In an interesting turn of events, recent revelations about the purchase agreement between Verizon (VZ) and Apple (AAPL) may mean a lot of bad news for both companies. As reported several days ago in Bloomberg, Verizon has not fulfilled its quota of iPhones as per its 2010 agreement with Apple.
And how big is this quota? According to Craig Moffett from Moffett Research LLC (a telecommunications analyst who left Sanford C. Bernstein & Co to start his own firm), under a multiyear deal signed with Apple in 2010, Verizon is obligated to buy $23.5 billion worth of iPhones in 2013 alone. According to Moffett, since the purchase commitment is more than twice what Verizon sold in 2012, the company may have a shortfall of $12 - $14 billion for 2013.
Nomura analyst Stuart Jeffrey also come up with the same number. He figures that Verizon has a commitment to purchase $23.5 billion in iPhones, but only sold 7.2 million units in the first half of the year and expects another 12.8 million units to be sold in the second half of the year. He figures that there is a 19 million unit shortfall, for a total cost about $12 billion.
Even assuming Verizon does not cover its commitments (a sure bet Ι would say), does this mean that Verizon is on the hook for the shortfall? Probably not. Since both companies have refused to comment on the issue, it probably means that both want to keep a lid on this revelation. While technically and legally Verizon is probably on the hook, I am sure both companies will come to some understanding.
Craig Moffett doesn't expect Verizon to write a check to Apple for $12 billion to make good on its shortfall either, however he thinks it is more than likely Apple will extract at least some consideration for the contract shortfall.
If Apple does pursue such a course, it might mean Verizon might be forced to sell iPhones -- undercutting the price in order to be able to make good on its quota -- for a considerable period of time. This might also mean that Verizon might not offer a broad range of devices to its customers in the future, choosing to push iPhones instead. That might mean it will lose a competitive advantage in the future. Either way, any way you slice it and dice it, I think this shortfall commitment will cost Verizon something.
However for Apple the implications are worst. If companies have not been able to fulfill their sales commitment for iPhones, that means that Apple's sales looking forward might be a whole lot less than what the street believes. In fact, Moffett thinks that there are many other companies around the world who have not fulfilled their sales quota and are in the same predicament with Verizon.
If this is true, then there is another twist to this story that very few people have realised.
See, these agreements are well know to the market through regulatory filings. As such, the market has modeled Apple's future sales -- partially at least -- on many of these fillings. But if all these commitments -- not just from Verizon but from many other companies as well -- will never be fulfilled, that means that analysts might (probably will) remodel the long term expectations for Apple all over again.
And I think that when this remodeling is done, future sales expectations for iPhones will be very lower from what the market has modeled in today.
Another negative for Apple is this. Since Verizon and many other companies have got burned committing very large numbers to Apple, they will not do so again. That will partially change Apple's business model, which has been based on large scale commitments with the biggest carriers.
The good news is that the market in its infinite wisdom has probably discounted all this and that's why the stock did not fall on this news.
And if the market is correct in marking down Apple's stock so much, I think that we can expect much lower iPhone sales, at least for the near to medium future.