decreased from $361 to $343 in the past year. In addition, of the 25 “initial markets” the company serves—it was serving 25 of its 38 U.S. markets by year-end 2005—Clearwire is EBITDA-positive in 10. Subscriptions in Clearwire’s initial markets have grown from 85,000 on March 31, 2006 to 175,000 a year later, representing 10.4% penetration of marketable households in those markets.

Clearwire’s ARPU increase is a result of three changes in the past year: an increase in users choosing Clearwire’s higher-priced “premium” plans (60%, up from 55% a year ago); rate increases in Clearwire’s older markets; and the expiration of promotional rates for some of Clearwire’s customers.

Multiple factors contributed to Clearwire’s reduction in CPGA, as well. First, as expensive introductory rollout marketing campaigns end, marketing costs in existing markets decrease. Second, entering adjacent markets creates clusters that allow Clearwire to market more efficiently to a larger potential customer base. Perhaps most importantly, however, is that Clearwire is changing the way it acquires customers. Direct sales representatives accounted for 39% of new customers in the first quarter of 2006. This year, only 21% of new customers are acquired via that channel. It has been replaced by lower-cost retail sales, notably indirect sales channels through local dealers and national big box retailers like Best Buy and Circuit City.

Clearwire Distribution Channels, By Percent of New Customers

SOURCE: Clearwire

Potential Trouble Spots

As mentioned earlier, Clearwire doesn’t currently face strong, direct broadband wireless competition. As WiMAX chips begin to be included in new PCs, that barrier to entry will be reduced. In addition, Sprint—already a major cellular carrier—holds nationwide 2.5 GHz spectrum licenses and may soon go head-to-head with Clearwire. Even if Sprint opts for unserved markets in its initial rollout, Clearwire’s advantage as the only large broadband wireless option in most of its markets will not last forever.

Clearwire states that its largest markets are Seattle and Honolulu. Raleigh-Durham and Jacksonville are, perhaps, the only other two Clearwire markets of decent size. Indeed, the ability to deploy quickly in order to leverage marketing expense and maintain quality of customer experience in all parts of town lends itself to small-town deployments. In order to become a national player, however, Clearwire will need to enter larger markets. Where will Clearwire find the capital to invest in large-market networks? This could get very expensive very quickly.

Map of Clearwire U.S. Markets

SOURCE: Clearwire

Indeed, the need for future financing—debt or equity—can be expected. At the moment, the company is cash-rich, with nearly two-thirds of its $2.5 billion in assets being relatively liquid ($1.6 billion in current assets, more than half of which is cash and cash equivalents). As long as the company is careful with its rate of expansion and continues to achieve profitability in existing and new markets, Clearwire is in a strong position. We can’t help but be reminded of the CLECs in the late 1990s, however. They, too, preached caution and measured growth. In order to attract investors, though, they shifted their focus to national footprints.

There are differences in Clearwire’s approach—the ability of a consumer broadband wireless carrier such as Clearwire to partner with retail outlets, for example, is a key difference—but it doesn’t hurt to tell the cautionary tale. Many CLECs took the bait, and most of them drowned in a sea of debt. The key to success is to resist the siren song of overly ambitious financiers and stick to a reasonable, fiscally responsible growth schedule. Clearwire seems aware of the need for restraint. Aware of the uncertainty of the financial markets, for example, the company has noted its ability to reduce its cash burn rate by adjusting its market expansion and rollout schedules. This is crucial because Clearwire expects to need to raise an additional $1.6 billion in order to complete its goal of reaching 125 million U.S. customers in the next five years. In order to reach its goal, even if circumstances dictate that it must delay that goal, Clearwire’s ability to modulate its rate of growth in the face of future difficulties is critically important.

Still, Clearwire has shown impressive growth in its older markets, insists the newer markets are on the same path, and has a measured, reasonable approach to growth. In addition, the company is still sitting on a sizeable war chest of cash and short-term investments. In the soon-to-be-growing broadband wireless market, Clearwire is the clear market leader. Though it’s early in the game, there is reason for Clearwire to be optimistic… cautiously optimistic.