Verizon (NYSE:VZ) is due to report its Q1 earnings tomorrow, and while that is obviously a big deal to Verizon investors, this quarter Apple (NASDAQ:AAPL) investors may also have a surprisingly large stake in what Verizon has to say.
Specifically, Verizon's subscriber count may tell us something about the state of the iPhone, Apple's most important product.
The New iPhone Subsidy System
During the first quarter, as everyone already knows, Verizon become the last major carrier to cave to competitive pressure and begin offering an unlimited data plan. The implications of unlimited data itself have already been thoroughly explored by me and others. But to help boost sign-ups at that time, Verizon coupled its new Unlimited offer with a free iPhone for each ported line, essentially a $650 payment for each new subscriber.
We're about to find out exactly how effective that combination was, so I won't guess. But there is widespread consensus that it was at least temporarily effective, as T-Mobile (NASDAQ:TMUS) felt compelled to respond with a new offer of its own just a few weeks later. Like Verizon, the deal was for free iPhones, on a two-year installment plan with offsetting bill credits.
I've written before about these new iPhone subsidies, which unlike the old system are born entirely of free-market device competition that sees customers responding strongly to offers of free iPhones. I've also explored before the possibility of using iPhone subsidy levels as a competitive indicator, something that tells us which carriers consumers are gravitating towards.
Carriers use iPhone subsidies opportunistically - they aren't present, or set at the same level, throughout the year. Rather, iPhone subsidies tend to be rolled out for specific windows of time when a carrier either needs to goose net adds because they're falling behind or need to respond to a carrier which is attempting to steal its subscribers in like manner.
Increasing Evidence Of Impact On Apple
As I've explained before, that really makes Apple, not any one carrier, the biggest winner of all. Carriers spent years separating themselves from these expensive iPhone subsidies so they could offer lower-priced plans without them. And now their own customers are dragging them back into thrall of Apple's profit engine.
There is at least some evidence that this promotional activity is boosting iPhone as a whole, as well as at specific carriers. The promotions tend to be concentrated in the winter quarter. And after months of iPhone declines, Apple reported that its iPhone returned to unit growth last winter. That obviously had to do with a lot of different factors, including the launch of iPhone 7.
But Apple's revenue growth in the Americas region, where the subsidies have increased drastically, was three times the size of the revenue increase in Europe, another mature iPhone market where subsidies haven't been altered so drastically. In fact Americas was the highest-growth region outside of Japan, which somehow grew a staggering 20% Y/Y. This represents a substantial swing from 2015, when Americas was the second-worst performer and actually shrinking.
If that - admittedly circumstantial - evidence doesn't persuade, there is always simple economic logic to fall back on. It would be very surprising if giving away the most premium-priced phone on the market for free wasn't boosting sales considerably.
Clouds On The Horizon?
By the same token, however, this also means there is a risk to Apple if carrier promotion of iPhone - in terms of subsidies, not marketing or retail availability which is unthreatened - was to end.
There are currently no iPhone installment subsidy offers ongoing, but that doesn't necessarily mean anything. It's the slow time of year and offers at this time haven't been common the last few years. But there were some earlier, and they didn't last long. Verizon ended its promotion after only a few days, and T-Mobile cut its promotion in half, running one week instead of the scheduled two.
This is a rather new twist in iPhone promotions. Since T-Mobile first resurrected them in mid 2015, some have run for a specified period and others have had no set end date when they were announced. But the length of the promos has always been measured in weeks, or even months. Never days, until now.
The iPhone Losing Punch?
There are a couple different possible interpretations to this. The first, more alarming one for Apple is that iPhone promotions, which have been so lucrative to the carrier, are coming to a close.
When T-Mobile first tried it, it was the only carrier offering free iPhones, as the practice had gradually faded out with the transition to subsidy-free phone plans pioneered by, well, T-Mobile, actually. When it started working Sprint got in on the act as well. It wasn't until last year that AT&T and Verizon finally began copying the practice, and since they account for two-thirds of the wireless market that doubtless provided the biggest boost to Apple sales. Hence the Americas growth in the earnings.
But these iPhone subsidies are of course incredibly expensive, and they are open to all switchers - even those who would have switched anyway, without the offer. That means Verizon and T-Mobile have to see enough extra switching to cover the costs of both the marginal added switchers and all the regular switchers who take the offer. If they weren't seeing that anymore, they would have every incentive to shut the incentive schemes down quickly.
But Hold On
On the other hand, it is also possible that the explanation is just the opposite: with Apple's most popular iPhone in some time, perhaps iPhone promotion schemes are more effective than ever, and they were shut down early because they had already achieved their objective.
As I said, the purpose of these subsidies now is to boost net adds to a level that management is targeting when they fall short. In other words, they are a way to basically "buy" a meet or beat on subscriber projections, when a shortfall might scare off investors and cause the stock to decline. Once the objective is reached, management doesn't necessarily want to keep buying subscribers at that same, expensive price.
So if a more popular iPhone sent more consumers than ever flocking to the carriers offering them for free, perhaps Verizon and T-Mobile, underestimated their impact rather than overestimating it. That would actually produce much the same effect: a decision to turn off the taps sooner than planned.
Watch The Carriers
This is why Apple cares what happens with Verizon tomorrow. A strong subscriber outperformance suggests that iPhone subsidies still work, a weak one suggests that they're losing their heft.
But since Verizon also started offering unlimited data at the same time, one data point from Verizon won't really be conclusive. What would make things even better would be if T-Mobile, which made no other major changes last quarter, also reported a strong net add. In point of fact Apple cares about all four carriers reports, including Sprint (NYSE:S) and AT&T (NYSE:T) which didn't offer iPhone subsidies in first quarter.
From Apple's perspective, the best outcome in the coming weeks would be for Verizon and T-Mobile to both report strong, and Sprint and AT&T to underperform. The subsidized win and the others lose. If Sprint or AT&T reports that they did just fine without the subsidies, however, or if Verizon and T-Mobile didn't really get the boost they were looking for, the second US iPhone subsidy system may die even faster than the first.
Apple is a large company with a broad geographic base, and I am talking about one market for one product. But it's Apple's most important product in its largest market. I believe the status of iPhone subsidies is significant to Apple. And a clue to their future is likely to be found in wireless earnings in the coming weeks.
Disclosure: I am/we are long S.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.