AT&T: iPhone an Anchor, Not an Albatross

Updated from 2:39 p.m. EST

Investors looking for insight into the health of the telecom sector got some mixed messages this week when AT&T ( T) and Verizon ( VZ) released quarterly results.

Buoyed by the growth of its wireless business and the popularity of Apple's ( AAPL) iPhone, AT&T is forecasting low single-digit revenue growth during 2009, despite an increasingly tough economy.

The telecom bellwether reported a 2.4% rise in revenue in its fourth-quarter profit Wednesday but saw its profit fall more than 23%.

Inevitably, telecom firms are feeling the strain of the recession. Rival Verizon also reported a mixed bag of results earlier this week. Unlike AT&T, however, Verizon was unwilling to offer specific 2009 guidance, citing the lack of visibility into its customers' spending.

"That TelCo growth should slow in the recession is obvious -- the big question is how much?" wrote Craig Moffet, senior analyst at Bernstein Research, in a note released Wednesday. "Unlike Verizon, AT&T offered relatively clear guidance, with an expectation of at least some revenue growth -- Verizon has indicated only that they expect to grow earnings."

AT&T also predicted approximately 19 cents of earnings pressure from benefits charges in 2009, and forecast wireless margins in the low 40% range by the end of the year. The Dallas, Texas-based company expects longer-term margins in the mid-40% bracket, it said, during a conference call Wednesday.

This growth will inevitably affect other parts of AT&T's business, according to Moffet.

"The company expects continued margin expansion in wireless, which unquestionably remains the bright spot for AT&T, but, therefore, by implication, expects continued margin contraction in wireline," he wrote.

The analyst estimates that, if AT&T's 40% margin expansion and earnings guidance is achieved, the firm's wireline margins could be around 30% in 2009.

"That's far worse than even our already below-consensus estimate of 33.7%," he added. "Their 40% guidance for wireless is, however, significantly better than our forecast."

Despite its modest revenue rise, AT&T's fourth-quarter profits felt the impact of its iPhone subsidy program, suggesting that the smartphone is still something of a double-edged sword for the telecom giant.

"The iPhone short-term margin pressure is just that: It's short-term," said AT&T CEO Randall Stephenson during the conference call, alluding to the service fees that his firm will receive from iPhone users.

Although iPhones took a 5-cent bite out of the telecom bellwether's earnings, this was much less than their 10-cent impact during the third quarter.

Clearly looking to the future, Stephenson described AT&T's service provider agreement with Apple for the iPhone 3G as the company's most important move in 2008.

"In the last six months, we activated more than four million customers," he said, adding that AT&T's wireless business is growing at a double-digit rate.

iPhones also offer an average retail price unit 1.6 times higher than the company's traditional postpaid products, added Rick Linder, the AT&T CFO.

Both Verizon and AT&T are enjoying strong wireless numbers, with the latter growing its wireless business 13.2% to reach $12.9 billion in the fourth quarter.

Boosted by iPhone 3G deployments, AT&T also added 2.1 million subscribers to reach a total customer base of 77 million, 7 million more than the same period last year.

Like Verizon, however, AT&T's wireline business is feeling the strain, with revenues declining to $17.1 billion from $17.7 billion, thanks largely to falling sales of its voice services.

Despite the challenges facing both firms, AT&T and Verizon are both seen as attractive stocks with plenty of growth potential.

Whereas AT&T expects to reap the benefits of its exclusive iPhone partnership, Verizon's FiOS business is growing rapidly. The firm added 303,000 new FiOS TV customers during the fourth quarter and 282,000 new FiOS Internet customers, a record for the company.

After an initial rally, shares of AT&T settled down 0.1% at $25.91 in Wednesday trading. Verizon's shares rose with the broader advance in stocks, closing up 96 cents, or 3.2%, to $30.92.

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