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Apple's Phil Schiller, Senior Vice President of Worldwide Product Marketing, introduces the new Apple iPhone 3G S at the Apple Worldwide Developers Conference in San Francisco, Monday, June 8, 2009. (Paul Sakuma)
Apple's Phil Schiller, Senior Vice President of Worldwide Product Marketing, introduces the new Apple iPhone 3G S at the Apple Worldwide Developers Conference in San Francisco, Monday, June 8, 2009. (Paul Sakuma)

Wireless

Phone firms missing out on Apple's party Add to ...

Apple Inc. is reaping the rewards of a popular product lineup, but the phone companies that have invested hundreds of millions to bring the most celebrated Apple invention to market aren't feeling the love.

As Apple shares jumped 5 per cent yesterday on news of impressive financial results, phone companies that carry the iPhone gave up ground or remained largely stagnant. The stock of No. 2 U.S. carrier AT&T Inc., Apple's first and biggest partner, was flat, while shares of Telefonica SA and Deutsche Telekom AG, two of Apple's key European partners, edged lower.

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Wireless phone companies are paying Apple far more for the iPhone than the company allows them to resell it for, and that large subsidy is eating into their profitability.

Apple said it sold 7.4 million iPhones in the quarter. Based on an estimated average selling price of $611 (U.S.) per device, the company received $4.5-billion from smart phone sales in the three months ended Sept. 26, boasting gross margins of between 50 and 55 per cent, according to estimates by Mike Abramsky of RBC Dominion Securities Inc.

Many telecom operators around the world have scrambled to get the iPhone ahead of their competitors, as a means to differentiate their wireless offerings in an increasingly competitive and saturated market. In some cases they are desperate to find ways to boost their wireless business to compensate for tumbling land line revenue.

Verizon Wireless, the No. 1 mobile operator in the U.S., meanwhile has maintained its market lead over AT&T without selling the iPhone. Verizon added more customers than its rival in the first quarter. In the second quarter, Verizon added 1.1 million net new subscribers, bringing its customer base to 87.7 million. AT&T added 1.4 million net new customers, expanding its base to 79.6 million. In terms of customer churn rates and operating income margins, the two companies were very similar.

Eventually, the wireless companies selling the iPhone expect to recoup their upfront subsidy costs with the additional wireless data fees that customers will incur, but this business model is not delivering the same results as Apple's more direct model.

Last quarter, for example, Apple had a profit margin of nearly 16 per cent, compared with AT&T's margin of 10 per cent. The price of Apple shares has rocketed 133 per cent this year, compared with a decline of 9 per cent for AT&T and a 23-per-cent decrease for Rogers Communications Inc., which has sold the smart phone exclusively in Canada for more than a year.

Tomorrow, investors will get a clearer picture on how much of Apple's fortunes trickle down to the carriers. AT&T is scheduled to release third-quarter results and analysts are expecting that the company will report that it added 1.3 million net new wireless subscribers, largely on the allure of the iPhone.

"If you think iPhone is a net positive for carriers (some are growing more cynical on the subsidies), AT&T is positioned well this quarter," said Greg MacDonald, of National Bank Financial Inc. He has an "outperform" rating on the stock and a $32 price target.

He expects that the company will beat expectations for new mobile phone customers, adding almost 1.5 million accounts. But the growth will come at a cost, as new customers mean more subsidies for iPhones and other smart phones.

"Assuming AT&T beats wireless subscriber estimates on strong iPhone sales, management guidance of 40-per-cent wireless service margins for the later part of the year is not likely achievable," Mr. MacDonald wrote in a report. He instead forecasts margins of 37.6 per cent in the third quarter and 38.9 per cent for the full year.

However, even with the pressure new iPhone customers put on profitability, "we consider strong iPhone sales to be a positive" for AT&T, Mr. MacDonald said.

Meanwhile, analysts heaped praise on Apple yesterday for its quality management and successful products, which included strong sales of Mac computers.

"We are very impressed by Apple's ability to post a record profit quarter during difficult macro spending conditions. A host of new product introductions and continued traction with the iPhone give us confidence in the sustainability of Apple's operating model," wrote Canaccord Adams Inc.'s Peter Misek, who reiterated his "buy" on the stock and raised his price target to $250 from $200.

Maynard Um, of UBS Securities LLC in New York, is the most bullish of analysts on Apple at the moment, forecasting that the stock will hit $280.

 

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