Tuesday afternoon, wireless carrier T-Mobile finally relented and announced that it will begin carrying Apple’s (click ticker for report: ) iPhone. Bears can attack market share numbers all day, but we’ve shown plenty of evidence supporting why the iPhone is exceptionally popular. Commscore showed data giving Apple 37.8% market share in January, Verizon (click ticker for report: ) reported that iPhones accounted for 63% of smartphones during the fourth quarter, and AT&T (click ticker for report: ) had iPhones account for 84% of its smartphone mix during the same period. Demand for the product remains robust, in our view.
Regardless, T-Mobile’s iPhone strategy is a stark departure from industry norms. T-Mobile will finance the phone, allowing consumers to purchase an iPhone 5 for $99.99 upfront with no contract, and 24 months of $20 payments, as opposed to the industry norm of $199.99 upfront with a two year contract. We like this idea for T-Mobile because its consumers tend to be more value conscious and might not be able to afford $199 at one time. Although the total cost of the phone itself will be substantially more ($580 versus $199), the financial burden of the low-end T-Mobile plan ($50/mo) plus the monthly iPhone payments isn’t much different from the low-end deal at Sprint (click ticker for report: )–$199 for the iPhone + $70/mo.. Of course, the plan includes the least amount of 4G data, but we question how many people need or upgrade to unlimited data.
At the end of the day, the deal amounts to T-Mobile taking a different course of generating revenue than its competitors, though the company runs the risk of its unlocked users opting for cheaper services. In its press release, T-Mobile made several references to “qualified customers,” so we believe the company will only allow consumers with past history and a reasonably low chance of fraud and churn to purchase the iPhone. Consumers must also offset the balance owed on the phone before swithcing to a different service (a de facto contract). In other words, don’t expect T-Mobile to subsidize a bunch of defectors.
The big question is whether or not this will change the wireless industry. Frankly, we doubt it will. T-Mobile’s move comes as the company experiences higher-than-average churn and needs a shot in the arm to keep customer defections from accelerating. More importantly, we doubt that other carriers like Verizon, AT&T, and Sprint will look to push more costs on to customers—at least given the current environment. Verizon and AT&T sport higher ARPU than Sprint, and we think customers would balk at a change in the current system. Given the higher prices, we do not believe price is as paramount to AT&T or Verizon customers as it may be for Sprint’s and T-Mobile’s, but rather customer service and network reliability/strength are more important. Neither T-Mobile nor Sprint can compete at this point.
Results over the past few years suggest that AT&T and Verizon’s model works well, and we think consumers, as well as Apple, might anger at a change. Plus, under the current arrangement consumers are locked into very attractive two year contracts that make the cost of the iPhone (and other high-end smartphones) to the carriers fathomable. Most importantly, we do not see any of the major carriers wanting to get into a contract-free selling environment that could put downward pressure on prices and margins. We believe AT&T and Verizon shareholders are relatively happy with how the business model performed since the Great Recession (VZ in red, T in blue – shown below).
Still, we think the wireless industry will be watching closely to see if becoming creditors works to boost smartphone sales. Sprint, which also positions itself as a value brand, could easily alter its iPhone pricing to $9 per month over a two year contract with zero money upfront and recoup more of the hardware cost. Although this model could hurt margins if more consumers opt for iPhones, we think it could also prompt less churn and lure consumers into higher-margin plans–the thought being that lower upfront costs could translate to higher monthly costs. AT&T and Verizon might choose to lower upfront hardware costs in exchange for monthly payments if T-Mobile’s strategy proves to be incredibly successful, but we doubt it happens in the near-term. However, as we said earlier, we do not believe the major carriers will get rid of the contract business model.
Overall, we see little to prompt change at AT&T or Verizon, but we think Sprint is the most likely to copy the hardware pricing model. Getting rid of contracts may be positive for consumers, but we think the wireless industry has little interest in getting rid of such a successful business model. T-Mobile’s new strategy could help boost iPhone sales, but we think the company is putting itself in a difficult position eliminating contracts. A strong competitive position, high ARPA (average revenue per account) customers, and a strong dividend growth profile make Verizon our favorite name in the wireless carrier space.