The prepaid market has gone from a telecom darling to a precarious prospect in mere months as intensifying competition and signs of slowing growth at Leap Wireless suggest that the euphoria may have been premature.

Rising customer dropouts, the likelihood of further market-share losses and poor visibility have cast a shadow on these stocks.

The recession helped boost services where consumers pay a set monthly fee in advance for unlimited phone calls without committing to a long-term contract.

As people lost jobs or looked to cut costs, they streamed into discount services from firms such as Leap and MetroPCS. Investors rolled in too.

But now the picture has changed as services such as Sprint Nextel Corp's Boost and America Movil's Tracfone have emerged as big rivals, muddying prospects for all.

This has resulted in more slices of the same pie.

Shares in Leap and MetroPCS have fallen 24 percent and 28 percent, respectively, since they posted weak numbers last week and investors started to doubt that enough monthly-bill-paying postpaid customers would switch to prepaid to sustain growth.

MetroPCS is off 52 percent from the 52-week high it hit on April 2. Leap is down 50 percent in the same period.

Investors may have gotten too optimistic, said Pali Research analyst Walter Piecyk. There's not going to be this mass migration from postpaid to prepaid and there's a lot more competition now than there was.

Last week, results from MetroPCS and Leap showed that customer growth was slowing. On Monday, Virgin Mobile USA reported net customer losses, citing competition.

It shows the lack of loyalty of the prepaid base, Wells Fargo Securities analyst Jennifer Fritzsche said. Recent actions on the pricing side have shown that this is just inevitably heating up in quite a competitive way and I think that will continue.

Fritzsche sees a challenging third quarter. And she doesn't have the confidence that the holiday season will be normal for them.

Carriers like MetroPCS were continuing to walk a fine line of how much to invest in a customer because you know the customer won't stay with you very long, said Fritzsche, who downgraded MetroPCS and Leap last week saying the thesis had changed.

All analysts seem to agree that the prepaid market will keep growing as young people and those with low credit ratings look for an easy and cheap way to get a new phone.


While Boost's strong second-quarter customer growth may have hurt MetroPCS and Leap Wireless, it gave some reassurance that people are still drawn to prepaid services.

However, the concern is that future growth and profits might be much less than had been previously hoped for as competitors in the crowded market use price cuts to compete.

And what happens in an economic recovery, which could kick in late this year or next year according to some estimates?

Here's the risk. As we come out of this recession, will people trade up (to postpaid plans)? said Roe Equity Research analyst Kevin Roe, who expects at least some consumers to replace prepaid phones for corporate devices once the economy improves and companies start hiring again.

I think we can conclude that the pay-as-you-go market is a moving target because its a function of people's pocketbooks, Roe said.

Pali Research's Piecyk estimated that the U.S. prepaid market represents about 19 percent of total subscribers and has been growing in the mid-to-high teens percentage rate in recent quarters, a rate he does not believe is sustainable.

The growth of prepaid is clearly going to slow in future years. Probably next year you'll see some slowdown, he said.

BMO Capital Markets analyst Peter Rhamey said while the unlimited prepaid segment has become more mainstream and should continue to grow, it has slowed. It's hit an air pocket.

Another factor that is offputting for investors is the relatively unpredictable nature of the business. There is a high risk of customer cancellations or churn for a service that comes without long-term contracts.

Now that prepaid has a host of new competitors all looking to offer the best price, it has become tougher than ever to anticipate churn.

In the past, investors were willing to accept the volatility because the visibility longer term was good, said Roe. Now because of rising competition, visibility in 2010 is very poor.

This is why some investors feel safer with larger companies such as Verizon Communications and AT&T Inc.

Manpreet Singh of Profit Investment Management is wary of MetroPCS and Leap because of their narrow investment profile.

We do not like to invest in companies that only differentiate on price, he said.

(Editing by Saumyadeb Chakrabarty)