T-Mobile Should Attack Apple Head On

| About: Deutsche Telekom (DTEGY)

For the past month, I've been dipping into the SEC filings of the American telecom giants: AT&T (NYSE:T), Verizon (NYSE:VZ), and Sprint (NYSE:S). On the face of it, all these companies look cheap right now. Sprint is selling at around a 35% discount to book value. AT&T has a dividend yield of 5.7% and a forward P/E multiple of 12. Verizon looks closer to being fairly valued with a 5.2% yield and a forward P/E of 14, but at least you can say, it doesn't look all that expensive. When you consider that these companies might have a significant bit of growth left in them, it makes them all the more intriguing.

Yet, I keep getting stuck on one issue: all three companies appear to be sacrificing a large portion of their profits to Apple (NASDAQ:AAPL). And none of them seem to worry too much about how iPhone subsidies might be harming them.

That's why hearing T-Mobile (OTCQX:DTEGY) Chief Marketing Officer Cole Brodman acknowledge "The Apple Problem" publicly is a breath of fresh air. In an interview on Thursday, Brodman attacked the heavy device subsidies that have become rampant in the telecom industry. Brodman might not have specifically mentioned Apple; but we all know which company is feasting the most off of these big subsidies.

Of all the wireless telecom companies, T-Mobile is the one that now intrigues me the most, as it's the only one of the four major companies to take a contrarian strategy, and not pursue a deal with Apple. This could become a competitive strength, but for that to happen, T-Mobile has to attack Apple head-on.

The Problem

Before jumping to the strategy, it's important to examine the competitive nature of the American telecom industry. The chart below showcases the margins of the "Big Three" telecom companies, as well as Apple's margins:

You can also see a comparative revenue analysis here:

As you can see, Verizon and AT&T actually make fairly hefty operating margins off of their wireless service; but it appears that they might be subsidizing their landline service with profits elsewhere. Sprint is strangely reversed, as they actually make bigger profits on landline than wireless, but wireless comprises about 89% of their total revenues. I couldn't get T-Mobile USA's exact figures, but I'm estimating their operating margin to be around -4.5%.

What is obvious from examining these firms is that there are economies of scale in the wireless industry. But the question is, where is this scale beneficial? Advertising costs might be one area; the more customers you have, the less advertising costs you have per customer. So this gives Verizon and AT&T a huge advantage over Sprint and T-Mobile.

There might also be economies of scale around the CapEx needed to build out and maintain a carrier's network infrastructure. While AT&T and Verizon seem to have similar depreciation expenses relative to their revenue bases, Sprint's is quite a bit higher.

One could also argue from this data that the smartphone subsidies don't actually harm AT&T and Verizon nearly as much as they harm Sprint and T-Mobile. Since both AT&T and Verizon are benefiting from economies of scale, they might gain more profit for each subsidized contract than Sprint and T-Mobile.

But regardless of the specifics, the obvious takeaway is that T-Mobile's lack of scale versus its competitors is a huge disadvantage. Now that it's the only carrier that is not dependent upon Apple, however, it actually has a clear path forward in attacking the other carriers for their heavy subsidy-based model that drives up the costs of their wireless plan.

The Plan of Attack

A few years ago, Domino's launched one of the more daring advertising campaigns of all-time. The company decided to change its pizza recipe and in order to market the changes, the company unveiled a campaign that showcased customers complaining about how badly Domino's pizzas tasted. One highlight from the commercials was the inclusion of the classic line "your pizza tastes like cardboard". It was a risky strategy, but it paid off dividends.

In order to be competitive with AT&T and Verizon, T-Mobile needs to pull a page out of Domino's playbook. Instead of running away from its Apple problem, T-Mobile should be embracing it in the boldest ways possible.

Imagine a commercial that begins with a completely black background and bold white lettering that reads "Why We Don't Offer the iPhone." Then, one of T-Mobile's high-level executive officers comes on and explains why carrying the iPhone would force T-Mobile to charge higher prices, just like its competitors. Then, the executive could highlight that T-Mobile does carry Android phones and can provide service at a much lower price-point than AT&T, Verizon, and Sprint; while still having as service quality on part with those firms. He could even lay out some basic math to support this. Customers would get the message.

Would this idea work? Maybe, maybe not, but it's certainly better than bleeding market share and dancing around the iPhone subsidy issue. The more T-Mobile spins this into "us against the Big Three" and "T-Mobile vs. Apple", the more publicity it's likely to get and the more likely it is to capture consumers' hearts and minds. An aggressive attack on the iPhone is really T-Mobile's only viable strategy to stay competitive in this environment.

Ultimately, what T-Mobile wants to accomplish is to brand itself as the place where non-iPhone customers go for service. If you buy an Android (NASDAQ:GOOG) phone, you go to T-Mobile. If you buy a Blackberry (RIMM), you go to T-Mobile. If you want the iPhone, you go to AT&T, Verizon, or Sprint.

Whether T-Mobile's management has the brass to do this, I'm not sure. But I'd love to see them make this type of play and force the Big Three into defensive mode. What do they have to lose?

For the record, I am a loyal T-Mobile customer.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.