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Hurricane Sandy Tests Consolidating Telecom Sector

Outside of Sandy, recent earnings give telecom investors a mixed picture heading into the final quarter of 2012. AT&T's (T - Get Report) generally mixed earnings released earlier in October gave new life to bearish predictions for the telecom sector amid an industry profit surge.

AT&T earnings confirmed some fears that surging demand for Apple devices -- namely the iPhone 5 -- may yet hit wireless earnings in spite of far stronger-than-expected third-quarter earnings posted by Verizon, also in October.

After Verizon's report, some skeptics on the iPhone 5's impact on wireless profits retreated from that bearish analysis. On the heels of AT&T's earnings, however, negativity on the direction of industry profitability is resurfacing.

Notably, industry bear Craig Moffett of Bernstein Research saw AT&T's earnings as reason to believe a looming surge in smartphone upgrades may hit overall sector carrier profits, which have been steadily rising in the past year.

"Handset life remains perhaps the fundamental question facing telecom investors. If handset life is not sustainably extending... then recent declines in subsidies will reverse, and margins will come back down. We continue to believe this is a question of when, not if," wrote Moffett, in an October note to clients.

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.

Moffett also highlighted a fast consolidating U.S. market that may increase competition on wireless leaders like AT&T and Verizon, who offer tiered-pricing smartphone data plans.

"With SoftBank's cash infusion into Sprint and T-Mobile's merger with MetroPCS and both companies apparently intent on using price as a key weapon in their fight for market share; it is hard to imagine that the market will not deteriorate for Verizon in the longer term," the analyst wrote.

For now, telecom investors await the impact from Hurricane Sandy on overall sector earnings. As telecoms deal with repairs and a big recovery effort, key themes for the industry such as handset subsidies and the impact of consolidation will loom large.

-- Written by Antoine Gara in New York
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