Is Sprint's iPhone Commitment Now A Slam Dunk?

| About: Sprint Corporation (S)

Much has been written, over the last year, about Sprint's (NYSE:S) $15.5bn iPhone commitment with Apple (NASDAQ:AAPL) and the risks associated with the deal. Following the completion of two quarters of iPhone sales from Sprint and, in light of, the recent announcement that Sprint will carry the iPhone under its Virgin Mobile pre-paid brand, it's a good time to crunch the numbers and see how things are looking with respect to the contract.

First of all, we only know about the dollar value and length of the Apple contract ($15.5bn over 4 years). In order to translate this dollar obligation into a volume commitment, we need to make price assumptions. To do so, let's look at the prices at which Sprint offers the iPhone without a contract:

Model No-contract price
iPhone 4 (8GB): 549.99
iPhone 4s (16GB): 649.99
iPhone 4s (32GB): 749.99
iPhone 4s (64GB): 849.99
Source: Sprint website
Click to enlarge

Given Apple's very strong pricing power, we can assume that these prices are cost and all of that money goes back to Apple (these are basically the same prices that Apple charges for unlocked iPhones in their stores). We can also assume that most of the sales are for the cheapest 4S model at $649.99 -- which seems like a reasonable estimate for the average cost (as sales of the higher-cost phones are offset by sales of the $549.99 iPhone 4 model). Over time, I simplistically assume no price/cost increase over the four-year contract with Apple.

Using the $649.99 cost estimate, we come to the following volume commitments, relative to Sprint's run-rate sales from the first two quarters (see chart below). Annualizing the past two quarters may be overly generous for Sprint -- as the fourth quarter of 2011 benefited from seasonal/holiday sales and a new product launch (launch of the iPhone 4s). Since those disproportionately high sales are only likely to occur one quarter per year, I adjusted for that dynamic with a normalized run-rate figure.

Contract amt. (billions): $ 15.50
Average unit price: $649.99
Volume commitment (millions):
Over 4-year contract: 23.8
Yearly: 6.0
Current run-rate:
Over 4-year contract: 26.4
Yearly: 6.6
*Normalized run-rate:
Over 4-year contract: 25.2
Yearly: 6.3
* Normalized run-rate assumes 1.5mn for 3 quarters
and one seasonal/launch quarter of 1.8mn
Click to enlarge

Under these assumptions, we can see that Sprint is trending along nicely, relative to the company's estimated volume commitments. From the chart, below, we can also see that Sprint's iPhone sales are trending favorably compared to AT&T (NYSE:T) and Verizon (NYSE:VZ) - increasing its share of iPhone sales and only falling 17% from the seasonal/launch Q4 period (versus 43% and 26% declines for AT&T and Sprint, respectively).

Q4 2011 Share Q1 2012 Share
AT&T: 7.6 55.5% 4.3 47.8%
sequential change: 43.4%
Verizon: 4.3 31.4% 3.2 35.6%
sequential change: 25.6%
Sprint: 1.8 13.1% 1.5 16.7%
sequential change: 16.7%
Total: 13.7 100.0% 9.0 100.0%
Click to enlarge

Sprint's recent announcement that its Virgin Mobile subsidiary will be offering the iPhone on June 29th, and rumors that Sprint's Boost subsidiary will follow suit in September, give further reasons for optimism. Sprint's pre-paid operations are sizeable (14 million subscribers on the pre-paid Sprint platform at the end of Q1 2012 versus 29 million post-paid subscribers). Even if take-up is a fraction of what we are seeing for the post-paid platform, it could provide a nice boost (no pun intended) to Sprint's iPhone numbers.

So, is meeting the Apple contract commitments now a slam dunk? Not at all. Four years is a long time and iPhone sales levels could certainly stagnate or deteriorate over time (particularly, after the low-hanging fruit is harvested). Furthermore, pre-paid subscribers are considered more price sensitive - and, thus, less likely to shell out for an expensive iPhone. As a result, the impact of Sprint's pre-paid iPhone offering is very uncertain and could be small.

All that said, the company's iPhone sales appear to be trending well, even without any pre-paid sales. Incremental sales from pre-paid would be pure upside, as not much was ever anticipated from that sale's channel. Overall, while risks with respect to Sprint's iPhone contract certainly remain, I believe that overall developments in that area have been positive and these risks have clearly reduced.

Disclosure: I am long S, AAPL.