As the telecom giants prepare to report, investors will get a full glimpse of how subsidized iPhone sales impact overall profit margins. While analysts are increasingly seeing reason for subsidies to cause earnings to fall short of expectations, they also argue an earnings miss by Verizon or AT&T could create a long-term buying opportunity.
Understanding the dynamics at the heart of Verizon and AT&T's much anticipated earnings gets to some of the key drivers of telecom sector investments. Apple, as it turns out, is a major factor that often goes underappreciated in the daily speculation on whether the iPhone and iPad maker is overvalued or undervalued.
The key issue for investors to consider is whether they are impressed by the strong overall subscriber and earnings growth posted by the likes of Verizon and AT&T, or whether they're fearful of falling wireless profit margins every time Apple rolls out a new iPhone.
Jonathan Schildkraut, an analyst with Evercore Partners says that while subscriber additions at Verizon and AT&T will push overall wireless margins lower for the fourth quarter, it could represent a buying opportunity for investors.
Schildkraut highlights that a big surge in subsidized fourth quarter iPhone subscriber additions could clear the air for both carriers in 2013. Currently, Schildkraut expects Verizon and AT&T to sell nearly 10 million smartphones for the quarter, with iPhones accounting for 75% to 80% of handset sales.
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The argument is borne out in the numbers and gives investors reason to decide, in fourth quarter earnings, whether they favor overall wireless subscriber and revenue growth, or quarter-to-quarter improvements on profit margins.
According to Schildkraut's calculations, Verizon will add 2.3 million total retail smartphone subscribers, representing an over 50% year-over-year surge that will also drive overall wireless revenue nearly 10% higher to $19.1 billion for the fourth quarter. Margins, on the other hand, are estimated to fall over 15% versus the third quarter as subsidized iPhone sales cot wireless margins from an estimated 46.7% to 41.7%.
At AT&T, a similar story of wireless revenue growth and margin pressure is expected to play out in the fourth quarter.