Could iPhone 5 Boost Verizon's Profits In Q4?

| About: Verizon Communications (VZ)

On Friday, Sept. 21, Apple (NASDAQ:AAPL) launched its iPhone 5 for carriers AT&T (NYSE:T), Verizon Communications (NYSE:VZ), and Sprint Nextel (NYSE:S), and some analysts have speculated that Verizon will ultimately be the carrier that comes out the winner. However, initial data from ComScore is showing that AT&T is dominating the U.S. market for iPhone 5 connectivity, with 68% of pre-orders during the first three days followed by Verizon (with a 24% share) and Sprint (with just 8%). In contrast, during the first three days for the iPhone 4S sales were 48% for AT&T, 35% for Verizon, and 17% for Sprint, but for the first month Verizon was the winner with 45%, followed by AT&T with 43% and Sprint with 12%.

With that in mind, I should mention that carriers bear the real expense of the iPhone because they must subsidize and host it on their networks. And while it's unclear just how much of a subsidy they pay to Apple, analysts believe that it could be as much as $400 to $425 for each customer who signs up for a two-year iPhone service contract. In other words, the iPhone 5 is a real hit on the bottom line and margins of carriers -- at least for the first nine months or so. So what will be the impact of the iPhone 5 on the bottom line of Verizon, and will it be the carrier that comes out as the winner?

Some Background on Verizon

Before I write about the iPhone's impact on Verizon, let me just give some background on the company. Verizon was founded in 1983 as Bell Atlantic Corporation and it was one of the seven so-called "Baby Bells" that were created out of the antitrust judgment against the American Telephone & Telegraph Company, with its original operations in New Jersey, Pennsylvania, Delaware, Maryland, West Virginia, Virginia, and Washington, D.C.

In 1999, Bell Atlantic and U.K.-based Vodafone AirTouch Plc -- as in the Vodafone Group (NASDAQ:VOD) -- agreed to create a new wireless business with a U.S. footprint, a common digital technology, and a single brand name (Verizon Wireless) by combining Bell Atlantic's and Vodafone's U.S. wireless assets. In 2000, Bell Atlantic acquired GTE in one of the largest mergers in U.S. business history and renamed itself Verizon Communications (which was added to the Dow Jones Industrial Average in 2004). But it was the 2005 acquisition of MCI (formerly WorldCom) that set the stage for the company to become the largest carrier in the country up until AT&T acquired BellSouth.

Today, Verizon is the second-largest fixed telephony provider in the United States and vies with AT&T to be the largest wireless carrier in terms of the number of subscribers. As of around the time of the iPhone 5 launch, Verizon's stock was also up 13.8% since the start of the year, up 2.8% over the past five years, and up 53.9% over the past five years.

Verizon and the iPhone 5

So how will the iPhone 5 impact Verizon? For starters, Verizon has made a big bet on the future with its aggressive and nearly completed 4G LTE rollout; plus, the company also sees the iPhone 5 rollout as the beginning of the end for 3G usage. At the recent Goldman Sachs Communacopia Conference, Verizon CFO Fran Shammo stated that he expects 3G usage on his network to decline as the iPhone 5 rolls out with the company reapportioning spectrum to 4G services. That will be critical as iPhone 5's data hungry customers will need to be on the more efficient 4G network, and Verizon is aggressively pushing this advantage as it markets itself to potential iPhone 5 customers. Of course, AT&T is not conceding 4G to Verizon as its 4G buildout is coming along as well, but for the time being the advantage goes to Verizon.

On the other hand, there is a catch for Verizon's iPhone 5 users. It has been reported that the iPhone 5 models for both Verizon and Sprint will not allow users to do other data-hungry tasks while making a phone call on their 4G networks (but AT&T customers will be able to). Hence, when making a voice call on either the Verizon or Sprint networks, you will need to be on Wi-Fi to pull data inside apps or browse the Internet. I am not so sure how big of a concern that will be for most customers, but you can bet that AT&T will make sure that everyone not signed up already for an iPhone plan with it will be made aware of any such difference.

Finally, it's important to put some hard numbers on the financial impact the iPhone 5 will have on Verizon's bottom line. Some analysts already expect Verizon's margin to fall from 49% in the second quarter to 47.4% in the third quarter and 43.6% in the fourth quarter due to the iPhone 5, but it's also hard to tell just what the impact will be as nearly all the carriers have been mum about pre-orders and all will share the pain of having their margins impacted in the near term.

However, Verizon's CFO has stated that the company will not take a big hit to its wireless profit margins this quarter (as its almost the end of the quarter anyway), and that the short-term revenue decline from the company's new data share plans (which allows families to share one data plan) will be less than he had feared because Verizon customers are buying bigger buckets of data. Nevertheless, he did concede that if volumes are high in the fourth quarter (aka the holiday season), profit margins will be impacted.

A Final Word on Verizon and the iPhone 5

It's worth remembering that the most important short-term financial indicator of whether or not the iPhone 5 is a success for the carriers will be the percentage of activations that are new customers. That's because these activations will represent new sources of revenue, along with the amount of data these new customers use. Likewise, there is the upcoming holiday season. Over the long term, having a low churn rate will be the most important metric to gauge the success of the iPhone 5 for the carriers.

Nevertheless, it does seem like Verizon will be an initial winner with the iPhone 5 as it can tout its 4G capability. But what matters most for the long term is how much the iPhone will ultimately add to its bottom line. For now, we simply cannot answer that question.

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

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