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My investing philosophy mostly centers around the Value discipline and GARP- Growth at a Reasonable Price. This blog includes commentary on market conditions as well as fundamental analysis of specific companies. Graduated from Rhodes College with a degree in Business with concentration in Finance & Marketing. Currently working on obtaining the CFA designation. Previously worked in Mortgage Trading for a major bank. Use MS Excel extensively for developing investment models, notably valuation models based on DCF methods.

Tuesday, November 24, 2009

My Comments on Bloomberg TV Interview with Apple Analyst

Broadpoint AmTech analyst Brian Marshall recently appeared on Bloomberg TV to discuss Apple’s iPhone exclusivity agreement with AT&T. Marshall believes that Apple should move away from its exclusive AT&T agreement and begin offering the iPhone through Verizon. He believes adding Verizon could boost iPhone unit sales by 14M. Marshall states that AT&T’s exclusivity ends in June 2010, and explains why Apple would benefit by offering the iPhone through Verizon. Fortune’s Apple 2.0 and Silicon Alley Insider summarized several of Marshall’s points, which I believe aren’t entirely accurate.


Here is a video of the Bloomberg TV Interview



1) Apple receives a $450 subsidy.

Incorrect: Apple receives a $400 subsidy.

I know from talks with Best Buy managers that the subsidy is $400. Best Buy purchases a 16GB iPhone from Apple for $542, and sells it for $199 with a 24 month service contract. AT&T reimburses Best Buy $400.

A 16GB iPhone without a contract commitment costs $599. If the subsidy were $450, then that price should be $650, or AT&T would be leaving $50 on the table. In addition, the math suggests $450 subsidy is too high given the ASPs implied by the cash value of iPhones sold reported by Apple.

2) After AT&T loses exclusivity that subsidy will drop to $300 for all carriers, domestic and international.

Incorrect: Subsidy shouldn’t change.

Tim cook addressed this issue on Apples Q4 2009 conference call (from Seeking Alpha):
Gene Munster – Piper Jaffray
We’re looking at the iPhone, it’s pretty clear we’re still in a greenfield opportunity here, but if you start to go to multiple carriers can you talk a little bit about the pricing of the phone when you go from exclusivity to multiple carriers? And obviously, not specific but any sort of color we can have in terms of pricing dynamics change on the phone from you to the carrier?
Timothy D. Cook
Our pricing is confidential, Gene, so it’s not something I could comment on in detail but generally speaking from markets where we’re already selling I would not expect to see a wholesale price difference as we bring on other carriers. However, the end user price is really set by the carriers themselves so you may or may not see a street price difference.
Gene Munster – Piper Jaffray
So when you go from exclusive to multiple carriers, you wouldn’t necessarily see change in pricing that you are charging the carrier? Is that correct?
Timothy D. Cook
That’s correct.
Handset subsidies are a function of ARPU, or a subscriber’s monthly service bill. The ARPU across all AT&T customers is ~$51 compared to iPhone ARPU of nearly $100. Since the ARPU is nearly double, this allows a greater degree of subsidy recapture, thus allowing for a higher subsidy to applied to a mobile device.

3) iPhone users represent 4% of total AT&T subscribers.

Incorrect: iPhone users represent about 14% of AT&T’s total wireless customer base.

AT&T has roughly 11.3M iPhone users. On the June call, AT&T said it had nearly 9M iPhone customers. AT&T has 81.6M wireless subs, with 63.4M being postpaid.



Screen+shot+2009-11-24+at+12.31.50+PM.png


Brian Marshall stated: “roughly 4% of the AT&T users of the iPhone, consume about 40% of the overall network bandwidth.”

It’s not clear exactly what Marshall was referring to when he mentioned 4%, but most people took it to mean iPhone users constitute 4% of AT&T’s customer base. I assume he got his figures mixed up. The 3.2M iPhone activations in September period would equate to 4% of AT&T’s subscriber base. If he meant 4% of iPhone users, or about 450K, consumer 40% of AT&T’s bandwidth, then I would think AT&T would address those users since they represent 0.6% of AT&T’s wireless subscriber base. It wouldn’t make any sense to allow such a miniscule portion of customers affect the quality of service of the overall network.

4) iPhone activations from new AT&T customers made up more than  90% of postpaid net additions in September quarter.

Not Meaningful: Gross additions not net additions should be used as the metric.

iPhone activations from new AT&T customers totaled approx. 1.28M.  AT&T reported 1.39 postpaid net additions. However, AT&T attracted 3.57M new postpaid customers, and 2.18M postpaid customers left AT&T, resulting in 1.39 net additions.

Comparing iPhone activations from new AT&T customers versus net additions is a faulty metric, since net additions is dependent on gross additions and the number of disconnects (churn). The more meaningful metric is comparing new iPhone additions to postpaid gross additions, which was 36% (1.28M / 3.57M). Using net additions is meaningless.

To imply that the iPhone was responsible for 92% of AT&T’s increase in postpaid customers is inaccurate. The 1.28M figure represents a portion of AT&T’s gross sub additions, therefore, it shouldn’t be used in a comparison of net additions. Subscriber churn affects subscriber net additions, and isn’t directly related to the iPhone’s ability to attract new customers.


Screen+shot+2009-11-24+at+12.32.03+PM.png

Let’s say AT&T activated 2.28M Blackberry devices from new AT&T customers. That would equate to 165% of postpaid net adds, whereas iPhone was 92% of postpaid net adds. Is that meaningful? Not really, since it’s possible that the figure can exceed 100%. Let’s say 2.28M iPhone activations were from new customers, then that 92% would be 165%. Since the ceiling can exceed 100%, we don’t know is 92% or 165% or whatever the figure, is good or bad.

5) AT&T’s contract ends in June 2010.

Unknown: I have heard from sources at AT&T the contract runs until the end of 2010.

Neither AT&T nor Apple has publicly commented as to when the exclusivity ends. It was reported last year that Apple and AT&T extended their agreement until the end of 2010. It would make sense that the agreement runs until the end of the year since it commenced in the beginning of 2007. Even though the iPhone didn’t go on sale until June 2007, it was announced that January, allowing AT&T marketing rights for the time preceding the actual product launch.

Many assume that the deal will end mid-2010 since Apple introduces new iPhone models during that time of year. However, all we know is that the exclusivity agreement will end at some future time, but when that is exactly is anyone’s guess.

Disclosure: Long AAPL

8 comments:

Skyler said...

As usual, great analysis. Thank you.

Anonymous said...

Great cross-examination. When I first saw his defense of the assertion that iPhone is going to Verizon in mid 2010, I also smelled a rat. The credibility killer for me was his reference to a lower subsidy which contradicted Tim Cook's concall comments. You're the first to bring this up in a public forum and I appreciate that.

I would add that there are other challenges in adapting the iPhone to the Verizon network which he seems to gloss over. As pointed out in the latest ads from Apple, the iPhone has functionality that depends deeply on the GSM family of protocols. Verizon's use of incompatible CDMA networks makes it a unique customer for Apple--one which may not deserve a unique product and possible platform fragmentation.

Having said that, I don't discount the possibility of a Verizon iPhone, but I would say that if/when exclusivity ends, the first US operator to take it will be T-Mobile.



-Asymmetric

abugida said...

The more I look at it the more I'm convinced that Apple hasn't dropped the price of the iPhone at all since July 2008 (more than a year ago). The only thing that happened was AT&T increasing the subsidy from $300 to $400, probably in exchange for an extension on the exclusivity agreement. This explains why there were no price drops in other major markets like the UK and Germany this June, and why Apple's wholesale ASP went up by $100.

charlie said...

The technical challenge of getting an iphone to work on the Verizon network are easy; I do foresee some customer confusion with the lack of seamless data/voice transitions.

I thought the price drop was an increased subsidy from AT&T in return for giving up the recurring monthly revenue for subs?

Anonymous said...

There are so many technical questions due to Verizon's unique, proprietary, non-standard network, you don't even have to do the financial argument to see the picture is grim for a Verizon iPhone.

Apple would have to make a special Verizon-specific iPhone model, doubling their SKU's for just 1 carrier, while the other 100+ carriers all use the current, standardized iPhone model. And they have to explain to users why you can't perform all of the actions in the iPhone training and marketing materials on your Verizon iPhone because you can't use data and voice simultaneously on Verizon like you can on every current iPhone carrier, why there's no SIM slot or card, why you can't use your Verizon iPhone outside the US, and so on. On the used iPhone market, Verizon iPhones would be like a trap you could accidentally fall into. And there will be bugs that are specific to the Verizon model because it would have a different software stack for the cell radio. The more you think about it, the more complex it gets and the less likely it seems that Apple will make a Verizon iPhone.

Verizon also has around 50 million users who have all declined to purchase 3 iPhone models over 3 years, even though their contracts with Verizon must have been up at some point during that time. These are not the most enthusiastic iPhone users. And Droid is Verizon's very first phone with a desktop-class Web browser like iPhone ... nobody knows if Verizon's 3G network can handle the iPhone kind of data traffic, and if it can't, how enthusiastic will Verizon be to build out their 3G further when they are building 4G right now?

Another thing that is not mentioned is that the $30 AT&T iPhone data plan is truly unlimited, while Verizon's $30 "unlimited" data plan is capped at 5GB and then a meter starts above that, causing the Verizon bill to be much more expensive. Verizon will very likely not be able to steal wholesale iPhone users from AT&T because the user will need all-new hardware, lose features they're used to, and their phone bill would go way up in many cases. For example, I use about 8-10GB of data per month with my AT&T iPhone ... on Verizon I would pay more than double the price for that data per month. When you consider the cost of the data plan is often cited as the main reason that someone who wants an iPhone doesn't get one, the Verizon iPhone has a few things against it from a sales point of view.

Both Apple and Verizon see themselves as closest to the customer, there would be tension as to who is making the final decisions. Or at least there would be tension inside Verizon because Apple isn't going to give them anything in that regard. For example, Verizon's app store is Java-based, and I believe iPhone is the only smartphone without Java.

So Verizon and iPhone are not really a match made in heaven. I'm skeptical we will ever see it.

Peter said...

Minor point on the Verizon comments:

CDMA is also used in Asia and South America. There are over 250,000,000 CDMA users in Asia and about 40,000,000 in South America. It's also used here in the US by Sprint.

CDMA's numbers are here.

Anonymous said...

The technical challenge of getting an iphone to work on the Verizon network are easy; I do foresee some customer confusion with the lack of seamless data/voice transitions. Still, i believe apple has some tricks up its sleeves

Horlic said...

Thanks for sharing your point of view and a long details analysis about Apple. After reading your analysis it gives me more info and clearer pic on the issue.

Share it

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