Apple's ( AAPL) iPhone has been a big hit with gadget lovers, but the success comes at a price for AT&T ( T). That scenario continues to play out in Ma Bell's earnings reports as the company has to balance the high costs of subsidizing the price of the phone with the long term benefits of high paying customers. When AT&T reports earnings next week, investors may be in for a bit of a shock thanks to the popularity of the iPhone, including the latest version, the iPhone 3G S. Customer acquisition costs -- the estimated $300 AT&T pays Apple for each iPhone -- is likely to have taken a bigger toll on finances than expected. AT&T sold a bounty of iPhones in the last 12 days of the quarter, and that eroded about 3 percentage points from the company's adjusted operating income margins, say analysts. Earlier in June, when AT&T announced the debut of the new iPhone, the company said the heavy customer acquisition costs would not harm its operating income before depreciation and amortization or OIBDA margins. In the announcement, AT&T said it expected those margins to be in the low 40% range, which would be roughly in line with the 40.9% OIBDA margins in the first quarter. But analysts say the surge in iPhone sales pulled the margin in to about 38.5%. This sudden dip will test investors' tolerance for negative surprises. It also puts a spotlight on AT&T's heavy financial strain.
The Dallas-based phone shop is under pressure to expand its wireless network as added traffic threatens to further damage voice and data quality. AT&T already faces great expenses as it continues to build more network systems to deliver its u-Verse TV service. The company also has a big bill to pay as it starts upgrading to 4G wireless technology next year. Fans, however, will point out that the rush of new iPhone customers, while painful to acquire at first, spend nearly twice as much on data and email plans as conventional cell phone subscribers. The iPhone also has helped AT&T swipe customers from rivals like Verizon ( VZ) and particularly Sprint ( S). AT&T will say next week that it had a strong performance from its wireless business, which is true. The real test for the stock will be how investors react to the price of that success.