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

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

Summary: 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.

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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.

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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.

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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.

Topics: Mobility, Hardware, iPhone, Networking, AT&T, Wi-Fi

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8 comments
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  • The bottom line here is...

    ...that you're going to serve your full 18 month contract on AT&T for your iPhone 3G so if a new one comes out next June you'll have to break your contract to get it.
    Sleeper Service
    • I Didn't Break Mine

      I bought one brand new from the Apple Store, turned around and sold my Tilt, end up only paying $150 total for the IPhone and didn't have to sign a new contract.

      Guess some of us are smarter than the two goons Guiding and Sleeper.
      itanalyst2@...
      • Well not really...

        ...since I'm talking about the next version of the iPhone not the current one.

        Never mind. I didn't expect anything better from you so I can't say I'm disappointed.
        Sleeper Service
        • I Still Won't Have To Break Mine

          My contract's up in February. And I'll sell this IPhone and use it to buy the new one.

          Any more zingers brain child?
          itanalyst2@...
  • And to think that so many laughed at

    Verizon, when approached first by Apple to host the iPhone on their network, and they replied "Thank you, but no"
    GuidingLight
    • No Flies On Verizon

      Well, did they say no because they "knew" that Apple couldn't
      deliver a successful product?

      Or did Verizon say no because they noticed that when it was
      wildly successful, there'd be quarters when the now current
      backlog and deferred revenues would be swamped by first
      quarter costs of new customers? If that's the case then
      Verizon does put the "MMMMMM" in MBA.
      DannyO_0x98
    • Apple is Lucky....

      They couldn't have kept up with demand if they built their phone on a real network and not that toy network AT&T has muddled together.
      notlehs
  • RE: iPhone 3G: Was it really such a great deal for AT

    Good Analysis.
    1) T's shareholders will demand margin improvement
    2) With T's margins are dropping, price increases are
    sure to come for iphone users (probably in the form of
    rate increases on the plans).
    3) Why not increase the rates? Who else are the iphone
    users going to do to?
    bigdady@...