Telecoms Reveal Competing iPhone Profit Theories

NEW YORK ( TheStreet) -- Investors entered 2012 mapping out probabilities on how the telecom sector would consolidate, as also-ran carriers like Sprint ( S), T-Mobile USA, MetroPCS ( PCS) and Leap Wireless ( LEAP) struggled to build networks to handle Apple ( AAPL) and Google ( GOOG)-powered smartphones and compete against industry titans AT&T ( T) and Verizon ( VZ).

In the wake of a frenzy of 2012 mergers, investors now need to understand how carriers are addressing key issues such as spending, profitability and long-term strategy when it comes to servicing high data load smartphones and tablet devices.

A flurry of recent announcements from the nation's largest carriers indicates that competing theories are emerging in the telecom sector on how to handle and profit from booming demand for smart devices.

Consider that earlier in the week, AT&T unveiled an ambitious "Velocity IP" plan to bolster its nationwide 4G LTE network. Along with the the plan the carrier announced an annual capital spending budget of $22 billion through 2015, with 60% allocated to the company's wireless network. The bet, in AT&T's case, appears to be that spending on network and service improvements is the way toward subscriber growth and long-term earnings.

Competitors like Sprint and recently merged MetroPCS and T-Mobile appear to see a slightly different way forward to iPhone and Android-powered profits.

Sprint continues to see unlimited iPhone data plans as its value proposition to consumers over competitiveness on wireless coverage and service, in the interim. From a pocketbook perspective, Sprint's unlimited data plans compare favorably to the tiered data plans of AT&T and Verizon; however, consumers need to take a leap of faith on coverage, data speeds and the company's improving financial picture.

Sprint also is in the process of completing Network Vision, a rollout of a nationwide 4G network, but that spending plan pales in comparison to AT&T even after the company was effectively recapitalized in a merger with Softbank of Japan.

Meanwhile, the biggest announcement from a recently merged MetroPCS and T-Mobile the deal's yet to close and faces regulatory reviews is that T-Mobile will finally start to carry the Apple iPhone, after years of rejecting the highly subsidized smartphone.

It's no surprise; however, that the subsidy averse U.S. arm of Deutsche Telekom will carry the phone in an unsubsidized manner that may break new ground in passing handset costs onto consumers.

The three aforementioned plans to handle smartphones illustrate the biggest issues facing the telecom sector - capital spending, data pricing and handset subsidies - and indicate that after this year's reshuffle, telecoms are approaching 2013 and beyond with increasingly divergent strategies.

While AT&T's plan may seem expensive to investors, the real question is whether competitors like Sprint are realistic in theirs?

Bernstein Research analyst Craig Moffett highlights the tension in a Thursday review of AT&T's higher-than-expected spending plan and the import for the industry. Notably, Moffett argues that when faced with a choice of spending, subsidies or service pricing wars, AT&T appears to see its comparative advantage in using a fortified balance sheet to invest tens of billions in its wireless network and outrun competitors.

In the face of AT&T's options and its comparative financial and network position, Moffett writes, "Starting a spending war is AT&T's best option," of the company's wireless capex budget through 2015.

The numbers are striking, according to Moffett's calculations.

In 2013, AT&T is expected to spend over $12 billion on its wireless network, roughly 30% more than competitor Verizon and 176% more than Sprint, who is already playing catch up when it comes to network strength.

Meanwhile, between 2009 and 2013, AT&T is projected to spend $57 billion cumulatively, compared with $54 billion at Verizon, $17 billion at T-Mobile and just $14 billion at Sprint.

For investors who have recently cheered AT&T's growing profit margins, free cash flow and returns of capital, the consequences may be negative. Meanwhile, the issue of iPhone subsidies - an earnings drain Moffett's been worrying about through 2012 - looks to rear its head in the fourth quarter.

AT&T now expects to sell 10 million smartphones in the fourth quarter, in a forecast that augurs poorly for wireless profit margins. On larger than expected smartphone sales, Guggenheim Partners analyst Shing Yin cut AT&T's price target and noted that roughly 8 million subsidized iPhone sales could reduce the company's wireless margins for the year below 40%.

On the surface, it would appear AT&T is heading down a misguided path of spending and more spending when it comes to Apple smartphones and tablets. That would miss Moffett of Bernstein's wider point.

In spite of what appear to be diverging strategies and earnings profiles heading into 2013, Moffett sees reason to believe AT&T is simply being forthcoming about the true capital costs telecoms face as they prepare for growing smartphone and data usage.

The bigger question for investors may be whether strategies, for instance Sprint's unlimited data plans and smaller-than-peer wireless network spending, reflect reality.

"Capital spending per post-paid equivalent subscriber, already much higher at AT&T than peers, is pulling away. And once again, Sprint's chronic under-spending over the past four years is striking, particularly in light of its open courtship of super heavy users as a consequence of its heavy promotion of its "unlimited" data plans,"writes Moffett of the differences between AT&T and Sprint.

"This raises obvious questions about the widely held expectation that capital spending can return to below-industry levels after just two years of Sprint's Network Vision,a" the analyst adds.

AT&T's spending plan in the context of its competitors raises the question of whether capex -- a perennial investor fear in the telecom sector "becomes a key industry issue in 2013 as carriers disclose just how much it will cost to serve surging demand for smartphone handsets and service.

For more on AT&T and Verizon, see why the iPhone drove telecom paranoia in 2012.

See why Dish Network's Earnings Revive DirecTV Deal Talk.

-- Written by Antoine Gara in New York

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