Cingular Hopes iPhone Will Distract Consumers From Unreliable Voice Service

Includes: AAPL, T
by: Bill Allen

Om Malik posted a great piece regarding the reluctance by wireless carriers to provide reliable voice service. As he notes, their use of reliability as a marketing tool almost insults consumers.

Why have Americans tolerated this? Cell phones have become very important to everyday life through ease of communication and safety. There are also few alternatives - large barriers to entry remain for potential competitors and carriers hold a near monopoly. Carriers have been licensed and regulated by the Federal government, possessed billions in legacy land-line cash flow to obtain these licenses and create/acquire their infrastructure, and have developed relationships with cell tower owners and local municipalities to build their networks.

They also have the mobile phone makers in a vise grip - they require certification from the carrier to sell their products, with carriers dictating costs and features. In the absence of unlocked phones and plans that do not require a long-term contract, customers maintain little influence or power.

Some alternatives may be available in the next few years. Former cell phone company exec Craig McCaw has teamed with Intel (NASDAQ:INTC) and others to build a nationwide, Internet-protocol based wireless network from scratch, Clearwire (CLWR). Faltering carrier Sprint/Nextel (NYSE:S) has initiated construction of its own WiMAX network to be operational by late-2008, and another firm, FON, with Google (NASDAQ:GOOG) as an investor, will attempt to provide equipment allowing home/office users to share their existing Wi - Fi connection and possibly create "one large hot-spot."

Somewhere, one of these initiatives may gain widespread use, but I don't know if they can legitimately challenge current providers. Also, although a recent WSJ article on Sprint notes that some analysts expect data services to become an increasingly large component of total revenue, I believe that core voice service will remain the main revenue generator for the wireless industry over at least the next 5 years and shouldn't be underestimated.

I would, however, keep a close eye on the iPhone and its influence on the entire wireless marketplace. Cingular/ATT (NYSE:T) decided to do something risky, giving Apple (NASDAQ:AAPL) the freedom to independently develop a completely new device, which effectively removed any meaningful limits for certification requirements. It knows that customers have reluctantly endured the company's shortfalls and hopes to leverage its fixed cost, existing network by stimulating additional demand for its services through a superior piece of hardware.

While choosing to focus on likely network improvements and features in preparation for the device's release, T offloaded its development to a firm known to champion the customer experience - look/feel, user interface, unique/advanced functionality for both data and voice. The device will allow consumers to gain much greater utility from their phone and T's network, and will help rebuild public perception of the carrier.

It's 1984/2001 all over again for AAPL - it won't tolerate any chance for failure. I would guess that the company has spent the last few, pre-production months fine-tuning every feature, including signal and voice reception. AAPL will demand high levels of service competence and network quality, and although the iPhone also possesses Wi-Fi capability to function outside of T's system, they have likely "encouraged" T to make additional investment in their voice and EDGE data capacity, with faster speeds to follow in 2008.

Both firms realize that the iPhone will be expensive for many consumers and have targeted early adopters to help introduce it to the marketplace. They can thus test usability and functionality, control initial manufacturing processes and sophistication, and steadily gain the capacity and advantage to mass produce the device. AAPL can also control potential iPod cannibalization that will surely occur as the iPhone gains popularity.

The shares of both companies have performed extremely well in the past few months. The former SBC benefited from its acquisition of AT&T, gaining large business customers and an associated IP-based network, and its merger with BellSouth enables full control of Cingular and large cost synergies in equipment purchases and marketing/administrative expenses. The shares also provide a sustainable dividend yield of over 3.5%.

However, several risks remain, including some fundamental concerns regarding T's core businesses that require attention. They have experienced yearly land-line attrition rates of 3-5% and initial difficulty introducing their new U-Verse video service, and will need to competitively price their DSL offerings to gain an advantage versus the cable companies.

Also, several media outlets reported this weekend that T will team with America Movil (NYSE:AMX), the Mexico-based wireless carrier controlled by billionaire Carlos Slim Helu, to purchase majority shares of a holding company that controls Telecom Italia. I expect T to continue to make deals and keep itself busy with some risk of distraction.

However, the iPhone and its positive effect on Cingular/ATT revenues could offset many of those concerns and attract users to its other services. Maybe I'm too optimistic, but I think T has made a bet that will handsomely reward AAPL and its own shareholders through the decade.

Full Disclosure: I am Long on AAPL.

AAPL vs. T 1-yr chart: