Start-up finds opening among cellphone giants
S. Douglas Hutcheson sees a big future in the little guy.
The chief executive of Leap Wireless International Inc. markets low-cost flat-rate cellphone service to the kinds of customers many of the nationwide carriers turn away: People with lousy credit, small paychecks and a tendency to talk a lot.
“We’re glad to serve that market,” Hutcheson said.
Spun off from mobile communications giant Qualcomm Inc. in 1998, the San Diego company has found a growing niche in an industry dominated by a few behemoths such as Verizon Wireless and Cingular Wireless.
Sales and profit are rising as Leap makes plans to use newly acquired radio spectrum to expand its relatively small patchwork of local calling networks.
Analysts applaud Leap’s rapid growth and strong financial performance -- particularly given that the company emerged from bankruptcy protection just two years ago -- but some worry that the jump from a small player to a large regional carrier may lead to another fall.
“Leap has given mixed messages about its future,” said Weston Henderek of the consulting firm Current Analysis Inc.
“It bought as much spectrum as possible to build a national image. But that takes a lot of cash to pull off. It’s a much more risky position,” Henderek said.
Leap’s primary business is dubbed Cricket, a calling plan with six flat-rate packages that range in price from $30 a month to $50.
Two-thirds of Cricket customers take the $45 plan with unlimited nationwide calling, text and picture messaging and a host of calling features like voicemail. The company doesn’t discount the phones it sells.
The upshot: The minutes are cheap and there are no long-term contracts or credit checks -- a big plus for the 69% of Leap’s 2 million customers who earn less than $35,000 a year. The downside: Customers who wander outside Leap’s 50-odd coverage areas sprinkled nationwide get socked with big roaming charges.
In California, Leap serves just a stretch of the Cental Valley between Visalia and Modesto, but is expanding into San Diego in early December.
Already in major markets such as Houston, Denver and Kansas City, the company will use some of the airwaves it purchased for $950 million in a federal auction to expand over the next few years into 35 of the nation’s top 50 markets, including Chicago, Philadelphia, Washington, Seattle, Minneapolis and Las Vegas.
Leap sees expansion beyond its current geographic base as a key to its ability to continue delivering the kind of financial growth that has made the stock a favorite on Wall Street. Shares have climbed more than 47% this year. They fell 70 cents Wednesday to $55.35.
In the first nine months this year, Leap earned $35.2 million, or 57 cents a share, up 41% from $25 million, or 41 cents, from the same period in 2005. Revenue rose 20% to $822.1 million from $685.7 million.
But growth can be risky -- and expensive. Rapid expansion was part of the reason Leap sought bankruptcy protection in April 2003.
The bankruptcy wiped out shareholders and about $2 billion in debt.
The company already has forecast that build-out and borrowing costs will drop Leap into the red for the final quarter this year and, probably, for the entire year.
Earlier this year, the company picked up $1.3 billion in funding from the sale of stock and bonds and an increased loan package. That’s in addition to a $900-million bond issue outstanding.
“I’m sure the Leap people are thinking, where do they go from here,” said Alfred Boschulte, chairman of Probe Financial Associates Inc. “But they must try not to mirror what the top four carriers are doing.”
Instead, Boschulte and others said, Leap should stick to its niche and expand its existing coverage areas rather than leapfrog into new areas.
Henderek, for instance, pointed to privately owned MetroPCS, the only similarly sized company with the same business model. MetroPCS operates in almost as many markets as Leap, but those markets are consolidated in five states -- rather than Leap’s 22.
In MetroPCS’ home base of Florida, it effectively has a statewide system.
“One thing Leap does very well is run the service very cheaply,” said Michael J. King at Gartner Inc. research firm. “Because it’s a flat rate, there are no real billing questions or errors, no minutes to track. All the things other carriers worry about and trip up on.”
That means fewer customer service complaints, said Amin Khalifa, Leap’s chief financial officer.
The company’s modern, efficient network and a lean operating structure allow it to cut the expense of delivering calls to 1.3 cents a minute, Khalifa said, compared with the national average of 3.1 cents.
Leap’s revenue amounts to 2.9 cents a minute, which means customers pay less than what it costs the big carriers to deliver service.
“We focus on every penny of the cost structure,” Khalifa said. “We keep plans simple so when the bill is sent, it’s only a couple of lines.”
Hutcheson said he embraces the idea of clustering markets. In addition to building out new areas, Leap is filling in its existing network, reducing dropped calls to about 1 in 100.
But he and Khalifa said the company also is built for rapid expansion.
“Part of the reason we’re growing fast is that our business plan gives us a lot of room to grow,” Khalifa said.
“We look at where people live, work and play, and then try to cover that area.”
Fast growth hasn’t hurt existing operations, Hutcheson said. The company still saw 30% gains in revenue in markets that it entered more than a year ago.
And returns at new locations are coming quickly.
Houston, which the company entered in June, should be profitable by the end of the year, he said.
Despite concerns about fast growth, Wall Street likes the company’s flat-rate basic service because it is easy to deploy and to support, King said.
It also likes the fact that Leap already has funded its building plans for the next two years or so, said David W. Barden, a Banc of America Securities analyst who recommends investors buy the stock.
Despite its growth and ambitions, Leap remains largely below the radar of the major carriers, and Cricket customers don’t fit the profile of customers nationwide.
Nearly half have no other phone, compared to about 6% nationally who have cut off land line telephone service at home, and Cricket customers talk an average of 1,500 minutes a month, more than twice the national average.
But customers quit at a rate that is more than double the churn at Verizon and Cingular.
“Our cost structure is designed to allow for more churn than the major carriers have,” Khalifa explained.
Some find they travel more than they thought they would and need a larger carrier with nationwide coverage.
Some simply want the latest handsets. And because of the company’s focus on lower-income customers, some simply can’t pay for phone service every month.
“We’re part of the macro-economic environment, and we saw the impact from fuel prices,” Hutcheson said. “If you’re a low-income customer on a tight budget and see your fuel bill go up 20, 30%, you have to choose between a tank of gas or a month of phone service.”
Leap is “most flexible” in such situations, he said, allowing customers to sign up again without charging reactivation fees and security deposits.
“We’ve seen the reaction to that,” Hutcheson said. “People are coming back.”
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