Alltel stands strong as rivals gobble spectrum

— -- It's tough enough for David to take on Goliath.

Now imagine Goliath countering David's slingshot with a cannon.

That's roughly the challenge facing Alltel, the No. 5 cellphone carrier, as it battles its two largest national competitors, AT&T t and Verizon Wireless. vz

In a recent federal auction of wireless airwaves, AT&T and Verizon combined for $16 billion of the record $19.6 billion in winning bids as they stockpiled more spectrum to improve coverage and turbocharge their broadband services.

"The big guys got bigger," says Stifel Nicolaus analyst Rebecca Arbogast, noting the top two carriers widened their lead in spectrum.

Alltel, which was taken private in a $27.7 billion buyout last year, is the auction's most notable loser. It bid hundreds of millions of dollars for airwaves in prospective and existing markets but came away empty-handed. Sprint s and T-Mobile didn't participate.

The outcome raises a pointed question: Can a scrappy second-tier carrier survive in an increasingly saturated cellphone market when it's losing ground in the race for airwaves — the most vital building block of a wireless network?

"At a certain price, enhancing our spectrum holdings would have been a reasonable thing to do," says Alltel Chief Operating Officer Jeff Fox. But he adds, "I feel like we're in position to continue to execute our business plan for our customers."

Fox's confidence is borne of Alltel's success in leveraging its underdog status. With 13 million subscribers, Alltel is a hybrid: Its footprint largely encompasses rural and midsize markets, but it also serves cities such as Tampa, Phoenix, Cleveland and Charlotte.

The company has stayed competitive in bigger markets by having innovative calling plans, offbeat advertising that pokes fun at its larger rivals and attentive service that taps deep consumer frustrations with wireless carriers.

Alltel said last week it notched record customer growth in the first quarter. Its churn, customers who quit the service, was 1.8%, behind just Verizon and AT&T. Analysts say tougher terrain lies ahead. Alltel continues to lag behind the major carriers, growing subscribers the past year at about 9% vs. more than 10% for AT&T and Verizon.

With wireless penetration at 84% of the consumer market, growth is slowing. Carriers, in turn, must draw from a smaller pool of prospects and wrest subscribers from each other, a dynamic that plays to big carriers' strengths. Their size lets them buy handsets at lower prices and get exclusive deals on the hottest models, says CreditSights analyst Ping Zhao.

Alltel also carries $24 billion in debt from its private-equity takeover by TPG Capital and GS Capital Partners, crimping its ability to upgrade its network and buy spectrum, says Dave Novosel of Gimme Credit. The tepid industry growth will prompt AT&T and Verizon to use their new airwaves to invade Alltel's rural markets, Novosel says. Yet Alltel's small spectrum war chest will limit its ability to enter new markets and enhance service. "Long-term, it's not a good thing," Zhao says. "You need spectrum to serve your customers."

Fox downplays the concerns. He says Alltel already vies with Verizon and AT&T in many markets and offers similar broadband, including video. Growth, he says, can come from college grads seeking discount plans and customers buying separate handsets for data.

So far, Alltel has defied the odds. It was founded in 1985 when its rural land-line parent company received some of the original cellular licenses the FCC granted to land-line providers across the USA.

In 2005, the carrier spiffed up its image. It revamped stores to offer an interactive experience, decided to spin off its land-line unit to focus on wireless and updated its digital network and logo. Executives also knew they had to counter AT&T and Verizon slogans that tout their networks' size and reliability. Alltel targeted consumer discontent with dropped calls, rigid contracts and poor customer service.

"We took a very distinct position of customer advocacy," chief marketing officer Frank O'Mara says.

Alltel became the first wireless carrier to let subscribers change plans without having to extend their contract. Others have followed. It's also the only big provider to offer a network guarantee, crediting one minute on the customer's bill for each dropped call.

In 2006, Alltel went a step further with its market-changing My Circle plan. It offered unlimited calling to any 10 numbers for $60 a month as well as a bucket of minutes and free nights and weekends.

"It gives them differentiation," says Roger Entner, senior vice president of IAG Research.

T-Mobile has since followed with MyFaves, which includes unlimited calls to any five numbers.

Alltel also has shaken up the tame world of cellphone advertising by gently mocking its competitors. In 2006, it launched ads with characters resembling those in rivals' campaigns, like former T-Mobile spokeswoman Catherine Zeta-Jones. Alltel now features four nerds outclassed by a cool guy who represents Alltel. "We poke fun at the big guys because what else can we do, right?" O'Mara says.

Subscriber growth has steadily risen since 2005. Salesman Richard Faulkner, 35, of Salisbury, N.C., switched to Alltel from Sprint 15 months ago because My Circle let him cut out monthly overages of $30. Alltel also had better coverage in tiny Mid-Atlantic towns where he works.

Can Alltel's strengths sustain it? As big carriers roll out faster broadband in a few years, they'll likely eat into Alltel's customer base, Arbogast says. That and its debt could threaten Alltel's survival as a stand-alone firm, Zhao says.

For now, Alltel's slingshot should keep Goliath at bay. Enough customers care about service and innovative pricing "to keep (Alltel) alive for the foreseeable future," says Yankee Group's Andy Castonguay.