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Verizon Survived Apple iPhone Subsidy Pain, But...

NEW YORK ( TheStreet) -- After a big fourth-quarter earnings miss, Verizon's (VZ - Get Report) far better-then-expected first-quarter wireless unit profitability indicates the telecom has finally survived Apple (AAPL - Get Report) iPhone subsidy pain.

Since fourth-quarter earnings, Verizon shares are up about 20% to $50.91, a new 10-year high, while Apple shares have fallen by an almost identical amount to multi-year lows not seen since late 2011.

Is the correlation between Verizon's stock gains and Apple's plummeting shares over the past three months a coincidence?

Likely not.

Thursday's report from Verizon confirms some expectations iPhone subsidies are lessening as a drag on earnings, as fees collected from a growing network of smartphone users continue to rise.

For instance, Evercore Partners analyst Jonathan Schildkraut said prior to Verizon's fourth-quarter earnings in January, a miss would be a buying opportunity for investors.

Schildkraut forecast a surge in fourth-quarter subscriber additions and handset upgrades for Verizon that would hit wireless profit margins because of subsidy costs. In the wake of those earnings, however, Schildkraut expected subscriber growth and rising revenue per user to again be at the forefront of investor focus, instead of handset subsidy costs.

After predictably missing earnings on higher subsidy costs that pushed wireless unit margins down, Verizon chief executive Lowell McAdam indicated the company would hit a profit margin in excess of 50% by the end of 2013.

In first-quarter earnings, Verizon's wireless profit margins came in at 50.4%, surpassing just about every analyst forecast. Prior to earnings, analyst estimates polled by Bloomberg forecast margins of 48.92%, according to 10 estimates.

The wireless margin beat is explainable because, according to Verizon CFO Fran Shammo, only 50% of the 4 million iPhones Verizon sold in the quarter were high-cost iPhone 5 handsets. The remainder, according to Shammo, were devices such as iPhone 4 and iPhone 4S phones.

Increasingly, it appears consumers are opting for cheaper iPhones over the flashiest and most expensive new Apple devices, in a consumer switch that bolsters the earnings of Verizon.

Consumers also upgraded just 10 million handsets in the first quarter, a sequential drop that put upgrade rates at just 6.7%, down from the 8.9% rate Verizon recorded in the fourth quarter.

For Apple, Verizon's earnings may highlight the company's lack of innovation in its iPhone 5 launch, which is failing to draw a "must have" premium paid out of the pocket of subscriber-hungry carriers such as Verizon, AT&T and even Sprint (S).

Verizon's earnings appear to also confirm a January analysis from UBS analyst Steven Milunovich, who forecast a drop in the average selling price in Apple handsets as customers flock to the cheaper offerings.

"We have moderated our iPhone price estimates because the survey finds that demand for storage has declined from about 30GB with the 4S to 20GB for the iPhone 5 with fewer customers opting for the 64GB model . . . [Demand] for older models has increased from 33% in the 4S cycle to 50% so far for the 5," wrote Milunovich, in mid-January.

Finally, subsidy free iPad tablets made up 44% of postpaid net additions, according to a Thursday analysis from Schildkraut.

While lower costs on handsets are denting expectations for Apple, they are driving growth at Verizon.

The company's 15% year-over-year earnings growth was driven by a 6.8% rise in wireless service revenue, as well as rising margins in the unit. Those figures offset a flat-to-declining performance from Verizon's wireline business, which accounts for about a third of overall revenue.

Verizon's wireless business posted better-than-expected revenue of $19.5 billion, 677,000 post-paid subscriber additions and average revenue per account (ARPA) of $150.27 a month.

Overall, Verizon said 7.2 million smartphone devices were activated in the quarter, including 5.9 million 4G LTE devices. Total smartphone activations represented a 28% increase from year-ago levels, while the company also said 54% of total data traffic was on its 4G LTE network.

"Net/net, Verizon's performance -- particularly on the wireless side -- was solid, with the strong increase in sequential margins confirming our view that the upgrade cycle is increasingly seasonal," Schildkraut of Evercore, wrote in reaction to Thursday's earnings.

Of course, given a slowing in Google (GOOG)-Android market share gains and mixed consumer reception to recent Nokia (NOK) and BlackBerry (BBRY) smartphone launches, there's always the risk Apple creates another blockbuster phone to drag down carrier margins.
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