Here's the Real Reason Investors Should Be Worried About Apple's iPhone 5
Moffett of Bernstein Research and other industry bears have long pointed to a looming iPhone handset upgrade cycle as contradicting forecasts of structurally higher profits for wireless carriers.
"Verizon's margin for full year 2012 will be something like 46.8%, or perhaps a bit lower. In 2010, Verizon's margin was ... 47.0%. They're actually flat over the timeframe the margin expansion thesis gained popularity," writes Moffett. "For the foreseeable future, however, margin volatility rule[s] ... and that dictates that the sloppy margins the industry will surely post in Q4 must not be ignored."
Analysts across the telecom sector have slowly been cutting earnings expectations for Verizon an AT&T heading into the fourth quarter, highlighted by Hodulik's Monday morning downgrade.
In an early December research note, bullish comments made by AT&T about overall quarterly smartphone sales caused Guggenheim Partners analyst Shing Yin to cut fourth quarter earnings and margin forecasts for the carrier.Given an estimate of 10 million smartphone sales in the fourth quarter - 80% of which Yin calculates are iPhones -- the analyst now sees wireless EBITDA margins at 31% for the quarter, bringing overall margins at or below 40% for the year. "We believe 2012 upgrade rates had benefited from a one-time impact related to upgrade policy changes made in early 2011. Now that this one-time impact has passed, we expect upgrade rates, and subsidy expense, to be higher in 2013," wrote Yin, in a Dec. 6 note to clients that followed comments made by AT&T's head of wireless. That insight into what the analyst calls the "basic principles of smartphonomics' caused Yin to cut AT&T's price target from $35 a share to $33. Yin made a similar downward revision following Verizon's January disclosure of smartphone sales and subscriber growth. The potential deterioration in wireless margins for growing industry players comes at a time when the likes of Sprint (S), the industry's number three player, are investing billions to grow out wireless networks and take on smartphone users. So far, however, efforts to handle the iPhone and slow-moving network upgrades have led to subscriber losses that raise more questions then they answer. Meanwhile, the Wall Street Journal's report that Apple may cut second quarter iPhone supplier orders by 50% was received with some skepticism by tech analysts. Notably, UBS analyst Steven Milunovich wrote in a note to clients that the report may be citing old news. "The article says Apple notified suppliers of the cut last month, which is when we and most of the Street reported it. Consequently, it appears this is old news--our analysts indicate no changes since," wrote Milunovich. In December, UBS cut its iPhone 5 order estimates by five million handsets a quarter due to the 30% production cut being reported out of Asia. At that time, UBS had estimated Apple's second quarter iPhone shipments would total 35 million handsets, at maximum. Wells Fargo analyst Maynard Um added in a note to clients, that reports of supplier cuts might have already been anticipated given Apple's optimistic forecast of second quarter iPhone 5 sales. "[Investors] should not put too much merit in the 65 million estimate as order cuts are not new news and the likelihood that Apple would have shipped 65 million iPhone 5's for the March quarter would have been miniscule," wrote Um, in a note to clients. For investors growing tired on the tick-by-tick hysteria surrounding Apple's value and shares, a focus on the iPhone's impact on overall telecom carrier profits may prove to be a far more revealing exercise. Watch wireless margins to either provide a wrench in the profitability story of telecom giants, or to quiet skeptics once and for all. Follow @agara2004 -- Written by Antoine Gara in New York
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