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.
"Similar to what we are expecting with
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.
The key question is whether investors should care. Schildkraut argues investors should accumulate shares were Verizon or AT&T to miss earnings. He rates both carriers 'equal-weight' and gives them price targets of $47 a share and $36.50, respectively.
Other telecom analysts, notably Craig Moffett of Bernstein Research, have been far more alarmed by the interplay between iPhone subsidies and wireless margins... and with good reason.
Amid a mid-2012 telecom stock surge that put Verizon and AT&T among the top performers on the Dow Jones Industrial Average, Moffett argued iPhone subsidies could turn wireless margins negative, potentially disproving a fundamental shift in telecom profitability.
While a later than expected rollout of the iPhone 5 has buffered carriers from the full-impact of handset subsidies, Moffett's analysis appears to be playing out in persistent earnings downgrades for Verizon and AT&T.
While Verizon and AT&T are up over the past year, shares are down nearly 10% in the past three months, as investors brace for an iPhone-based earnings hit.
The real question for analysts like Moffett and wireless investors to ponder is whether after a iPhone subsidy hit plays out in fourth quarter telecom earnings, industry leaders like Verizon and AT&T come back into favor and become a safe holding for investors, as they were in 2012.
In the wake of a fourth quarter margin decline, analysts like Schildkraut of Evercore appears to be more optimistic about the benefits of long-term wireless growth profiles of Verizon and AT&T. Will investors and analysts agree?
The debate on absolute subscriber growth and cyclical margin pressures takes on a new dimension as lagging carriers like Sprint
Meanwhile, demand for Google
Verizon reports earnings on Jan. 22, with analysts expecting 48 cents a share in profit on $32.1 billion in revenue, according to analyst estimates compiled by Bloomberg, as of Jan 14. AT&T reports on Jan. 24 with analysts expecting an adjusted profit of 55 cents a share in $29.7 billion in revenue, the Bloomberg data show.