On June 22, 2012, Leap Wireless (LEAP) will begin offering the Apple (AAPL) 8GB iPhone 4 and 16GB 4S through its Cricket Communications subsidiary. On June 29, 2012, Sprint (S) will follow suit and offer both Apple iPhones through its Virgin Mobile subsidiary. Cricket and Virgin Mobile specialize in pre-paid phones that do not lock their customers into long-term service contracts.
These moves will change the game. Taken together, Apple, Leap Wireless, and Sprint can all unlock new standing armies of potential customers that will translate into impressive top-line growth. Competitors, such as Microsoft (MSFT), Nokia (NOK), and AT&T (T), however, should tread lightly. Tim Cook and Apple management have upped the ante, and are more than willing to outflank any desperate organization that decides it wants to play hardball.
Cricket Cost Savings
Apple sells its unlocked, contract-free iPhone 8GB 4 and 16GB 4S devices for $549 and $649, respectively. At AT&T, you may purchase these iPhones for $99 and $199, if you agree to the terms and conditions of a two-year service plan. Your two-year service plan is likely to cost you more than $100 per month for unlimited talking minutes, texting, and data usage. Potential hidden costs within your service plan, of course, include an early termination fee that caps out at $325. Basic arithmetic indicates that traditional phone carriers are effectively granting $450 worth of up-front iPhone subsidies, in exchange for future revenue streams of at least $2,000.
Later this month, Cricket will offer the iPhone 4 and 4S for $400 and $500 up-front, respectively. After purchasing the device, Cricket pre-paid customers will pay $55 monthly for unlimited access to this carrier's 3G network, which it effectively leases from Sprint. Alternatively, Sprint will retail the iPhone 4 and 4S for $549 and $649, before offering flexible monthly calling plans that range between $30 and $50.
The Cricket point-of-sale is of special interest. Here customers must pay an additional $300 up-front (Cricket will sell iPhone 4 for $400 and iPhone 4s for $500), in order to achieve cost savings of at least $50 each month, relative to conventional mobile phone plans. After six months of use, the additional up-front cost would have paid for itself, and Cricket customers will begin to realize real savings. After several years, Cricket iPhone users would have saved thousands of dollars, in comparison to contractual plans offered at Verizon, AT&T, and Sprint. For cost conscious hipsters, these moves could not have come at a better time, as the U.S. economy continues to flash signs of looming recession.
For Apple, both Cricket and Virgin Mobile partnerships provide gateways into the rapidly developing pre-paid phone market. According to Nielsen research, pre-paid phones are especially popular with working class and "decidedly downscale" individuals and households, who must adhere to a strict budget. Large numbers of these people may have also been simply shut out of traditional service contracts, due to weak credit ratings. This low-income market will covet iPhone quality that finally legitimizes the pre-paid business model. Outside of the United States, Apple can rely upon Cricket and Virgin Mobile sales as a model to generate additional profits in developing nations within Africa, the Middle East, and West Indies.
If coordinated properly, this entire prepaid movement will add billions of dollars to Apple's bottom line.
The Phone Wars
The Leap Wireless, Sprint, and Apple deals will set off a price war as smartphones are increasingly commoditized. This looming price war will obviously heighten tensions between the Google (GOOG) Android, Nokia / Microsoft Windows, and Apple iOS trinity that currently dominates the mobile device market. Further, the AT&T, Sprint, and Verizon (VZ) carriers must offer price concessions through combinations of more efficient service plans and marketing machines that hawk cheap phones. To remain competitive, the phone carriers can eat dirt, in the form of larger and larger up-front subsidies for Apple's most popular phones.
On May 2, 2012, I submitted that Nokia Lumia is No iPhone Killer. Within the article, I reasoned that AT&T's aggressive rollout of the Microsoft / Nokia Lumia would be perceived as a blatant slap in the face towards Apple executives. I calculated that AT&T was unwittingly setting itself up for a pyrrhic victory of Russian roulette. Yes, the carrier was set to save $100 worth of up-front subsidies on every Nokia Lumia that AT&T shoved out the door, at the expense of Apple iPhone unit sales. Apple executives, however, have always proven their mettle to get down and dirty and retaliate against any slight.
Apple's first foray into the pre-paid market proves that the chickens have come home to roost even earlier than I could have ever imagined.
The Bottom Line
Expect all but the most ruthlessly efficient corporations retailing commoditized product to trade as quasi- utilities. AT&T, Microsoft, Verizon, and Sprint may generate substantial levels of stable cash flow, but they will fail to engineer robust profit growth. Sprint, Baby Bell, and Microsoft shareholders should expect little from their investments, besides keeping pace with the S&P 500 Index and making out quarterly dividend payments. If global growth rates continue to decelerate, these positions will lose significant value over the next twenty-four months.
At $2.85, Nokia stock is effectively a call option. Nokia stock will outperform, if it can leverage both its brand name and Microsoft's briefcases full of cash to steal share in the smartphone market away from both the Google Android and Apple iOS platforms. If Microsoft, however, abandons ship, Nokia shareholders would then be forced to prepare for bankruptcy.
At $5, Leap Wireless shares are in a similar boat to that of Nokia. Leap shares have collapsed from $100 over the past five years and its managers have bet the farm on this Apple deal. According to Mike McCormack of Nomura Securities, Leap has locked itself into a hefty three-year, $900 million investment that will only drive iPhone sales for 10 percent of its customer base. In 2011, Leap Wireless lost $315 million, on $3 billion in revenue. Leap's financials will be challenged further, by the fact that Apple has concurrently recruited Virgin Mobile to do its bidding. Knowing Apple's history, I am certain that Cupertino executives will deftly play these pre-paid operators against each other, and haughtily force destructive price concessions. With that in mind, I would avoid Leap Wireless stock.
As the dominoes fall, it is quite obvious that Apple holds all of the cards. The technology marketplace rewards innovation and happily pays premium prices for anything identified as "cool." The Apple iPhone is but a mere gateway into closed loop iTunes, iPad, and iMac infrastructure. Certainly, both private consumers and institutional buyers agree, as they continue to willingly bankroll a corporation that hawks products featuring gaudy 40-percent gross margins. Apple has grown annual profits by 75 percent over the past three years, yet trades for a measly 14 times earnings. The stock also carries $120 / share in cash and investment securities on its balance sheet.
Apple is still a strong buy at $570 per share.
Disclosure: I am long AAPL.