T MOBILE US INC (TMUS), Verizon Communications Inc. (VZ): Will Investing in Prepaid Phones Pay Off?

Barely a day goes by without some aspect of the mobile computing revolution appearing in the news. There are new phones, new features, the rise of Samsung Electronics Co., Ltd. (KRX:005930), and so on. One aspect of the revolution is less glamorous and hence less talked about, but is likely more important from an investment perspective–the rise of the prepaid phone.

The rise of the prepaid phone

According to NDP group, smartphone sales grew about 9% in the second quarter of 2012. That growth is almost entirely attributable to growth in prepaid smartphones, however, which grew 91% year-over-year. In other words, the smartphone use in prepaid plans almost doubled in one year. This growth in smartphones helped to cause the overall growth rate to double in this sector. America’s cell phone market is somewhat strange compared to the worldwide market in that it relies on a two-year contract model with subsidized phones. In most parts of the world, the majority of consumers purchase a phone and then bring it to the cell phone provider of their choice.

Prepaid plans are substantially cheaper than their postpaid counterparts — often amounting to savings of $1,000 over the life of a contract even once the phone subsidy is accounted for (http://wallstcheatsheet.com). So why are consumers not flocking to prepaid phones in droves faster than they already are? First, consumers simply are not doing the math. They do not like the idea of paying several hundred dollars up-front for a phone, and as a result they can be suckered into paying substantially more per month. This will likely not change. The other two reasons will likely change however.

The first reason is consumer inertia. Consumers simply do not know about the phones and associate them with a budget, no-frills experience. This is changing, however. As more and more consumers adopt the technology, more consumers become aware of it. Furthermore, with T MOBILE US INC (NYSE:TMUS)’s recent switch to being an entirely prepaid carrier, prepaid will likely see a major increase in advertising support. The second reason is that these plans have typically been associated with no-frills phones. They usually did not get the nice smartphones as soon as the major carriers did. This is starting to change as well. For example, Virgin Mobile Telecoms Limited currently has the iPhone 4S and Straight Talk has the iPhone 5, while T MOBILE US INC (NYSE:TMUS) continues to maintain its offering of top-of-the-line phones including the Samsung Electronics Co., Ltd. (KRX:005930) Galaxy S IV.