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Verizon Proves iPhone 5 Skeptics Wrong

Stocks in this article: VZ T AAPL GOOG S

NEW YORK ( TheStreet) - What a difference a month makes for Verizon (VZ) and its battle to prove to skeptics that rising profits from wireless subscribers and surging data usage are here to stay, as customers clamor for new Apple (AAPL) and Google (GOOG)-powered devices.

Just over a month ago Apple unveiled its newest smartphone -- the iPhone 5 - in a blockbuster launch that set opening records for the company. Amid all the iPhone 5 hysteria, however, not everyone was cheering.

As launch numbers rolled in, investors and analysts following AT&T (T) and Verizon began to wonder aloud whether the adoption of Apple's latest smartphone would wreck telecom sector profitability and disprove an emerging notion that after spending billions to build national networks, both carriers' investment would pay off in steadily rising profits.

Verizon's stronger-than-expected third quarter earnings released on Thursday signal that, for now, doom and gloom scenarios on the interplay between iPhone 5 sales and wireless carrier profitability are misguided.

At issue is whether the carriers can use new smartphone launches to profitably steer users onto their networks. On one hand, carriers pay in the range of $500 a phone in subsidies to handset makers like Apple to lure in customers - or to meet the terms of upgrade schedules - in a relationship that can cost big money. Over the long term, carriers expect to make their money back on subsidized handsets by way of the monthly cost of wireless contracts, and in particular, the tiered pricing of smartphone data usage.

Heading into third quarter earnings, the fear was that a record iPhone 5 launch at the end of the quarter would cost billions for carriers like Verizon, potentially cutting against steadily rising profits through the first half of 2012.

Verizon's earnings, and, in particular, record wireless revenue and profit margins unveiled on Thursday prove that iPhone 5-related fears are unfounded. At least for now, the company's earnings momentum continues to build.

As profit margins grow, Verizon also appears to be adding new iPhone and Google Android-addicted subscribers at a faster-than-expected clip, potentially disproving a theory peddled by analysts that waves of subscriber additions and phone upgrades could turn stable telecom earnings cyclical. Near 5% dividend yielding carriers like Verizon and AT&T are seen as ballast to equities in a low interest rate and economic growth environment.

Early on Thursday, Verizon reported revenue of $29 billion and an adjusted profit of 64 cents a share for the quarter, both meeting estimates and rising from year-ago levels. While top and bottom line numbers generally met analyst estimates, Verizon's wireless unit - seemingly joined at the hip to iPhone customers - posted far stronger-than-expected results.

Profit margins at Verizon Wireless hit a record 50% in the third quarter based on calculations of earnings before interest, taxes, depreciation and amortization EBITDA , beating consensus analyst estimates compiled by Bloomberg.

Growing profit margins were tied to fast-rising wireless phone bills, which surged 6.5% in the quarter to an average of $145.42 per account. At the same time, Verizon Wireless added far more subscribers than expected in the quarter, bringing in 1.54 million post-paid contracts, surpassing expectations of less than a million subscriber adds.

"The clear highlight of the print was the performance of wireless - where Verizon posted a very impressive 1.8MM retail net adds (of which 1.5MM were postpaid) and grew its smartphone base to 53%, while posting a company record 50% wireless EBITDA service margins," wrote Evercore Partners analyst Jonathan Schildkraut, in a note to clients. " Verizon continues to deliver against a lukewarm macro backdrop," he added.

The results indicate that the carrier can lure subscribers onto its network using flashy iPhone and Android devices without wrecking its profit margins. That contrasts sharply with some analyst expectations, forcing some to backtrack from projections that the iPhone 5 would take the air from a so-called telecom sector dividend bubble.

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