Value Line is regarded as the best independent research available. More than just recommendations, Value Line provides the rationale behind its picks for greater understanding.
- Don D., California
The iPhone Effect
Even though the iPhone was not the first smartphone, it has had a profound effect on the telecommunications services industry and has obviously been a sought after commodity by consumers. Since the device’s debut in June, 2007, Apple (AAPL) has sold around a quarter of a billion iPhones. As a result, we have witnessed the company’s market capitalization balloon from $104 billion in June, 2007 to over $600 billion today, and it may even become the first trillion dollar market cap company.
The iPhone changed the relationship between cell phone manufacturers and wireless carriers forever. Until the phone was introduced, carriers held more clout in the negotiations with phone manufacturers, using access to their networks as the ultimate leverage. This allowed them to have a huge say in the specifications and prices of mobile devices. In this old model, customers would choose their carrier first, and then choose their cell phone. However, Steve Jobs and his iPhone all but did away with this model. Jobs had a vision for a phone, which he was later able to sell to AT&T (T - Free AT&T Stock Report) largely under his terms. After the success of the iPhone, manufacturers began creating cell phones that consumers would want to buy, rather than ones that the carriers would necessarily want to sell. As a result, consumers began choosing a phone and would later pick their carrier.
This phenomenon is most evident in the early years of the iPhone release, when consumers flocked to AT&T for the device. The June 29, 2007 launch of the iPhone allowed for less than two days of sales and activations before the end of the company’s second quarter. In that time period, AT&T activated 146,000 iPhone customers, of which more than 40% were new customers.
In a recent study from research firm Strategy Analytics, it is believed that Apple has generated cumulative revenues of $150 billion since the launch of the iPhone. And this number only includes hardware sales. Accessories, apps, and software and services, which typically represent 3% to 5% of the company’s iPhone revenue each quarter, were factored out. In the first quarter of 2012, the iPhone represented nearly 40% of worldwide mobile phone (not just smartphone) revenues and 9% of units shipped.
Needless to say, this device is incredibly popular, which is why service providers are desperate to offer the iPhone, but at what cost? Apple earns very attractive profit margins on the device largely because people love it, but also because of the subsidies it demands from carriers – by some estimates, 40% higher than those of other smartphones. As a result, telecoms typically lose money up front on many smartphone deals because of these heavy subsidies. They eventually make their money back, however, on the multiyear contracts that most people sign. This is why they charge so much for early termination and push users into long-term commitments.
At first, AT&T was the sole provider of the phone, and due to this exclusivity, it helped fuel much of the carrier’s subscriber growth. Eventually, Verizon (VZ - Free Verizon Stock Report) joined the party and made the device available in February, 2011. With the two largest companies in the wireless industry offering the phone, it made competition in the industry a little lopsided. As time went on, other carriers had little choice but to reach an accord with Apple to offer the device.
Sprint Nextel (S) started offering the iPhone in October, 2011, but at a huge cost. The telco agreed to purchase up to $15.5 billion in iPhones from Apple during the next four years. While CEO Daniel Hesse is confident that the deal was worthwhile, he did admit the company likely will not see a profit from the phone for several years. In a related move, Mr. Hesse agreed to cut $3.25 million from his compensation package after shareholders complained that the formula to determine his pay package did not account for the hefty upfront expense of carrying the iPhone. So far, the gamble seems to be paying off. Over the first half of the year, Sprint has activated 3.3 million iPhones, compared with 11.9 million and 7.5 million for AT&T and Verizon, respectively. In defense of the move, Mr. Hesse said, “If you have any doubt go look at T-Mobile’s net subscriber numbers.” T-Mobile USA (a division of Deutsche Telekom AG (DTEGY)) is the only major carrier without a deal to carry the iPhone and has lost contract customers in 10 straight quarters. In connection with Sprint’s iPhone agreement, it is also offered through its Virgin Mobile USA division on a prepaid basis.
Leap Wireless (LEAP), which is among the bigger prepaid players in the industry, is the latest telecom company to offer the device. Under terms of their deal with Apple, Leap agreed to a three-year minimum purchase commitment estimated to be about $900 million, with annual commitments that increase its payments in the second and third years. In addition to these large telecoms, a host of regional carriers such as Alaska Communications (ALSK), Appalachian Wireless, Bluegrass Cellular, C Spire, Cellcom, GCI (a subsidy of General Communication Inc. (GNCMA)), Golden State Cellular, MTA, Nex-Tech Wireless, nTelos (NTLS), and Pioneer Wireless now offer the iPhone as well.
For investors looking to profit from this device, there are multiple options to select from. Of course, the obvious choice is Apple. For income-oriented accounts, Verizon and AT&T are solid plays. For those looking to take more of a gamble, Sprint, Leap, Alaska Communications, General Communications, and nTelos may be more appealing. As always, we encourage investors to refer to The Value Line Investment Survey for a detailed evaluation of each company’s investment merits, while keeping an eye out for Supplementary Reports when breaking news occurs.
At the time of this article’s writing, the author did not have positions in any of the companies mentioned.