Was the iPhone Deal Worth It for AT&T?

AT&T’s iPhone 3G pact with Apple (AAPL) doesn’t come cheap. It cost AT&T (T) its quarterly targets and took a chunk of cash flow even though company officials declare the iPhone-induced earnings hit “success-based costs.”

The company on Wednesday reported adjusted third quarter earnings of 67 cents a share, four cents below Wall Street estimates. What’s notable is the reason AT&T fell short of its targets: The adjusted figure includes a 10 cents a share hit for iPhone 3G subsidies. AT&T had expected a 10 cents a share to 12 cents a share iPhone hit in the second half.

If you’re keeping score on this Apple-AT&T deal it’s clear that Steve Jobs & Co. is the winner in the early going. Morgan Stanley analyst Simon Flannery said in a research note that “iPhone dilution” spiked for AT&T. Now contrast that dilution to what Apple is seeing. Jobs drops in on an Apple earnings call, reveals a host of figures arguing that the company is a mobile juggernaut and is cautious about the economy but bullish about the company.

And why shouldn’t Jobs be stoked? He has AT&T subsidizing Apple’s iPhone and driving usage. AT&T did say that it activated 2.4 million iPhone 3Gs and 40 percent of them went to new customers. These customers have higher revenue per unit and lower churn.

On AT&T’s conference call with analysts, AT&T Wireless chief Ralph De La Vega said:

Our iPhone 3G initiative is doing everything we had hoped for and more, and as for our business going forward, and we have a very strong technology and network roadmap which we believe offers tremendous opportunity for us.

The rub: These new iPhone 3G customers cost AT&T $900 million in the third quarter. To put that into perspective AT&T took a $145 million, or 2 cents a share, hit due to costs related to hurricanes.

Is the iPhone deal worse than a natural disaster to AT&T earnings? Perhaps initially. AT&T is betting on that time-honored razor-blade business model. Use the iPhone to get customers in the door and then rake in data fees over two years.

AT&T’s plan sounds swell, but the company is obviously doing some damage control. Citi analyst Michael Rollins partially attributed AT&T’s lackluster quarterly results to iPhone sales.  In its statement, AT&T noted:

AT&T is optimistic regarding continued strong iPhone 3G activations and is confident in the long-term value created by this investment in acquiring high-value, data-centric wireless subscribers.

The key words there are “long” and “term.” Why? AT&T is taking a cash flow hit on the iPhone. In fact, its wireless service operating margin for 2008 will be about 37 percent compared to its previous outlook of 39 percent to 40 percent. As for all of AT&T, the iPhone shaves a point off of operating margins to 23 percent from 24 percent. That drop doesn’t sound like much until you consider that AT&T expects full year cash flow of $14 billion, down from $16 billion.

Randall Stephenson, AT&T chairman and chief executive officer, added:

The new customers we’re winning are high-value, with attractive revenue and churn profiles. We’re expanding the market, as users adopt more data and media-rich services and access a wide array of applications. These achievements are positive for the future of our business.

Yes, Randall we know.  At least AT&T is on message.

Stephenson’s statements are likely to turn out to be true, but if you’re a faithful AT&T shareholder you have to be wondering when the actual earnings benefit from the iPhone will arrive.

Comments

[.crazylegs..:]

Don't you have to factor in required capital investment from a lack of 3G capacity when all the 3g iPhones hit the network?

2008 Oct 23 11:26 AM

[Johnnymack:]

Should we also factor in not only TAKING new customers, higher margin customers, into ATT, but also the effect of TAKING those customers AWAY from the Verizons/TMobiles/and Sprints of the world? Those folks are going to be less able to compete, and will be left with the whiners who want everything for nothing! Cheers to them!

2008 Oct 23 11:36 AM

[20smoney:]

Buy all the Apple shares you can under $100. You'll thank me in 3 - 5 years.

Kevin
20smoney.com

2008 Oct 23 11:46 AM

[bobthenoob:]

it sucks to pay that initial investment money for future growth.

The real question should be, how long will it take for ATT to see a return on this deal.

2008 Oct 23 12:57 PM

[jmmx:]

Anyone who is fretting about this should not be investing in stocks, and certainly not in ATT.

Like DUH - everyone knew that iPhone would cost up front. Everyone SHOULD have known that the idea is that it will pay off over time.

So, you buy into iPhone for the long term. Everyone agrees that these are a moneymaker. Now you sell twice as many as you had planned. THIS IS GOOD NEWS! Really - I just do not understand how people can be so lame!

2008 Oct 23 01:19 PM

[KenC:]

LOL, to the people who don't want AT&T to invest in future growth, I guess the only answer is to NOT subsidize phones, or maybe they'd prefer AT&T sign up fewer iPhone subscribers.

2008 Oct 23 01:31 PM

[Hayweed:]

This is pretty simple. AT&T paid $900 million for 2.4 million new iphone customers which is a subsidy of $375.00 per phone. Cheapest cell plan at AT&T is $39.99 a month and the cheapest iPhone plan is $69.99 a month. Thus $30.00 more per user a month over 24 months = $720.00. Thus AT&T pays $375.00 at signing to get $720.00 over 2 years which is a 92% return. Family plans may skew this higher and lower and also there are text messaging fees to be added to the iPhone and maybe the cheap plan.

And they get the benefit of the hottest phone so they get more traffic in the AT&T store which allows them to get parents on the iphone and maybe kids on the cheap phones.

Larry, do some math on these articles. It appears to me that the shortfall will be made up once the sales cool off if they do. I am getting more and more people looking at my iPhone and asking about it.

The big news is the $900 million subsidy to Apple means that Apple will 900 milliion shares made a $1.00 in non gaap earnings on the subsidy. That is awesome for Apple which on non gaap earnings made 2.45 billion.

2008 Oct 23 01:31 PM

[Geldpress:]

The $900 million iPhone cost to AT&T only includes subsidies and other up front sales and marketing costs. The true cost of the iPhone to AT&T is in the additional demand it places on the RF network. With a voice call, a user only occupies one time slot. But with a data session - something the iPhone is remarkably good at hogging up - a user can occupy 4 or even 8 simultaneous time slots. Those data time slots are extremely expensive to AT&T because they place additional constraints on the voice network. When AT&T tunes the network at each cell site, they pre-determine how many data time slots vs voice slots are available. The more iPhone demand, the more data slots they need, and the more cell sites they have to build. AT&T does not come forth with accurate iPhone data usage statistics, but it's virtually certain that they are losing their A$$ES by selling the data plan to iPhone subs.
www.geldpress.com/2008.../

2008 Oct 23 01:32 PM

[aapladay:]

It will not be long for the increased revenue from the iPhone to help ATT. Remember they increased their fee's and that will, over the term of the contract, more than pay for the subsidy. Throw in an excellent dividend and this stock is just as much of a buy as Apple. I just hope they have better customer service than they had in the past.

2008 Oct 23 03:43 PM

[Bastion:]

Ugh, poor analysis, and it shows a lack of understanding in the general wireless telecom market. We have *huge* customer cost of acquisitions in general, and it is even higher in the smartphone category. Like the other poster said - it is the handset subsidies, which is why you only get them when you agree to sign a long-term contract (notice the words "long" and "term") - because the carrier knows that over the course of the contract the subsidy will be recouped either in monthly charges or an early termination fee.

So, when you get more customers than your current operating budget and conditions support, it does look bad in the short-term. Even my company, which is not AT&T, got a lift in smartphone sales due to the iPhone (I guess a rising tide does lift all boats...), and it affected our short-term budget plans. It's a good "problem" to have.

But make no mistake, getting new customers is never a bad thing, especially those who are some of the most coveted and the current and future drivers of ARPU - data users! To the poster who said that AT&T is losing money on data usage, you're just plain wrong. This is where the money's at.

This is just a continuing symptom of what got us into this leveraged mess of an economy - too much focus on short-term gain!

2008 Oct 23 04:57 PM

[mollytjm:]

AT & T has been in a tough fight for quite awhile with Verizon. It's worth a lot to take customers from their competitors. Initially the iPhone is costing them, but it's like advertising...you pay up front and if you did it right, you make $ later. People buying iPhones are on 2 year contracts, but a lot of them will want the new iPhone and then the next one. I know people who had the first iPhone and already have the 3G. each time you get a new phone, you extend your contract.
and i agree with the above comment about people seeing the iphone. everywhere i go and use mine, people ask about it...and the range of ages is amazing.
AT & T has been around a long time and i think they take a long view about this and the long view is that Apple will help them greatly increase market share.

2008 Oct 24 11:17 AM

[jackooo:]

It seems to me T is ALWAYS donating millions to some cause. How about T thinking about driving up the stock price?

2008 Oct 24 12:01 PM

[Nextel Acce...:]

the question is how long can they retain these customers with their limited 3G network....

2008 Oct 24 05:34 PM

[i build fib...:]

they just continue to beat up on att, no matter what they do and they just continue to make lots of money lol, really its just unbelievable! Their the only american carrier to have a worldwide 3g network and i have it and it is quick and the edge network isn't bad at all! Their new u verse tv was voted no.1 by jd powers over even the supposed superior fiber to the house verizon fios offering!!!Their video build cost a fraction of verizon's also!! They have the largest i p backbone in the world!!! Crank out a great dividend and no matter what the analysts just won't give them any credit.....any right now their stock price is very cheap!!!!And they have the coolest cell phone in the world the i phone!!!!!!!!! I guess they all must be just jealous of this fabulously successful company!!!!

2008 Oct 25 12:01 AM