• by Mark Walsh  @markfwal, June 30, 2008

With its pay-as-you-go plans and youth appeal, Virgin Mobile USA practically invented cheap cell phone service for teens. But with its $39 million buyout of mobile operator Helio, Virgin is taking a more conventional approach to competing with the major U.S. wireless carriers.

The deal announced Friday allows Virgin Mobile to offer a high-end 3G device and a subscription-based service intended to help it hold onto more customers. Virgin said that about 20% of its departing customers switch to subscription, or "postpaid," services, requiring a contract and monthly bill payments.

"With the integration of Helio, we'll offer a unique offering to customers, which will reduce our churn," explained Virgin Mobile CEO Daniel Schulman during a conference call Friday about the acquisition. The company has already warned that it expects to lose between 130,000 and 160,000 customers in the second quarter.

Most importantly, Helio's flagship Ocean device gives Virgin a 3G phone (running on Sprint's EV-DO network) to compete with high-speed handsets offered by the leading carriers that feature video, music, the mobile Web and other applications.

The impending release of the iPhone 2.0 has only accelerated efforts by wireless operators and handset makers to launch their own consumer-friendly smart phones such as Sprint's Instinct from Samsung, released June 20.

With its standard voice service, "Virgin remains stuck in 2002," wrote Eddie Hold, vice president for consumer services at technology research firm Current Analysis, in a report on the Virgin-Helio merger.

Even so, Virgin last week moved to keep up with the industry trend toward flat-rate pricing by introducing its $79.99 unlimited calling plan, undercutting similar plans offered by Verizon Wireless and AT&T. Helio offers unlimited voice and data plans for the Ocean as well.

As "virtual" operators, Virgin and Helio also both rely on the Sprint network for service, and both focus on the youth market, for whom newer mobile media features are especially attractive.

While the deal is expected to enhance Virgin's competitive standing, it's nothing less than a lifesaver for Helio. A joint venture of South Korean phone giant SK Telekom and EarthLink, the company wound up a spectacular failure after falling far short of its goal to sign up 3 million subscribers by 2009 while sucking up a half billion dollars in investment.

The company now has only 170,000 customers, although they are each estimated to spend $80 a month on mobile services--well above the approximately $20 Virgin Mobile's 5.1 million prepaid customers typically spend each month.

Virgin now plans to target $40 to $70 in average revenue per customer.

Still, Helio at least managed to be acquired. Other mobile virtual network operators (MVNOs) that launched with great fanfare and big investments have since been scrapped, including Amp'd Mobile, Mobile ESPN and Disney Mobile.

So how will putting two MVNOs together succeed? "You can't lump MVNOs together with all MVNOs--this is all about how to get scale," said Schulman. "Each was unique, but at the end of the day, you can't be successful without scale."

To help make the marriage work, Virgin Group and SK Telecom will invest $50 million at $8.50 per Virgin Mobile share. Sprint, a part-owner of Virgin, will also charge 8% less for wholesale service in 2009, with further reductions over the next three years and a bonus $2.50 credit for every new customer Virgin signs up.

By shutting down Helio's swanky retail outlets and kiosks among other cost-cutting moves, Virgin expects to reduce overhead by 70% by year's end. The company plans to phase out the Helio brand except in Korean-American markets, where it remains popular.

While the acquisition may not have much of an immediate impact on the wireless market, Current Analysis' Hold believes T-Mobile USA will feel the most threatened by the deal. That's because it's the carrier most similar to Virgin in targeting youthful customers with low-cost services.

"Also, T-Mobile is the last of the big four carriers to have not yet launched a national 3G network," noted Hold, although he acknowledged that the company had begun rolling out 3G service last month in New York City. Even so, he said, T-Mobile's efforts could be trumped by "a new, aggressive Virgin Mobile."

Investors did not appear to be so sure the Helio acquisition would result in a quick turnaround, however, as shares fell on Friday by 10% to $2.68. Virgin Mobile went public last October at $15 a share.