iPhone 3G: Was it really such a great deal for AT&T?

AT&T's iPhone 3G pact with Apple doesn't come cheap. It cost AT&T its quarterly targets and took a chunk of cash flow even though company officials declare the iPhone-induced earnings hit "success-based costs.

AT&T's iPhone 3G pact with Apple doesn't come cheap. It cost AT&T its quarterly targets and took a chunk of cash flow even though company officials declare the iPhone-induced earnings hit "success-based costs."

The company on Wednesday reported adjusted third quarter earnings of 67 cents a share, four cents below Wall Street estimates. What's notable is the reason AT&T fell short of its targets: The adjusted figure includes a 10 cents a share hit for iPhone 3G subsidies. AT&T had expected a 10 cents a share to 12 cents a share iPhone hit in the second half.

If you're keeping score on this Apple-AT&T deal it's clear that Steve Jobs & Co. is the winner in the early going. Morgan Stanley analyst Simon Flannery said in a research note that "iPhone dilution" spiked for AT&T. Now contrast that dilution to what Apple is seeing. Jobs drops in on an Apple earnings call, reveals a host of figures arguing that the company is a mobile juggernaut and is cautious about the economy but bullish about the company.

And why shouldn't Jobs be stoked? He has AT&T subsidizing Apple's iPhone and driving usage. AT&T did say that it activated 2.4 million iPhone 3Gs and 40 percent of them went to new customers. These customers have higher revenue per unit and lower churn.


On AT&T's conference call with analysts, AT&T Wireless chief Ralph De La Vega said:

Our iPhone 3G initiative is doing everything we had hoped for and more, and as for our business going forward, and we have a very strong technology and network roadmap which we believe offers tremendous opportunity for us.

The rub: These new iPhone 3G customers cost AT&T $900 million in the third quarter. To put that into perspective AT&T took a $145 million, or 2 cents a share, hit due to costs related to hurricanes.

Is the iPhone deal worse than a natural disaster to AT&T earnings? Perhaps initially. AT&T is betting on that time-honored razor-blade business model. Use the iPhone to get customers in the door and then rake in data fees over two years.

AT&T's plan sounds swell, but the company is obviously doing some damage control. Citi analyst Michael Rollins partially attributed AT&T's lackluster quarterly results to iPhone sales.  In its statement, AT&T noted:

AT&T is optimistic regarding continued strong iPhone 3G activations and is confident in the long-term value created by this investment in acquiring high-value, data-centric wireless subscribers.

The key words there are "long" and "term." Why? AT&T is taking a cash flow hit on the iPhone. In fact, its wireless service operating margin for 2008 will be about 37 percent compared to its previous outlook of 39 percent to 40 percent. As for all of AT&T, the iPhone shaves a point off of operating margins to 23 percent from 24 percent. That drop doesn't sound like much until you consider that AT&T expects full year cash flow of $14 billion, down from $16 billion.

Randall Stephenson, AT&T chairman and chief executive officer, added:

The new customers we’re winning are high-value, with attractive revenue and churn profiles. We’re expanding the market, as users adopt more data and media-rich services and access a wide array of applications. These achievements are positive for the future of our business.

Yes, Randall we know.  At least AT&T is on message.


Stephenson's statements are likely to turn out to be true, but if you're a faithful AT&T shareholder you have to be wondering when the actual earnings benefit from the iPhone will arrive.


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