MorningWord 10/23/14: Subsidies and Mirrors – $T $AAPL

by Dan October 23, 2014 9:56 am • Commentary

After the bell last night, AT&T (T) reported a Q3 that missed on net subscriber adds, and earnings and sales despite the lowest level of cap-ex since Q1 2013, while offering guidance for the balance of the year that was below consensus.  The quarter and guidance was messy, and largely the result of the competitive shake-up from wireless competitors like T-Mobile (TMUS).  The competition, at least on the surface, has annihilated the traditional contract model in favor of bring your own device (BYOD) or no contract device pricing, allowing for ostensibly lower monthly service charges.

Yesterday prior to the results, I closed a long stock position in T that I entered back in August as I felt that my own personal experience in the last 6 weeks buying iPhones and converting my plans on AT&T was hugely confusing.  I was left with the feeling that their customer service representatives had little understanding of the new pricing schemes, while some of the literature as to the pricing of devices is either unintentionally deceptive or AT&T is knowingly ripping off their customers.  My sense was that if their report was anything like my customer experience buying new iPhones and changing plans, it could be a mess.

What becomes fairly evident is that the days of locking into a 2 year plan to get discounted device pricing could be near its end.  For instance, AT&T is offering iPhone 6 Plus with 64 GB for $399 with a 2 year contract.  But to get that pricing, you agree on their Share plan to pay a one time $40 upgrade fee and to pay $40 a month in a line charge (BYOD on this plan would be $15/month line charge, so difference of $25/month over 24 months), which essentially pays back the subsidy for the full price of the iPhone over the 2 year life of your contract.

So doing a little math, that is $399 (initial iPhone price) + $40 (one time upgrade fee) + $600 ($25/month line charge x 24 months) = $1039.  That’s what you are paying for the privilege to be on AT&T’s new wireless phone pricing that they say is as good or better than any of their competitors.

Why would anyone pay $1039 for an iPhone 6 Plus with 64 GB when the phone with a no contract price at TMUS is $849, or $190 less??


The whole situation is preposterous.  After I walked numerous customer service reps through the math, none had a good answer for why this was the case.  Many tried to argue the merits of their Next plans, which are also VERY confusing, where you spread out the purchase price of the phone and in some cases you don’t own it but turn it in for a new one in 12,20 or 24 months (full on Rent-A-Center model.) The Whole thing is a MESS.  As a 10 year plus AT&T customer who has paid the company probably close to $25,000 in that time period, I was disgusted by their misinformation, and their own employees lack of understanding of the pricing landscape.

So the days of the subsidies on hot NEW phones is going away, but most of the U.S. carriers still don’t know how best to do that for their own bottom line and churn.  I suspect we will see high churn and possibly lower upgrades as a result, which will be bad for the carriers who MARK up the phones.  It could also be bad for phone manufacturers as upgrade cycles may be more pronounced initially, possibly like this iPhone 6 cycle, but consumers may keep the phones longer, especially if the upgrades are merely for more memory and better battery/camera/display.

Oh and riddle me this Batman… how does the new iPad Air 2 with 64 GB and enabled for cellular cost only $729, $120 less than the iPhone 6 Plus with 64 GB without a contract??


If there is NO subsidy on the iPhone at T-Mobile, then how and why would a device such as the iPad Air 2 with 64 GB with these dimensions:


…made with many of the same materials and similar components of the iPhone 6 plus with 64 GB with these dimensions:



Is the conclusion that the much smaller, less resource intensive iPhone is more complicated to manufacture?  But considering how many more iPhones sold than iPads (39.3 million vs 12.3 million in fiscal Q4), it is safe to assume that Apple gets much greater economies of scale on iPhone.  Teardown of iPhone 6 Plus places costs for 64 gb model likely around $250 (here), while last year’s iPad Air showed cost to build of about $300 (here).

I guess my conclusion is simple – if consumers are no longer going to get ripped off by Wireless Carriers’ ridiculous pricing plans for hardware, then consumers are not likely to upgrade every two years if they are expected to pay $700 to $900 for the new hot iPhone.  Either that, or the pricing is going to have to come down substantially to encourage this behavior. Or the business model will be unrecognizable from what we now know.

In the quarter just reported, Apple’s ASPs (Average Selling Price) on iPhone of $606 well above the consensus estimate of $566.  This is largely the result of the mix shift and intro of the 6 Plus.

So while we watch the long race to the bottom in Wireless Service charges, we could also be at a sort of AS GOOD AS IT GETS period for ASPs on high end smartphones.

In a world where much lower priced Android offerings, with ASPs around $250, dominate the marketshare at about 85% worldwide, it is hard to imagine that Apple will be able to merely hold on to the lion’s share of profits on what appears to be an increasingly niche HIGH END segment of the smartphone market.

This is not a post to BASH Apple (though AT&T deserves some bashing).  It is merely stating what are important risk factors to the story at a time when it appears the investment world is in uniform agreement that this past quarter and current quarter guidance is just the start of a super cycle.  I arrive at this observation because it appears there are tectonic shifts going on in the wireless service landscape, and aside from Apple buying its own wireless carrier, I am not sure how they can emerge unscathed when it is all said and done.