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Tuesday, May 08, 2007

Virgin Mobile USA IPO Filing

Virgin Mobile USA offered a little insight in the MVNO business model with its IPO filing last week and it appears that red is not only the brand colour, but also the colour running through the accounts – to the tune of US$683m of losses since launch in June 2002.

Venture Start-Up losses are not necessarily a good indicator of future performance, however with Virgin Mobile the future looks decidedly dodgy with the following lowlights gleaned from the IPO filling.

High Levels of Debt

Most of the start-up losses have been financed by debt rather than with equity with total debts of US$553m promising to be a drag on earnings for many years to come, especially one where the business has still not reached cash-flow positive.

Large Losses from Box Breaking

In the UK, prepaid handset subsidies attract box breakers like excrement attracts flies: fortunately for Virgin Mobile USA, they use CDMA technology which is less popular in emerging markets than GSM technology, however they are still suffering losses to the tune of $25.4 million (228k handsets) and $30.4 million (322k handsets) in 2005 and 2006 respectively.

Despite a decade long attempt to crack the problem of box breaking in the GSM market, no long term solution apart from not subsidising non-locked prepaid handsets has ever emerged. Investors should consider how many customers would buy the service if subsidies were not offered.

Strange Customer Count Metric

Alarm bells always ring when a company uses a non industry standard metric for calculating an important metric: Virgin Mobile use an inactive limit of 150-days before taking customers off their customer count – the industry standard is 90-days. This is an overstatement of 60-days and with a churn rate of 4.8% means the Virgin Mobile customer base is “overstated” by around 10%. This is significant on a base of 4.57m subscribers.

Rate of Growth is declining

The net customer growth has declined from 1423k (2004) to 994k (2005) to 729k (2006) over the last three years. This can’t be explained by the general USA cellular market which is still experiencing good growth, but can be explained by more competition for the particular segment which Virgin Mobile is targeting – which is youths with no or poor credit rating and no parental subsidy.

As markets in Western Europe have saturated, this is a keenly fought segment which does not bode well for Virgin Mobile in the 3-5 time frame when the USA market will be saturating.

Rate of Spend is declining

Average Revenue Per User is dropping from US$24.24 (2004), US$22.54 (2005), US$21.48 (2006). To be fair this can probably be accounted for by a growth in the inactive customer base rather than any drop in minutes, texting or rates.

Life Time Spend is low

US$21.48 per month spend with a 4.8% churn implies a customer life time of 20.8 months with a life spend of US$447. This is extremely low, especially given up front cost of acquisition is US$120 and Virgin Mobile doesn’t own its own network and therefore pays higher network charges than network owners.

Shareholders charges appear high

Virgin Mobile USA is predominately owned by Sprint and the Virgin Group with around 47% of the equity each. Related party transactions in 2006 amounted to US$264.1m (including US$1.3m in contributed equity) for Sprint and US$5m for the Virgin Group. (including US$1.4m in contributed equity) This represents a large chunk of total Opex in 2006 of US$1,093k.

It is perhaps the biggest truism in the MVNO game that the network deal is the most important contract and with Virgin Mobile, Sprint seems to be earning a large chunk of mainly high margin wholesale revenue from the Virgin Mobile MVNO. Sprint earnt US$225.3m from serving a weighted average number of customer throughout 2006 of 3,957k or US$4.74 per month on average. No real detail on how these charges are calculated is provided and this is crucial to determining the long run sustainability of the company especially as prices typically drop over time.

Why Now?

The most intriguing question is why are Virgin and Sprint floating the Virgin Mobile now? It make a lot more sense for me to float the venture when it is generating cash rather relying on a leap of faith from investors for Virgin Mobile to bridge the gap. I suspect the real reason for flotation now is that either one or both of the partners aren’t prepared to put more equity into the company and need the IPO proceeds to further finance ongoing losses.

In conclusion, I can’t really see anything at all in the IPO which changes my opinion of all MVNOs basically having zero prospects in the long run. For sure in the short run, there may be money to be made for the speculator playing the expectations game, but as a long term investment hold – no chance.